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How ARM could become a threat to Intel in PCs.

How ARM could become a threat to Intel in PCs.

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  • Produced and issued by: ABN AMRO Bank NV+ Equity | Tech Hardware & Equip | United Kingdom 7 October 2009 Change of recommendation ARM Buy (from Hold) ARM-ed and dangerous Target price £1.80 (from £1.21) We upgrade ARM to Buy with a target price of 180p for two reasons: 1) higher EBIT margins for 2009-14F driven by growth in Smartphones and MCU and 2) re- Price £1.43 rating of the stock due to our forecast of market share gains in notebook PCs, Short term (0-60 days) which could substantially disrupt the Intel/Microsoft model by 2012/13. n/a Sector relative to market Key forecasts Underweight FY07A FY08A FY09F FY10F FY11F Revenue (£m) 259.2 299.0 297.5 342.4 382.7 Price performance EBITDA (£m) 108.2 124.2 111.3 136.7 % 164.8 % Reported PTP (£m) 86.70 100.8 85.60 111.2 % 139.6 % (1M) (3M) (12M) Normalised PTP (£m) 86.70 100.8 85.60 111.2 % 139.6 % Price (£) 1.27 1.19 0.90 Normalised EPS (p) 4.68 5.64 4.94 6.41 % 7.99 % Absolute (%) 12.7 20.4 59.3 Rel market (%) 11.7 4.5 78.7 Dividend per share (p) 2.00 2.20 2.42 2.66 2.93 Rel sector (%) 11.7 8.4 65.9 Dividend yield (%) 1.40 1.54 1.69 1.86 2.05 Normalised PE (x) 30.50 25.30 28.90 22.30 17.90 Oct 06 Oct 07 Oct 08 1.6 EV/EBITDA (x) 16.50 14.20 15.60 12.40 9.98 1.4 EV/invested capital (x) 2.63 2.18 2.03 1.88 1.72 ROIC - WACC (%) 2.31 3.63 2.58 3.92 5.23 1.2 1.0 Use of %& indicates that the line item has changed by at least 5%. year to Dec, fully diluted Accounting standard: US GAAP 0.8 Source: Company data, ABN AMRO forecasts 0.6 0.4 ARM could become a major competitor of Intel ARM.L Europe Technology Over the next two to three years, we believe ARM could become a viable alternative to Intel in the PC market. First, we believe ARM processors will match Intel’s performance while Market capitalisation beating them on power consumption and possibly cost. Second, we expect PC £1.84bn (€2.01bn) manufacturers to switch from Intel/Microsoft OS-based platforms to ARM/Chrome OS-based Average (12M) daily turnover platforms beginning in 2H10 to reduce their dependence on Intel and improve margins. Third, £8.03m (€9.18m) with ARM-based PCs gaining traction with consumers, we believe ARM could receive RIC: ARM.L, ARM LN Priced at close of business 6 Oct 2009. support from Microsoft and port Windows to the ARM architecture. We estimate ARM could Source: Bloomberg capture 30% of the notebook PC processor market by 2014, creating a major disruption to the Intel-Microsoft domination of the PC market. Strategic value of ARM could trigger bid speculation, in our view We do not expect PC market share gains to give a major boost to ARM’s EPS before 2014, but we believe it may lead to a re-rating of the stock as the company could become an Analysts acquisition candidate. If ARM were to be acquired by a major player, it would likely cost Didier Scemama hundreds of millions of dollars to unify their systems and it would disrupt the long-term +44 20 7678 0772 roadmap of virtually all handset and consumer electronics OEMs, an unacceptable risk for didier.scemama@rbs.com the entire electronics industry, in our view. So, we believe a consortium of electronics Alexandre Faure companies could pre-emptively bid for all or part of ARM in an effort to guarantee its +44 20 7678 7231 alexandre.faure@rbs.com independence. Marketing analyst Upgrading ARM to Buy from Hold with a new target price of 180p Paraag Amin, CFA We raise ARM’s medium-term growth and margin forecasts on growth in smartphones and +44 20 7678 7513 MCU. We also raise our DCF-based target price from 121p to 180p. Our target price implies paraag.amin@rbs.com mid-term EBIT margin of 43% (37.5% previously). At our target, the stock would trade on an 250 Bishopsgate, London, EC2M 4AA, FY10F P/E of 28x, near the top-end of its historical P/E range of 15-29x. United Kingdom Important disclosures can be found in the Disclosures Appendix. + http://www.abnamroresearch.com ABN AMRO group companies are subsidiary undertakings of The Royal Bank of Scotland Group plc.
  • The basics Versus consensus Catalysts for share price performance ! Stronger-than-expected shipments of smartphones, as they carry an average 4x ARM-based EPS (p) ABN Cons % diff AMRO chips than an average electronics product; 2009F 4.94 4.80 +3.0% ! Continued shift in the mobile phone market from mid-range phones to smartphones: we 2010F 6.41 6.00 +6.9% expect smartphones to account for 16% of the overall mobile phone market this year and 20% 2011F 7.99 7.00 +14.2% by 2011; Source: Bloomberg, ABN AMRO forecasts ! Further market share gains in the Home and Enterprise segment at major chipmakers such as STMicroelectronics, Broadcom and LSI; ! Faster adoption of ARM-based MCU in the embedded market; ! Major product announcement from ARM licensees indicating their entry into the PC processor market; ! Microsoft announcing it would port its Windows operating system to the ARM architecture; ! Google’s Chrome OS receiving support from major PC OEMs such as Dell, HP, Acer and Forced ranking* Toshiba; and, Company Rec Upside / ! Increased subsidies from mobile operators for netbooks and notebooks based on ARM Downside processors. Nokia Buy +27% ARM Buy +26% Earnings momentum ASML Buy +23% ARM, like all semiconductor companies, should benefit from improving trends in the chip sector Infineon Buy +18% and from the secular growth in the smartphone market. We expect consensus forecasts to Ericsson Hold -8% Philips Hold -13% increase post 3Q09 results. STMicro Hold -21% Logitech Sell -22% Valuation and target price Wolfson Sell -25% At our target price, the stock would trade on FY10/11F P/Es of 28.1x and 22.5x, within its Alcatel-Lu. Sell -51% historical forward P/E range of 15-29x. Given our view that ARM is rapidly becoming a strategic * by difference to target price as at time of publication. Recommendations may lie asset for the electronics industry, we believe it will continue to trade towards the high end of its outside the structure outlined in the forward P/E, particularly if the market were to price in a potential full or partial bid for ARM shares. disclosure page. Source: ABN AMRO forecasts We forecast a 21% EPS CAGR from 2009 (4.94p) to 2014 (13.05p). Discounting this P/E (21x) by five years would imply a target P/E of 13.5x on 2014F EPS, which also gives us a fair value of 177p, similar to our DCF-based analysis. The stock currently trades on FY09/10/11F P/Es of 28.9x, 22.3x and 17.9x, on our forecasts. How we differ from consensus We are substantially more positive than Bloomberg consensus for FY10/11F EPS (6.9% and 14.2% above), as we have a more positive view than the market on the company’s revenue Key events growth, particularly in terms of royalties, which drive higher gross and EBIT margins. Date Event Risks to central scenario 27/10/09 3Q09 results Downside risks to our investment case and target price include: 1) substantially weaker end- Source: Company demand than we model, particularly in the smartphone market; 2) a less successful uptake of Google’s operating system (OS) in the PC market, hindering ARM’s progress; 3) inventory build- up in the supply chain leading to much weaker-than-expected 2010 semiconductor industry growth (our estimate +14.5%), and 4) materially higher GBP/USD rates than our assumption of 1.65x. ARM | The Basics | 7 October 2009 2
