The article was written by Motek Moyen Research Seeking Alpha’s #1 Writer on Long Ideas and #2 in Technology  – Senior Analyst at I Know First. 

ARM Holdings Share Price

• Intel’s decision to cancel further development of its Broxton and Atom mobile processors is a long-term tailwind for ARM Holdings.
• Without Intel’s highly-subsidized Atom tablet and smartphone processors, more OEMs will stick to ARM-based processors.
• Top-ranked phone vendor, Xiaomi’s decision to license its own ARM-based processor is another tailwind for ARM Holdings.
• My recommendation is going long on ARM Holdings. It’s a beaten-down stock that has a lot of potential upsides.
• I Know First is currently bullish on ARMH stock for the mid and long term

ARM Holdings Plc designs microprocessors, physical intellectual property (IP) and related technology and software, and sells development tools to deliver the intelligence in applications ranging from sensors to servers, including smartphones, tablets, enterprise infrastructure and the Internet of things between others.

More OEM Partners, More Royalty Income For ARM

With the upcoming absence of Intel’s highly-subsidized Atom processors, OEMs who use x86 chips for their phones/tablets  like Asustek (ASUUY), Acer, and Lenovo (LNVGY) will source out ARM-based chips  from Qualcomm (QCOM) or MediaTek. Intel’s decision to kill development of its SoFIA LTE chips has even forced Intel-loyalist Asustek to use 100% ARM-based processors for its upcoming ZenFone 3 phones.

Asustek targets 30 million smartphone shipments this year. The potential additional royalty revenue from Asustek’s shift toward ARM processors could reach $45-$90 million/year. This guesstimate is also from just one new OEM client.

30 million units  x ZenFone’s Average Selling Price of $150 = $4.5 billion

$4.5 billion x 2% royalty fee = $90 million.

My $90 million guesstimate is already 11.5% of ARM’s royalty-based revenue last year of $780.2 million.

(Source: ARM Holdings)

A 10%-15% increase in annual royalty fees should help ARM’s stock receive higher valuation within the next two years. Revenue from royalty fees is of the easy-money, zero-cost type of doing business.

Xiaomi Licensing Its Own ARM-based Processor

I also expect ARM Holdings to notably improve its licensing revenue this year.  Xiaomi, who sold more than 70 million smartphones last year, is reportedly going to get its own license from ARM holdings. The rumor is that Xiaomi’s custom Rifle ARM SoC design will be unveiled this month.

Xiaomi will allegedly use its custom Rifle ARM SoC for entry-level phones only. However, I think that like Huawei, Apple (AAPL) and Samsung (SSNLF), Xiaomi will also eventually start designing its own ARM-based chip for its $350++ flagship phones and tablets.

An OEM with a global appeal like Xiaomi using ARM chip IP will certainly sell more phones than Asustek. ARM Holdings’ partnership with Xiaomi could again contribute another $50 -$100 million in extra annual revenue. This is from initial licensing and future per-device-sold royalty fees.

More money could be extracted from Xiaomi thanks to its planned entry in smartwatches. I suspect that Xiaomi will use its own custom ARM SoC design to optimize its first smartwatch. Knowing Xiaomi’s penchant for selling affordable products, its upcoming watch will likely sell for $100-$150.

Such pricing strategy will help Xiaomi sell 1-5 units of its smartwatch in its first year of release. ARM Holdings’ 1% – 2% royalty fee from Xiaomi’s future watch could build-up to a nice figure.

Likewise, let us not forget that Xiaomi has other expansion products that will use ARM-based chips. Xiaomi unveiled its “Mi Ecosystem” brand for its Internet of Things products. The Xiaomi Smart Rice Cooker is likely using ARM-based chips.

Recommendation

ARM Holdings’ (ARMH) stock price went up by more than 2% yesterday. However, the stock’s one-year performance is still down by 22.32%. I’m therefore betting that ARMH still has a lot of upside potential. I expect institutional investors to soon add more ARMH in their portfolios. ARM Holdings is obviously a top beneficiary of Intel’s (INTC) retreat from mobile processors.

 (Source: Google Finance)

ARM Holdings’ licensing revenue could notably improve after Intel’s cancellation of its Atom SoFIA and Broxton processors. Without these x86 heavily-subsidized tablet/smartphone chips, all consumer mobile device manufacturers will go back to using ARM-based processors. The more ARM-based phones and tablets that are sold, the better it is for ARM Holdings’ topline and bottom-line growth.

ARM gets much of its revenue from the 1% – 2% royalty fee it receives from every device sold using its licensed ARM chip design/technology. Please study the chart below. Royalty fees now comprise more than 54% of ARM’s total revenue.

(Source: ARM Holdings)

Conclusion

The inability of Intel to compete with ARM-based mobile processors is a strong tailwind for ARM Holdings. I expect smartphone sales to again post double-digit annual growth rates next year. The smartphone is emerging as the new productivity computer. It makes sense therefore that more OEMs will eventually license the most advanced 64-bit ARM Cortex-A72 SoC to create smartphone-as-a-pocket-PC products. The Cortex-A72 ARM design offers 350% better CPU performance than the Cortex-A57.

The much-improved computing power of Cortex-A72 processors could soon go inside Android-based computers and laptops. My point is that ARM Holding could also eventually threaten Intel’s grip on laptop processors.

(Source: ARM Holdings)

Long-term investors should really consider adding ARMH to their portfolios. I suspect that the lower cost and perceived better power/energy efficiency ratio of an ARM-based chip will also help it dominate the Internet of Things industry.  ARM recently unveiled its latest Cortex-A32 SoC for embedded systems and Internet of Things products.

My Buy rating for ARMH is also strongly supported by I Know First’s forecasts. ARMH’s 12-month algorithmic forecast score from I Know First Research is a crazy-high +760.80. It means there’s an extremely high probability that this stock will shoot up in price after one year.

The I Know First algorithm has previously predicted the ARMH stock movement in this forecast. With a magnificent signal of 152.17 and predictability of 0.2 it managed to bring returns of 7.34% in 1 year. Returning an average for the long position of 28.24% and for the short position 22.76%.