ARM takes pulse of tech industry

UK chip designer to feel pain of Cisco, Nokia, Ericsson in coming quarter
Written by Matthew Broersma, Contributor

British chip designer, ARM Holdings, (quote: ARM) has been largely unaffected by the slowdown in high-tech sales over the last two quarters, but that could be about to change, according to analysts.

ARM's practice of deferring income from licenses, by a quarter, could mean that its second-quarter earnings will show the effects of the drop-off in shipments of data networking products and particularly mobile phones, analysts said, following a meeting with ARM executives last week.

As of 12:46 GMT, ARM was trading down 12.5, or 3.57 percent, at 337.5p.

Because ARM gets its revenues from other firms' research and development, as well as royalties from the sale of high-tech products, the worries over the company's stability point to fundamental fears about the health of the tech sector.

In April, ARM announced first-quarter profits of £11.4m before tax, a 39 percent increase on the same quarter last year. "As an intellectual property licensing business, we have not been directly exposed to the inventory corrections seen by many technology companies in the last few months and have experienced a strong quarter, with 20 licenses signed," said chairman and chief executive, Robin Saxby, at the time.

But now, some analysts believe the effects may simply have been delayed. ARM is expected to be hit from two sides: mobile phones and the networking products that run the Internet's infrastructure. Mobile phone sales are expected to be significantly down this year, with all the major manufacturers restructuring and laying off staff to cut costs. One investment bank estimates annual handset sales could be down from 550 million to 450 million or lower.

ARM gets 25 percent of its total turnover from royalties on the sales of such products as handsets, and counts Nokia and Ericsson among its major customers. "I'd be amazed if there wasn't a drop in royalty revenues," said Keith Woolcock, head of technology research at Nomura International.

The other, more dramatic impact is expected to come from data networking. Observers say the information-technology market now has to be divided into two periods, Before Cisco and After Cisco, referring to the company's shock announcement in mid-April that it would have to take a $2.5bn (£1.7bn) charge on inventory it had manufactured, but was unable to sell.

The charge was an all-time record for the IT industry, and sent fresh waves of distress through the sector. "I think that Cisco's statement is beyond the comprehension of most of us," said analyst, Woolcock. "For a company of that size to see a 45 percent drop in sales in America means something is dramatically wrong out there in the technology market... the data networking business just hit the wall at 90 miles an hour."

For ARM, selling chips to data-networking giants like Cisco had been the company's fastest-growing area of growth, and royalties will inevitably be affected. But the Cisco crash -- details of which only came to light last week -- also brings ARM's license revenue into question.

Licenses account for most of ARM's business, and protect it from the vagaries of annual sales, since they are sold for development on products that may not be released for a year or more. "If the downturn is as savage as Cisco suggests, if companies are hurting that much, there is always a risk they will start to cut R&D expenditure, and that could hurt ARM on the license side," said Woolcock.

There is no sign of such cuts for the moment, and in fact ARM said recently its sales of development systems are still growing.

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