  • Key assumptions and sensitivities Table 1 : EPS sensitivity table Bear Base Bull Comments US$m 2008A 2009F 2010F 2011F 2009F 2010F 2011F 2009F 2010F 2011F PD 145.0 118.9 122.5 128.6 123.4 132.0 138.6 130.5 143.6 157.9 Cortex-A9 licensing cycle YoY growth (%) -18% 3% 5% -15% 7% 5% -10% 10% 10% PIPD 44.6 37.5 38.6 38.6 39.0 41.7 43.8 40.1 44.2 47.2 32nm/22nm licensing cycle YoY growth (%) -16% 3% 0% -13% 7% 5% -10% 10% 7% Total licensing 189.6 156.4 161.1 167.2 162.4 173.8 182.5 170.6 187.7 205.1 YoY growth (%) -18% 3% 4% -14% 7% 5% -10% 10% 9% % of total sales 35% 34% 32% 31% 34% 31% 29% 34% 31% 29% PD royalty units Mobile 2,616 2,093 2,407 2,647 2,209 2,877 3,355 2,302 3,453 4,247 Smartphone account for 16%/20%25% YoY growth (%) -20% 15% 10% -16% 30% 17% -12% 50% 23% of handset market by 2011f Home 320 256 274 288 241 270 299 256 300 348 LCD TV/STB market growth YoY growth (%) -20% 7% 5% -25% 12% 11% -20% 17% 16% and share gains Enterprise 506 491 515 536 517 569 614 541 623 697 HDD, printers + WiFi adoption YoY growth (%) -3% 5% 4% 2% 10% 8% 7% 15% 12% in smartphones Embedded 539 458 595 774 509 764 1,146 565 961 1,634 ARM's share of 16/32-bit MCU reaches YoY growth (%) -15% 30% 30% -5% 50% 50% 5% 70% 70% 12%/16%/20% of market by 2011f Total PD units 3,981 3,298 3,791 4,245 3,476 4,479 5,414 3,665 5,337 6,927 YoY growth (%) -17% 15% 12% -13% 29% 21% -8% 46% 30% ASP (c x 100) 5.69 5.75 5.92 5.86 5.71 5.84 5.75 5.58 5.35 5.03 ASPs drop faster if Embedded grows faster YoY growth (%) 1% 3% -1% 0% 2% -2% -2% -4% -6% PD royaty sales 226.5 189.5 224.4 248.8 198.5 261.5 311.3 204.4 285.7 348.5 YoY growth (%) -16% 18% 11% -12% 32% 19% -10% 40% 22% PIPD royalties 40.3 33.9 38.9 41.7 35.2 43.2 47.6 36.3 47.2 54.2 Outsourcing of 45nm and below from IDMs YoY growth (%) -16% 15% 7% -13% 23% 10% -10% 30% 15% Total royalty 266.8 223.4 263.4 290.4 233.6 304.8 358.8 240.7 332.9 402.8 revenues YoY growth (%) -16% 18% 10% -12% 30% 18% -10% 38% 21% % of total sales 49% 49% 52% 54% 49% 54% 57% 49% 54% 57% Dev Systems 57.9 50.4 50.4 50.4 51.9 54.5 57.2 53.3 57.0 61.0 YoY growth (%) -13% 0% 0% -10% 5% 5% -8% 7% 7% Services 31.8 29.9 29.9 29.9 30.7 32.0 33.0 31.2 33.4 35.4 YoY growth (%) -6% 0% 0% -4% 4% 3% -2% 7% 6% Total revenues 546.1 460.0 504.7 537.9 478.6 565.0 631.5 495.7 610.9 704.3 (US$m) YoY growth (%) -16% 10% 7% -12% 18% 12% -9% 23% 15% £/$ assumption 1.83 1.58 1.65 1.65 1.58 1.65 1.65 1.58 1.65 1.65 Revenues (£m) 299.0 291.2 305.9 326.0 297.5 342.4 382.7 313.8 370.3 426.8 YoY growth (%) -3% 5% 7% 0% 15% 12% 5% 18% 15% Gross margin (%) 89.4% 89.7% 90.4% 91.0% 91.0% 90.7% 91.3% 91.3% 91.0% 91.6% R&D 65.8 88.8 91.6 93.6 88.8 95.2 100.8 88.8 99.1 106.6 R&D grows at 33%, 40% or 50% % of sales 22.0% 30.5% 30.0% 28.7% 29.8% 27.8% 26.3% 28.3% 26.8% 25.0% of revenue rate SG&A 103.8 97.8 101.0 103.2 97.8 105.8 110.9 97.8 109.2 117.5 SG&A grows at 33%, 40% or 50% % of sales 34.7% 33.6% 33.0% 31.6% 32.9% 30.9% 29.0% 31.2% 29.5% 27.5% of revenue rate EBIT 97.6 74.6 83.9 99.8 84.3 109.7 137.8 99.9 128.7 166.9 EBIT margin (%) 32.6% 25.6% 27.4% 30.6% 28.3% 32.0% 36.0% 31.8% 34.8% 39.1% Interest income 3.2 1.3 1.4 1.6 1.3 1.6 1.8 1.3 1.8 2.1 PTP 100.8 75.9 85.3 101.4 85.6 111.2 139.6 101.2 130.5 169.0 Tax rate 28% 26% 27% 27% 26% 27% 27% 26% 27% 27% Net income 72.7 56.4 62.7 74.0 63.6 81.7 101.9 75.3 95.9 123.3 EPS (p) 5.64 4.39 4.92 5.81 4.94 6.41 7.99 5.85 7.52 9.67 # of shares (m) 1289 1287 1275 1275 1287 1275 1275 1287 1275 1275 Source: Company data, ABN AMRO estimates ARM | The Basics | 7 October 2009 3
  • Contents ARM could become a threat to Intel 5 We upgrade ARM from Hold to Buy, as we expect the company to become a real 5 threat to Intel in PCs beginning 2012. We have raised our mid-term EBIT margin forecast from 37.5% to 43%. As a key strategic asset, we believe ARM could generate acquisition interest. Why ARM processors are likely to become successful in PCs 10 Over the coming two to three years, we believe ARM could become a serious 10 contender in the PC processor market, disrupting Intel’s domination. Introduction 10 ARM processors have caught up with Intel on performance while requiring substantially less 10 power Quantifying the possible benefit to ARM’s bottom line 14 ARM could become an acquisition candidate, in our view 16 Revisiting our medium-term forecasts; 40% EBIT margin by 2012/13F 19 We have revised our financial forecasts to reflect three elements: the faster and 19 broader adoption of smartphones, our higher market-share assumptions for ARM in the embedded segment, and initial take-off of ARM’s architecture in notebook PCs from 2011F. Financial statements 24 ARM | Table of Contents | 7 October 2009 4
  • ARM could become a threat to Intel We upgrade ARM from Hold to Buy, as we expect the company to become a real threat to Intel in PCs beginning 2012. We have raised our mid-term EBIT margin forecast from 37.5% to 43%. As a key strategic asset, we believe ARM could generate acquisition interest. Why ARM processors are likely to become successful in PCs The ‘ARM’ world and the ‘Intel’ ARM processors have so far dominated the portable electronics market (handsets, MP3 players world are on a collision course, and the like), and we believe they are on the verge of a substantial take-off in the PC market. So in our view far, all notebook and desktop PCs have been run on an x86 architecture (coming either from Intel or AMD), and netbooks, a new class of entry-level portable computers with smaller screens and size, have seen the first head-to-head battle between ARM and Intel’s architecture. We believe that, although the market is slowly realising that ARM is becoming a viable alternative to Intel in the netbook market, it has not understood how much ARM is becoming an alternative to Intel (and AMD) in the notebook and desktop PC markets. So how exactly could ARM become successful on Intel’s home turf? ! ARM processors have caught up with Intel on performance while requiring substantially less power. In the past, ARM processors have lagged those of Intel, clocking at 600MHz in, for instance, the iPhone 3G S, vs 2GHz for Intel’s mobile Atom processors. ARM recently announced a new processor based on two Cortex-A9 cores capable of delivering 2GHz of processing speed. Beyond that, we believe ARM processors already outperform Intel’s on power consumption and size. ARM-based microprocessors combine on a single chip an applications processor, memory controller and graphics processor, while Intel needs two or three chips to do the same. On footprint, the Cortex-A9 is a third the size of Intel’s current Atom chip manufactured on the 45nm process node. A single-chip approach is not only less costly but also requires substantially less power. A slimmer and lighter form factor enables entry into new markets and more end-products. ! ARM-based processors for PCs likely to be announced soon. Several ARM licensees (Qualcomm, Samsung, Nvidia and Marvell in particular) have already developed system-on- chips (SoCs) around ARM processors clocking at 1Ghz. So far these chips have been aimed at the high-end smartphone and the netbook PC markets. With the announcement of a 2Ghz dual ARM core, we believe these same companies will likely soon launch SoCs that integrate this new ARM processor with other functionalities, such as graphics processors (GPU), on a single chip, allowing them to enter new markets such as higher-end notebooks. ! David against Golliath? While it might appear unlikely that a small company based in Cambridge, England, can compete effectively with Intel in the PC market, we believe this is not the most helpful way to look at a possible confrontation. The sum of the revenues over the last 12 months of the ARM licensees most likely to enter the PC processor market (namely Qualcomm – chipset division only – Marvell, Nvidia, Broadcom, Texas Instruments and Freescale, all of which have already announced processors running at 600Mhz or higher) comes to US$30.2bn, only 10% lower than Intel’s total. The combined R&D budget of these ARM licensees is US$7.6bn, 1.4x higher than that of Intel. The key element of differentiation in the next three to five years in the portable PC market is likely to become similar to the key success factors in the smartphone chip market, namely the ability to integrate different technologies on a single chip. Supplying a PC processor will not be enough, in our view, to win in the portable PC market in three to five years; supplying a 3G platform and connectivity as well as the system software than runs the platform will likely differentiate the winners from the losers. We believe ARM is well positioned to deliver on this trend. ! Google’s Chrome OS could open up the PC market to ARM. After releasing the Linux- based Android OS for smartphones, Google is about to launch the Chrome OS, also based on Linux but targeting the PC market. Although Linux-based OSs (like Ubuntu) have had little success so far in the netbook market (consumers prefer to stick with the familiar name of Windows), we believe this could change if consumers see the Google brand on netbooks. ARM is a major partner in Google’s Chrome launch. We believe ARM/Chrome will initially be ARM | Executive Summary | 7 October 2009 5
  • successful in the netbook market and, as ARM-based 2Ghz processors hit the market, we believe higher-specification notebooks and perhaps even desktop PCs could be based on ARM/Chrome OS by 2011/12. ! Support from Microsoft would be the cherry on the cake. Clearly, as Windows is only available on the x86 processor (ie, those coming from Intel or AMD), PC makers must work with Intel or AMD to make Windows-based PCs. While still highly hypothetical, we believe the threat from Google’s Chrome OS might push Microsoft into supporting ARM-based processors for Windows in the future. If that were to happen, we believe it would further cement ARM as a credible alternative in notebook/desktop PCs for consumer and corporate customers (50% of the notebook market in units). Clearly, for ARM, winning in the corporate segment would take several years as CIOs are typically slow to adopt new technologies for fear of massive disruption to their IT systems; however, we believe these companies could embrace ARM- based processors once the architecture has been field-proven by consumers. ! How about AMD? We can not ignore AMD, which still commands 15-20% of the PC processor market. While ARM won’t be in direct competition with AMD for some time (AMD is not really exposed to the netbook PC market), it is inevitable that ARM and AMD will be in competition at some point, if our assumption of ARM taking 30% market share in notebook PCs within five years is correct. However we think the trends are better illustrated by focusing our analysis on the relationship between ARM and Intel. ! Where could we be wrong? Clearly, for ARM to be successful in netbooks and notebook PCs, Google’s Chrome OS will have to be reasonably successful with consumers. So far, Linux-based OSs (such as Google Chrome) have had limited success in the market place because consumers are not familiar with them. It is currently unclear how well designed and easy to use Google Chrome will be, because it will only be available from 2H10. Secondly, for ARM and Google to win a reasonable market share in the PC market, they will have to win some business away from the Intel-Microsoft duo, which has been an impossible task for other companies in the last 15 years. Quantifying the benefit to ARM’s bottom line We provide three scenarios to estimate how much ARM might benefit if it is successful in the PC market. Overall, we estimate that even reasonable success for ARM in the notebook/netbook PC market (30% share in notebooks and 35% share in netbooks by 2014F) will not have a material impact on EPS. In our scenarios, we have only adjusted the incremental PD units related to the sale of an ARM- based processor running a netbook or notebook, but have maintained our assumptions regarding other ARM-based chips (such as a 3G baseband, WiFi, bluetooth or GPS). Chart 1 : EPS sensitivity Chart 2 : ARM-based PC units Chart 3 : % of portable PC with 3G 14 120 45% 13 40% 100 12 35% 11 80 30% 10 EPS (p) 25% m of units 9 60 20% 8 40 15% 7 6 10% 20 5 5% 4 0 0% 2009F 2010F 2011F 2012F 2013F 2014F 2009F 2010F 2011F 2012F 2013F 2014F 2009F 2010F 2011F 2012F 2013F 2014F Base case Bear case Bull case Base case Bear case Bull case Base case Bear case Bull case Source: ABN AMRO forecasts Source: ABN AMRO forecasts Source: ABN AMRO forecasts Bottom line, we estimate ARM’s 2014 EPS will range between 12.8p under our bearish scenario and 13.4p under our bullish scenario. Under our most bullish scenario, only 6% of ARM’s Processor division (PD) royalty revenues come from portable PCs (PC processor and/or 3G baseband), demonstrating that royalties remain substantially more sensitive to growth in the smartphone market. ARM | Executive Summary | 7 October 2009 6
  • ARM could become an acquisition candidate, in our view What would be Intel’s response if ARM succeeds in the PC market? ! What could Intel do if ARM were to become a threat in the PC market? The most obvious option would be to cut prices to hurt ARM-based processor vendors like Qualcomm or Samsung. While this may hurt ARM licensees, we believe it will only delay the success of ARM in the PC market, as PC OEMs will most likely jump at any opportunity to diversify away from Intel. This was probably best demonstrated when Hon Hai, the largest electronics contract manufacturer, commented publicly on 16 July 2009 that it would make US$200 netbooks based on ARM processors to meet demand from telecom operators. Also, on September 2009, the Financial Times reported that Dell would soon make netbooks based on ARM processors. Intel could update product to compete better with ARM-based competitors. However, the key issue for Intel will be power consumption and die size. It is generally easier to improve speed/power consumption, as ARM is doing, than to scale down die size, as Intel would need to do. Third, Intel could capitulate in wireless and refocus on the high-end wired world, which seems unlikely to us as Intel’s management views wireless computing as the company’s big growth area based on public comments made by CEO Otellini at the Intel Developers Conference in September 2009. Intel also recently (29 June 2009) licensed Nokia’s 3G baseband IP, indicating that it intended to be a major player in the wireless chip market. Lastly, given the potential damage ARM’s market share gains in the PC processor market would have on Intel, we cannot rule out that Intel may bid for ARM in order to eliminate its nascent competitor. ! Why ARM is so valuable to the global electronics value chain? If ARM were to disappear, it would cost each of its licensees in the semi market US$50m-100m pa (at least) to replace the ARM processor and develop their own, based on our estimates (a typical leading edge chip design costs US$40m-50m for instance). Electronics OEMs (such as Nokia, Apple or Samsung) have hundreds of engineers writing software for designs based on the ARM architecture. To change these designs to a new architecture would not only be extremely costly but would also greatly hurt product innovation and time to market (it would take years before all software code is ported to this new processor architecture with continuing support for ARM devices already in the market). Finally, foundries (such as TSMC, GlobalFoundries and UMC) rely not only on ARM IP for their process technology but, more importantly, need ARM-based SoCs from companies like Qualcomm and TI to load their fabs. Even if a new architecture emerged from a hypothetical Intel takeover of ARM, it would take months before these designs could be qualified on major foundry companies’ processes. ! Why ARM could be bid for by a consortium of electronics companies? Given the importance of ARM for the electronics ecosystem, we believe that companies in various parts of that system could organise and bid for all or part of ARM. This consortium could then license out the ARM technology and preserve the product relationship with each consortium member. With the company’s EV of £1.7bn and scattered shareholding, we believe a takeover of ARM would be relatively easy to organise since its free float is 100%. Spread over 10 or more companies that are major users of ARM technology or have a vested interested in seeing ARM succeed (like Nokia, Apple, Samsung, LG, Sony, Google, Qualcomm, Marvell, Nvidia, Broadcom, Texas Instruments, TSMC, GlobalFoundries and many others) it would cost them a limited amount. Revisiting our medium-term forecasts; 40% EBIT margin by 2012/13F We revise our forecasts to reflect: 1) the faster and broader adoption of smartphones, 2) higher market-share assumptions in the embedded segment (mostly microcontrollers and SIM cards), and 3) initial take-off of the ARM architecture in notebook PCs from 2011F onwards. Overall, we raise our FY09/10/11F EPS estimates from 4.77p/5.90p/6.10p to 4.94p/6.41p/7.99p. ARM | Executive Summary | 7 October 2009 7
  • Table 2 : Summary of estimate changes 2009F 2010F 2011F Old New Change Old New Change Old New Change Revenues (£m) 294.5 297.5 1.0% 327.3 342.4 4.6% 348.7 382.7 9.8% Gross margin 90.9% 91.0% +0.1pts 91.2% 90.7% -0.5pts 91.3% 91.3% - EBIT margin 27.6% 28.3% +0.7pts 30.8% 32.0% +1.2pts 33.1% 36.0% +2.9pts Tax rate (%) 25.6% 25.6% - 26.5% 26.5% - 28.0% 27.0% -1pt EPS (p) 4.77 4.94 3.7% 5.90 6.41 8.6% 6.10 7.99 31.0% Source: ABN AMRO forecasts The major driver of our forecast changes is the growing proportion of royalties in the mix, driven primarily by the increased adoption of ARM-based chips in smartphones and embedded markets and, to a lesser degree, ARM’s nascent success in netbooks and notebooks (see Charts 4 to 6). Chart 4 : PD royalty unit shipments Chart 5 : PD royalty revenues Chart 6 : PD ASPs per segment 9,000 500 0.25 8,000 450 7,000 400 0.20 6,000 350 m of units 0.15 US cent 5,000 300 US$m 4,000 250 0.10 3,000 200 2,000 150 0.05 1,000 100 0 50 0.00 2008 2010F 2012F 2014F 0 2008 2010F 2012F 2014F 2008 2010F 2012F 2014F Traditional phones Converged devices Traditional phones Converged devices Traditional phones Converged devices Netbooks Notebooks Netbooks Notebooks Netbooks Notebooks Home Entreprise Home Entreprise Home Entreprise Embedded Embedded Embedded Source: Company data, ABN AMRO forecasts Source: Company data, ABN AMRO forecasts Source: Company data, ABN AMRO forecasts We expect royalties to account for 62% of total revenue by 2014 vs 49% this year (Chart 7). Given the near-100% gross margin on royalties, the growing proportion of royalties in the mix ought to mechanically lift gross and EBIT margins. We raise our mid-term (2011-17) EBIT margin forecast from 37.5% to 43% (see Chart 8 for our near-term EBIT margin assumptions). Chart 7 : ARM revenue split 2008-14F Chart 8 : ARM revenue growth vs EBIT margin (%) 100% 900 50% 90% 800 45% 80% 700 40% 35% 70% 600 EBIT margin 30% 60% 500 US$m 25% 50% 400 20% 40% 300 15% 30% 200 10% 20% 100 5% 10% 0 0% 0% 2008 2009F 2010F 2011F 2012F 2013F 2014F 2008 2009F 2010F 2011F 2012F 2013F 2014F Licensing Royalties Dev Sys Licensing Royalties Dev Sys Services Services EBIT margin Source: Company data, ABN AMRO forecasts Source: Company data, ABN AMRO forecasts We raise our target price to 180p (from 121p) and upgrade ARM to Buy Based on our base case assumptions, we upgrade our recommendation to Buy (from Hold) with a new DCF-based target price of 180p. Our DCF valuation is based on a WACC of 9%, which assumes a risk-free rate of 5%, beta of 1.0x, market risk premium of 4% and unlevered balance sheet. Note that if we were to use the current risk-free rate of 3.6% and five-year equity beta average for ARM of 0.9x, WACC would be materially lower at 7.2%, which we estimate would ARM | Executive Summary | 7 October 2009 8
  • boost ARM’s fair value to 227p. We have decided to use more conservative assumptions for beta and risk-free rate to be prudent. That said, ARM has unusual characteristics not only for a technology company (high visibility, recurring revenues, high margins and high free cash flow generation) but for any company (it has limited competition and we forecast its end-markets will grow in excess of 15% for the next five years). Given the nature of ARM’s business (‘annuity-like’ in a way), one can understand why such a low WACC would be warranted. At our target price the stock would trade on FY10/11F P/Es of 28.1x and 22.5x, within its historical forward P/E range of 15-29x. Given the increasing potential strategic value of the company, we believe it will continue to trade towards the high-end of its forward P/E, particularly if the market were to price in a potential full or partial bid for ARM shares. We forecast a 21% EPS CAGR from 2009 (4.94p) to 2014 (13.05p). Discounting this P/E (21x) by five years would imply a target P/E of 13.5x on 2014F EPS, which also gives us a fair value of 177p, similar to our DCF-based analysis. The stock currently trades on FY09/10/11F P/Es of 28.9x, 22.3x and 17.9x, on our forecasts. ARM | Executive Summary | 7 October 2009 9
  • Why ARM processors are likely to become successful in PCs Over the coming two to three years, we believe ARM could become a serious contender in the PC processor market, disrupting Intel’s domination. Introduction ARM will likely challenge Intel in ARM processors have so far dominated the portable electronics market, particularly in handsets the PC processor market, in our where they have over a 96% share. With the launch of the Cortex-A9 processor, ARM vendors view can now not only compete in the netbook and notebook markets but, in our view, are positioned to take off in the PC market. Notebook and desktop PCs have consistently run on the x86 architecture (ie, coming from either Intel or AMD), but with netbooks, a new class of entry-level portable computers with smaller screens and size, we see a possible battle between ARM and Intel’s architecture. ARM’s new Cortex-A9 processor (which can operate in excess of 2GHz) will allow chipmakers to immediately integrate this dual-core processor into their system on chip designs for low-power, high-performance applications such as netbooks and notebooks, and later scale up to the wired world of desktops and servers. So how exactly could ARM become successful on Intel’s home turf? ARM processors have caught up with Intel on performance while requiring substantially less power ARM processors can beat Intel ARM has its roots in low-power embedded processing, which quickly found a home in mobile on a number of performance devices due to its extremely low power consumption. These first-generation ARM processors factors previously operated at lower speeds but are now able to compete with Intel in the notebook market, in our view. For instance, the Cortex-A8 ARM core in the iPhone 3GS runs at 600MHz whereas the Intel mobile Atom processor runs at 2GHz. ARM recently announced its new processor, Osprey, based on two Cortex-A9 cores, which is capable of delivering 2GHz of processing speed. The Cortex-A9 will be fabbed in TSMC’s 40nm manufacturing process. The table below shows how the Cortex-A9 measures up against the current Intel solution for netbooks, the Pine Trail Platform, and the more comparable Medfield chip. The Pine Trail will be available to netbook manufacturers in early 2010 followed by the Medfield SoC in mid 2011. This is roughly the same timing as the Cortex-A9 Table 3 : ARM Cortex-A9 versus Intel’s Atom ARM SoC Intel Chipset Intel SoC Cortex-A9 (2011) Pine Trail (2010) Medfield (2011) # of chips 2: 1 1 Atom chip & I/O hub chip SoC Cortex-A9, mem ctrl, I/O hub No Atom, mem ctrl, I/O hub # of cores 2 1 1 Speed ~2GHz ~1.6GHz ~2.0GHz Technology 45nm 45nm 32nm Price US$25-30 US$20-25 Unknown Footprint Cortex-A9 1/3 size of the 45nm Atom Unknown Power 2.5W for Atom 500mW Unknown 2.5W for I/O hub Source: Company data Few details are available about Medfield in terms of footprint, power consumption and price. Table 3 details the quantum leap Intel has to make to transition from Pine Trail to Medfield to match ARM | Executive Summary | 7 October 2009 10
  • Cortex-A9 in these critical areas, which are necessary for mass adoption in netbooks and smartphones, given Pine Trail consumes 5x more power than the equivalent ARM core. ! Chipset to SoC: Intel has consistently maintained a two chipset solution in its legacy architectures but now has to integrate the equally power-hungry southbridge I/O controller hub into the Atom processor. This is new territory for Intel and provides a serious challenge to keep the die size at a low enough footprint to compete with ARM. At 45nm the Cortex-A9 is already a third the size of the Atom, giving SoC vendors a lower-cost per chip or bandwidth to integrate more functionality for the same price. ! Power: From Intel and ARM press releases, the Cortex-A9 SoC (500mW) dissipates a fifth of the current Atom chip at 45nm. Although Medfeld fabbed at 32nm should automatically consume less power (30-50%), we believe technology shrink alone cannot account for a 2W reduction in power consumption between the Atom and the Cortex-A9, without even considering the power impact of the integrated I/O hub chip. In the mobile sector, ARM has raised the bar to 500mW, which Intel will have to meet or exceed. ! Price: On raw price Intel looks like it could have an edge over ARM when Medfield hits the market in 2011. But semiconductor vendors such as Broadcom, Qualcomm, Marvell, Samsung, Freescale and Nvidia will likely integrate more functionality into the Cortex-A9 SoC, so it is difficult to draw any conclusions for Medfield from price alone, which will probably be at about US$20. Even if Intel somehow delivers on power and footprint, integrates 20 years of legacy code and achieves an adequate form factor for around A$20, it will likely loose market share because ARM now offers a competitive product in the smartbook/netbook/notebook space. David against Goliath? It's not just ARM vs Intel While it might appear unlikely that a small company based in Cambridge, England, is able to compete effectively with Intel in the PC market, we believe this is not the most helpful way to look at a possible confrontation. The sum of the revenues over the last 12 months of ARM’s licensees most likely to enter the PC processor market (namely Qualcomm - chipset division only, Marvell, Nvidia, Broadcom, Texas Instruments and Freescale, all of which have already designed processors based on ARM running at speed of 600Mhz or above and are therefore the most likely to launch products based on ARM Cortex-A9) comes to US$30.2bn, only 10% lower than Intel’s total. The combined R&D budget of these ARM licensees adds up to US$7.6bn, 1.4x higher than that of Intel. Table 4 : Comparing Intel’s skill set to ARM’s leading licensees within the PC and the Mobile & Wireless segments Total ARM PC chip skill set INTC QCOM TXN MRVL FSL NVDA BRCM licensees CSR ATHR Processor design Strong Strong Strong Strong Strong Medium Strong Weak Weak Leading edge litho design Strong Medium Medium Weak Weak Strong Medium Weak Weak Low power processor design Weak Strong Strong Strong Medium Strong Strong Strong Medium PC OEM/ODM relationships Strong Weak Weak Weak Weak Strong Strong Medium Strong Mobile and Wireless chip skill set SoC integration Medium Strong Medium Strong Weak Weak Strong Strong Medium 3G baseband Nokia IP Strong Weak Weak Weak Weak Medium Weak Weak Mixed signal design Weak Strong Strong Strong Medium Weak Strong Medium Medium RF CMOS Weak Strong Medium Strong Weak Weak Strong Strong Strong Cellular RF Weak Strong Weak Weak Medium Weak Medium Weak Weak Bluetooth Weak Medium Medium Weak Weak Weak Strong Strong Weak WiFi Medium Weak Medium Strong Weak Weak Strong Medium Strong GPS Weak Strong Medium Weak Weak Weak Strong Strong Medium Wireless system IP Weak Strong Medium Medium Medium Weak Medium Medium Weak Handset OEM/ODM relationships Weak Strong Strong Medium Weak Weak Medium Medium Weak LTM sales (US$m) 33,612 6,197 10,421 2,466 4,013 2,820 4,318 30,235 539 437 % of INTC 100% 18% 31% 7% 12% 8% 13% 90% 2% 1% LTM R&D budget (US$m) 5,407 2,163 1,693 774 1,024 806 1,144 7,604 142 121 % of INTC 100% 40% 31% 14% 19% 15% 21% 141% 3% 2% Source: Company data, ABN AMRO estimates ARM | Executive Summary | 7 October 2009 11
  • Beyond the size argument, we believe several of ARM’s licensees have mobile and wireless system IP (including 3G platform design and wireless connectivity, as shown in the table above) that will increasingly differentiate ARM in the portable PC space in the medium term, where Intel is, in several cases, not even in the market. We have also added CSR and Atheros to the table comparing Intel’s chip design skills and ARM’s licensees. Even though we doubt either CSR or Atheros would enter the PC processor market, we do believe that both companies have interesting and complementary skills that would be valuable to Intel. We made this point in our last CSR note (SiRFin’ China, published 30 July 2009), but we believe it is worth re-iterating. Portable PCs likely converge The key element of differentiation in the next three to five years in the portable PC market is likely with smartphones; wireless chip to become similar to the key success factors in the smartphone chip market, namely the ability to vendors likely to be more integrate different technologies on a single chip and on a leading-edge CMOS process. Supplying competitive than Intel, in our view a PC processor will not be enough, in our view, to win in the portable PC market in three to five years; supplying (preferably through an integrated chip with the apps processor) a 3G platform and connectivity (bluetooth, FM radio, WiFi and GPS) as well as the system software than runs the platform will likely differentiate the winners from the losers. We believe ARM is well positioned to deliver on this trend. Therefore, we believe the playing field for ARM/Intel competition is far more level than is initially evident. ARM-based processors for PCs likely to be announced soon Product announcements from SoC vendors (Qualcomm, Samsung and Marvell in particular) will now be able to take ARM’s ARM licensees are likely to come Cortex-A9 processor and integrate a graphics processor, memory interface, and baseband all on soon the same piece of silicon. The result is lower chip ASPs and subsequently lower PC prices. For example, NVIDIA currently buys the unbundled Intel Atom for around US$45 to use in its Ion netbook platform. However, with Cortex-A9, Nvidia will now have another supplier choice for the same level of performance as the Intel Atom. By integrating Cortex-A9 into its Tegra platform (which currently uses an ARM11 + ARM9 pictured in Chart 9) Nvidia could quickly get to market with a netbook platform at a low cost, which would provide real competition for Intel, most likely resulting in Intel dramatically reducing its ASP. RF and mixed signal chip design Chart 9 : Nvidia Tegra processor skills will become more important in PCs Source: Nvidia RF and mixed signal chip design Last week, Broadcom announced the licensing of the Cortex-A9 dual core processor from ARM skills will become more for use in mobile and wireless applications. Neither ARM nor Broadcom were specific about the important in PCs exact application, but we think it could be for a netbook platform that would integrate with Broadcom’s wireless technology (3G baseband, power management, RF transceiver, WiFi, bluetooth, FM radio, GPS and touch screen IC). This integration factor favours ARM, in our view: its leading licensees (Qualcomm, Marvell, Broadcom for instance) all have more to offer to PC vendors than Intel. They already have all or most of the technology necessary to make a 3G phone and it will be easy for them to re-use this IP in netbooks and notebook PCs. Intel, in contrast, does not have any RF capability (apart from some WiFi capabilities) or mixed signal design capabilities (used for power management and touchscreen ICs for instance). ARM | Executive Summary | 7 October 2009 12
  • The handset market is at the leading edge of ARM integration with multiple chip vendors (eg Qualcomm, Samsung and TI) already producing Cortex-A8 devices. They will likely integrate Cortex- A9 to capitalise on the additional performance boost, which would allow them to target new markets. In our view, the OS is the only aspect of the netbook configuration that is missing for seamless application to notebooks or desktop PCs. The best chip in the world is no good unless it supports an OS such as Google Chrome OS or Microsoft Windows OS. Google’s Chrome OS could open the PC market to ARM Google wants a piece of the PC Google’s Chrome OS would be the first major OS to support ARM’s architecture and is set to operating system market launch in 1H10. Although netbooks running on flavours of the Linux OS (like Ubuntu) are already available in the market (and are running on ARM processors), they have had only modest success so far, as consumers are not familiar with the Linux OS. Chrome is Google’s streamlined Linux- based OS that is designed for the web and will run on ARM’s low-power architecture cores. It is also included in the netbooks, a move that is directly aimed at Microsoft. Given the broad appeal of the Google brand to consumers, the ARM/Chrome alliance could prove to be much more successful in the PC market, in our view. Initially, we believed that ARM/Chrome OS would be successful in the netbook market. However, as ARM-based processors running at 2Ghz hit the market, we believe that higher-specification notebooks and perhaps even desktop PCs aimed at the consumer segment could be based on ARM/Chrome OS by 2011/12. Support from Microsoft would be the cherry on the cake Difficult to predict if or when The final blow to Intel could come from Microsoft. Microsoft and Intel (Wintel) have dominated the PC value chain for the last 20 years, polarising profits on their respective products (MPU/chipset for Intel and operating system for Microsoft) and leaving very little profit for the PC makers. Clearly, the fact that Windows is only available on the x86 processor (ie, those coming from Intel or AMD) means PC makers use either Intel or AMD to make Windows-based PCs. Although ARM has some of its people sitting at Microsoft, we have no evidence that Microsoft could evolve to support ARM-based processors for Windows. However, we believe ARM’s relationship with Google’s Chrome OS is likely to tip the balance in its favour, because: ! A free Chrome OS will likely cause a major disruption to Microsoft’s Windows OS software revenue, which accounted for 26.7% of Microsoft revenue in FY09 with a significant 72% operating margin (as reported in their 2008 annual report). ! By comparison Windows’ Server division operates in a much more competitive market with IBM, Unix and Linux, so attaining only a 35% operating margin. Microsoft’s Windows operating profit could fall if Google’s Chrome OS provides serious competition. If Microsoft were to move toward supporting ARM-based processors, we believe it would further cement ARM as a credible alternative in notebook and desktop PCs, not only for the consumer segment but also for the corporate segment. If Microsoft extends support for ARM in the latter half 2010, we estimate ARM/Microsoft netbooks could hit the shelves in the latter half of 2011. Chart 10 : Hypothetical timeline for ARM architecture deployment in portable PCs 140m Proliferation of low cost mobile internet devices 120m Microsoft announces Mobile computing unit forecast First Microsoft A9 100m ARM support? netbooks in stores Google Chrome 80m OS release First A9 Chrome netbooks in stores 60m Broadcom working on Release of ARM A9 A9 device platforms to OEMS 40m 20m ARM announces Cortex-A9 m 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 Source: ABN AMRO ARM | Executive Summary | 7 October 2009 13
  • In our view, ARM could fairly easily take share in the consumer notebook market, but the enterprise notebook market will be more challenging. Today, the notebook market is split 50/50 between corporate and consumer in terms of units. For ARM to win in the corporate segment would take several years, as CIOs are typically slow to embrace new technologies, preferring instead to wait for initial problems to be ironed out and avoid any disruption to IT systems and legacy support. Also as power consumption becomes more of a pressing issue for CIOs, ARM’s offering should become more competitive. We believe enterprises could embrace ARM-based processors once the architecture has been field-proven by consumers. Quantifying the possible benefit to ARM’s bottom line Unlikely to have a significant We provide three scenarios to estimate how much ARM could benefit if it were successful in the impact for the next five years, in PC market. Overall, we estimate that even reasonable success for ARM in the notebook/netbook our view PC market (30-40% share by 2014) will not have a material impact on EPS. In our scenarios, we have only taken into account the incremental PD units related to the sale (or not) of an ARM-based processor running a netbook or notebook. We do not take into account other ARM-based chips (such as 3G baseband, WiFi, bluetooth or GPS) that are already reflected in our model. Chart 11 : EPS sensitivity Chart 12 : ARM-based PC units Chart 13 : % of portable PC with 3G 14 120 45% 13 40% 100 12 35% 11 80 30% 10 m of units EPS (p) 25% 9 60 20% 8 40 15% 7 6 10% 20 5 5% 4 0 0% 2009F 2010F 2011F 2012F 2013F 2014F 2009F 2010F 2011F 2012F 2013F 2014F 2009F 2010F 2011F 2012F 2013F 2014F Base case Bear case Bull case Base case Bear case Bull case Base case Bear case Bull case Source: ABN AMRO forecasts Source: ABN AMRO forecasts Source: ABN AMRO forecasts As we explain below, we estimate that ARM’s 2014 EPS would range between 12.8p under our bearish scenario and 13.4p under our bullish scenario. Under our most bullish scenario only 6% of ARM’s PD royalty revenues would come from portable PCs (PC processor and/or 3G baseband), indicating that ARM’s royalties will remain substantially more sensitive to growth in the smartphone market. ARM | Executive Summary | 7 October 2009 14
  • Table 5 : Bull/Base/Bear scenario analysis Base case 2009F 2010F 2011F 2012F 2013F 2014F Netbook shipments (m) 25 33 45 51 59 67 3G attach rate (%) 3% 8% 15% 20% 25% 30% ARM share % 3% 15% 20% 25% 30% 35% Notebooks shipments (m) 168 180 192 206 220 236 3G attach rate (%) 3% 8% 15% 20% 25% 30% ARM share % 0% 1% 3% 5% 10% 15% ARM-based PCs (m) 1 7 15 23 40 59 3G baseband units in PCs (m) 6 17 36 51 70 91 Attach rate for 3G in PCs (%) 3% 8% 15% 20% 25% 30% PD royalty units (m) 3,476 4,479 5,424 6,355 7,325 8,449 Incremental units due to PCs 0.2% 0.5% 0.9% 1.2% 1.5% 1.8% Blended ASP (c ) per netbook/notebook 0.00 0.02 0.03 0.04 0.06 0.08 PD royalty revenues (US$m) 198 262 312 356 398 455 Incremental royalties due to PCs 0 0 2 3 6 11 % of total 0% 0% 0% 1% 2% 3% EPS (p) 4.94 6.41 7.99 9.52 11.06 13.05 Bear case 2009F 2010F 2011F 2012F 2013F 2014F Netbook shipments (m) 25 33 45 51 59 67 3G attach rate (%) 3% 5% 8% 12% 15% 17% ARM share % 3% 5% 8% 10% 10% 10% Notebooks shipments (m) 168 180 192 206 220 236 3G attach rate (%) 3% 5% 8% 12% 15% 17% ARM share % 0% 0% 0% 1% 2% 3% ARM-based PCs (m) 1 2 4 7 10 14 3G baseband units in PCs (m) 6 11 19 31 42 51 Attach rate for 3G in PCs (%) 3% 5% 8% 12% 15% 17% PD royalty units (m) 3,476 4,468 5,397 6,319 7,267 8,365 Incremental units due to PCs 0.2% 0.3% 0.4% 0.6% 0.7% 0.8% Blended ASP (c ) per netbook/notebook 0.00 0.01 0.01 0.02 0.02 0.03 PD royalty revenues (US$m) 198 261 310 353 393 445 Incremental royalties due to PCs 0 0 0 1 1 2 % of total 0% 0% 0% 0% 0% 0% EPS (p) 4.94 6.40 7.94 9.46 10.92 12.76 Bull case 2009F 2010F 2011F 2012F 2013F 2014F Netbook shipments (m) 25 33 45 51 59 67 3G attach rate (%) 3% 8% 15% 25% 33% 42% ARM share % 3% 15% 23% 30% 35% 40% Notebooks shipments (m) 168 180 192 206 220 236 3G attach rate (%) 3% 8% 14% 23% 32% 40% ARM share % 0% 3% 8% 20% 25% 30% ARM-based PCs (m) 1 10 26 56 76 97 3G baseband units in PCs (m) 6 17 34 60 90 122 Attach rate for 3G in PCs (%) 3% 8% 14% 23% 32% 40% PD royalty units (m) 3,476 4,483 5,433 6,397 7,381 8,520 Incremental units due to PCs 0.2% 0.6% 1.1% 1.8% 2.2% 2.6% Blended ASP (c ) per netbook/notebook 0.00 0.02 0.04 0.08 0.10 0.12 PD royalty revenues (US$m) 198 262 313 362 409 470 Incremental revenues due to PCs 0 1 2 9 16 26 % of total 0% 0% 1% 3% 4% 6% EPS (p) 4.94 6.41 8.00 9.68 11.33 13.42 Source: ABN AMRO estimates ARM | Executive Summary | 7 October 2009 15
  • ARM could become an acquisition candidate, in our view What if ARM hurts Intel? What would be Intel’s response if ARM succeeds in the PC market? How might Intel respond to ARM in the PC market? If we are proven correct and ARM becomes a real threat to Intel in the netbook and notebook PC markets, Intel could respond in a number of ways: ! The most obvious response is price cuts. Intel is well positioned in this respect as it controls both the fabrication and distribution of its chips. Price cuts would hurt ARM-based processor vendors like Qualcomm, Samsung or Marvell. While this may hurt ARM’s licensees, we believe it would only delay ARM’s success in the PC market. PC OEMs, who until now have had Intel as sole supplier, would most likely jump at the opportunity to diversify away from Intel or, at the very least, create a dual supply strategy. This was probably best demonstrated when Hon Hai, the large electronics contract manufacturer, said on 16 July 2009 that it would make US$200 netbooks based on ARM processors to meet demand from telecom operators. Also in September 2009, the Financial Times reported that Dell would soon make netbooks based on ARM processors. In effect, what this means is a transfer of pricing power away from Intel and towards the PC OEMs. ! Intel could improve its product and edge out ARM-based competitors on performance. Intel is not standing still and continues to progress on its System on Chip (SoC) development path. SoC is a new area for Intel, which has traditionally maintained a chipset approach fabbed in Intel foundries (eg, Atom processor chip, graphics chip, I/O controller hub chip). ARM is climbing the performance ladder with its SoC architecture and Intel has changed its approach and has now begun to manufacture Atom SoC chips at TSMC (Intel/TSMC press release dated 1 March 2009). As technology moves mainstream to the 32nm node, it would not be surprising if Intel fabs all future Atom chips at TSMC. This could be a double-edged sword for Intel, as explained below: ! Upside: Atom chips have to be low cost (around US$20) to compete with ARM- based SoCs. Offloading Atom processing to TSMC would free up capacity at Intel fabs for higher-margin processors targeting desktops, workstations and servers. If Intel manufactures Atom-based SoCs in Intel fabs, it most likely would not be able to achieve the same cost per wafer as TSMC due to TSMC’s significant scale in SoC production. This would put Intel at a notable disadvantage in any price war vs ARM-based SoCs fabbed by TSMC. ! Downside: The ongoing story in fabrication is that fabs need to function at maximum capacity to achieve the lowest cost per wafer. By outsourcing Atom production to TSMC, Intel would reduce the utilisation of its fabs and most likely increase the cost of its other processors. Intel’s Pine Trail (which has an integrated Atom/Graphics chip) is to be fabbed at TSMC in early 2010, followed by Medfield (an integrated Atom/Graphics/IO controller on one chip) in 2011. However, the key issue for Intel will be power consumption and die size. Considering the 20 years of legacy code that Intel has to support and the power consumption of its existing chips (Atom chip 2.5W, I/O controller chip 2.5W), it could struggle to compete with ARM (Cortex-A9 500mW) on size. It is always easier to scale up in terms of speed/power consumption like ARM is doing, than to scale down in size as Intel urgently needs to. ! Intel could license ARM technology for the portable segment (netbooks, notebooks) and focus its own x86 architecture on the high-end wired-world processors (servers, workstations), which are its strength and produce the highest margins. ARM has a long road ahead before it can scale up and compete in the wired world with incumbent Intel. If Intel were to license ARM technology for the netbook/notebook space, it would have time to refocus on improving performance and power consumption in the wired high-end computing space. We believe that Intel is unlikely to abandon its own x86 core in portable PCs, as it would be an admission of failure for Intel. Plus, Intel’s management sees the wireless/portable space as the growth area for the company as indicated by CEO Otellini at Intel Developers Conference in September 2009. In addition, Intel also recently (29 June 2009) licensed Nokia 3G baseband IP, indicating that it intended to be a major player in the wireless chip market and 3G-capable portable PCs. However, if Intel were to license ARM technology, it would ARM | Executive Summary | 7 October 2009 16
  • effectively mean that ARM had de facto won the portable PC market. Lastly, given the potential damage ARM’s market share gains in the PC processor market would have on Intel, we cannot rule out that Intel may bid for ARM in order to eliminate its nascent competitors. Why ARM is so valuable to the global electronics value chain The independence of ARM as a Before we write that a consortium could bid for ARM, we have to explain the value of ARM as an company is essential to the independent company for the electronics value chain. ARM is deeply embedded in a myriad of health of the electronics industry electronics devices, from the low-end microcontrollers in toys and washing machines to the high- end processors in autos and smartphones. In whichever application, ARM processors form the brains behind these systems. It has more than 95% market share in mobile phones, about 25% in digital TV, about 25% in PC peripherals and about 10% in microcontrollers. ! If ARM were to disappear, it would cost US$50m-100m per annum for each of its licensees in the semiconductor market to replace the ARM processor, develop and maintain their own processor IP, as there is no other real substitute product. For reference, a leading-edge chip design costs US$40m-50m on average. Given the complexity and low power of the ARM architecture, we believe it is reasonable to assume a higher development cost for a processor core. Secondly a new processor architecture would require substantial investment in software to help software engineers write programmes. And this is actually the easy fix, in our view. ! The second upheaval would be in terms of software. Built on top of ARM chips are layers and layers of software written to run on ARM hardware and supported within a wider ARM eco- system (ARM has got more than 200 licensees). Each electronics OEM company (including Nokia, Samsung, Apple, Sony etc) has hundreds of software engineers working on systems built on ARM-based processors made by Qualcomm, Texas Instruments or Broadcom. To change all this to a new architecture would not only cost them hundreds of millions of dollars, but would also be a disaster in terms of product innovation and time to market, taking years before all software code is ported to a new processor architecture while also having to continue to support existing ARM devices already in the market. ! Finally, foundries (TSMC, UMC, GlobalFoundries) rely not only on ARM IP for their process technology but, more importantly, need ARM-based SoCs (ie, chips not made by Intel) from Qualcomm, TI, Marvell and Mediatek to load their fabs. Even if a new architecture emerges from an Intel takeover of ARM, it could take months before these designs can be qualified on TSMC’s processes, with each company’s architecture requiring a separate qualification, effectively sending the industry back to the 1990s model. In a nutshell, if ARM’s independence is threatened, it would create a significant financial blow for the entire electronics industry that would run into billions of dollars. Why ARM could be bid for by a consortium of electronics companies It would too costly and too risky Given the strategic nature of ARM for the electronics eco-system, we believe that big electronic to put ARM in the wrong hands companies (ie chipmakers, foundries and some software companies) could organise a buyout of ARM, taking it private through a LBO or setting up a foundation, which would then license out the ARM technology similar to the current model. Google, Microsoft, Nokia, TSMC, Qualcomm, Apple, Broadcom, Marvell, RIM, Samsung and virtually every single chip vendor and electronics OEM would be interested in keeping ARM independent, in our view. What options could be envisaged in case of a threat of an Intel bid? ! ARM foundation: To counter any move by Intel, major industry players could organise a buyout of ARM, taking it private and setting up a foundation which would license out the ARM technology. The players we envisage contributing most to taking ARM private would be ARM’s biggest customers and users as well as companies that have a vested interest in seeing ARM succeed: Google, Nokia, TSMC, Qualcomm, Apple, Broadcom, Marvell, Nvidia, Samsung, LG, Sony Ericsson, Sony and many others). With a €1.9bn market cap this would require these 10+ companies to contribute €190m or less each. Although a large sum, we believe that many large OEMs, foundries and chipmakers would rather pay that amount than see ARM in the wrong hands. ARM | Executive Summary | 7 October 2009 17
  • ! LBO: A buyout of ARM by industry players and a PE firm followed by subsequent loading of debt on the company is also an option. ARM through its licensing/royalty model is quite cash generative and we forecast it is set to generate EBITDA of £137m in 2010. Taking into account a net cash position of £105m at end 2009F, this would allow gross debt of £516m- 790m assuming a net debt/EBITDA of 3x to 5x. We estimate ARM’s highly cash generative business model will be able to cope with such heavy debt load with its gross interest payment accounting for 23% or 35% of annual EBITDA. This in turn would imply an equity/debt financial structure for such deal ranging between 51% and 80% (as shown in the table below). Finally, assuming a takeover bid for ARM from a consortium of 10 companies would imply a cash contribution of £83m to £206 from each partner, which in our view would be manageable. Table 6 : Potential LBO calculation for ARM shares (£m) Take-out price (p) 135 150 165 180 195 210 Market cap 1,721 1,913 2,104 2,295 2,486 2,678 Net cash -105 -105 -105 -105 -105 -105 EV 1,616 1,808 1,999 2,190 2,381 2,573 EBITDA (FY10f) 137 137 137 137 137 137 Gross debt @ 3x net/debt EBITDA 516 516 516 516 516 516 Net debt 411 411 411 411 411 411 Interest payment @ 6% 31 31 31 31 31 31 as a % of EBITDA 23% 23% 23% 23% 23% 23% Equity portion of the LBO 1,100 1,292 1,483 1,674 1,865 2,057 as a % of EV 68% 71% 74% 76% 78% 80% Implied equity contribution 110 129 148 167 187 206 Take-out price (p) 135 150 165 180 195 210 Market cap 1,721 1,913 2,104 2,295 2,486 2,678 Net cash -105 -105 -105 -105 -105 -105 EV 1,616 1,808 1,999 2,190 2,381 2,573 EBITDA (FY10f) 137 137 137 137 137 137 Gross debt @ 5x net/debt EBITDA 790 790 790 790 790 790 Net debt 685 685 685 685 685 685 Interest payment @ 6% 47 47 47 47 47 47 as a % of EBITDA 35% 35% 35% 35% 35% 35% Equity portion of the LBO 826 1,018 1,209 1,400 1,591 1,783 as a % of EV 51% 56% 60% 64% 67% 69% Implied equity contribution 83 102 121 140 159 178 Source: ABN AMRO estimates ! Industry stake in ARM: If the first scenario proves too expensive at €190m a head and the second LBO scenario is rejected, it might be more realistic for industry players to do a joint investment, taking around a 30% stake to protect ARM from Intel. A 30% stake would cost about €570m, much more manageable at €57m a head for the top-10 players mentioned earlier. This stake could be increased or reduced, as more industry companies come on board or as the risk of an Intel takeover subsides. ARM | Executive Summary | 7 October 2009 18
  • Revisiting our medium-term forecasts; 40% EBIT margin by 2012/13F We have revised our financial forecasts to reflect three elements: the faster and broader adoption of smartphones, our higher market-share assumptions for ARM in the embedded segment, and initial take-off of ARM’s architecture in notebook PCs from 2011F. Raising FY09/10/11 EPS estimates Overall, we have raised our FY09/10/11 EPS estimates from 4.77p/5.90p/6.10p to 4.94p/6.41p/ 7.99p as shown in the table below. Table 7 : Summary of estimate changes 2009F 2010F 2011F Old New Change Old New Change Old New Change Revenues (£m) 294.5 297.5 1.0% 327.3 342.4 4.6% 348.7 382.7 9.8% Gross margin 90.9% 91.0% +0.1pts 91.2% 90.7% -0.5pts 91.3% 91.3% - EBIT margin 27.6% 28.3% +0.7pts 30.8% 32.0% +1.2pts 33.1% 36.0% +2.9pts Tax rate (%) 25.6% 25.6% - 26.5% 26.5% - 28.0% 27.0% -1pt EPS (p) 4.77 4.94 3.7% 5.90 6.41 8.6% 6.10 7.99 31.0% Source: ABN AMRO forecasts ! The major driver of our forecast changes is the growing proportion of royalties in the mix, driven primarily by the growing adoption of ARM-based chips in smartphones and embedded markets and, to a lesser degree, the nascent success of ARM in netbooks and notebooks. ! As we show in Chart 15, we expect royalties to account for 62% of overall revenue by 2014 versus 49% this year. Given the near 100% gross margin on royalties, the growing proportion of royalties in the mix ought to mechanically lift gross and EBIT margins. ! We raise our medium-term (2011-17) EBIT margin forecast from 37.5% to 43%. Specifically, we expect ARM’s EBIT margin to increase from 28.3% this year to 39.2% in 2012 and 45.1% in 2014. Revenues We forecast 11% revenue CAGR between 2009 and 2014. This is evident in Table 8 and Chart 15 with revenues comprising of Licensing, Royalties, Development Systems and Services. Table 8 : ARM revenue forecasts by products US$m 2008 2009F 2010F 2011F 2012F 2013F 2014F PD 145 123 132 139 146 153 160 YoY growth (%) -11% -15% 7% 5% 5% 5% 5% PIPD 45 39 42 44 46 48 51 YoY growth (%) -18% -13% 7% 5% 5% 5% 5% Licensing 190 162 174 182 192 201 211 YoY growth (%) -13% -14% 7% 5% 5% 5% 5% PD 227 198 262 311 356 398 455 YoY growth (%) 28% -12% 32% 19% 14% 12% 14% PIPD 40 35 43 48 52 58 63 YoY growth (%) 25% -13% 23% 10% 10% 10% 10% Royalties 267 234 305 359 408 456 518 YoY growth (%) 28% -12% 30% 18% 14% 12% 14% Dev Sys 58 52 54 57 60 63 66 YoY growth (%) 5% -10% 5% 5% 5% 5% 5% Services 32 31 32 33 34 35 36 YoY growth (%) -1% -4% 4% 3% 3% 3% 3% Total sales 546 479 565 631 694 755 831 YoY growth (%) 6% -12% 18% 12% 10% 9% 10% Source: Company data, ABN AMRO forecasts ARM | Forecasts & Assumptions | 7 October 2009 19
  • ! Licences: Composed of PD and PIPD licences. We assume a 5% CAGR for both during 2011-14. For 2010, we assume 7% growth in revenue from licences, reflecting a recovery in chip-design R&D cycles and roll-out of the new Cortex-A9 processor. ! Royalties: Composed of PD and PIPD royalties, they make up the bulk of ARM’s revenue. We expect royalties to account for almost 50% of its revenue in 2009. We assume that PIPD royalties will grow at 10% pa between 2011 and 2014, while for 2010 we assume a 23% recovery in revenue yoy, aided by a general recovery in the Semis. PD royalties, which alone account for 41.5% of revenue (FY09F), is composed of royalties from Mobile (75%), Home (6%), Enterprise (13%) and Embedded (6%). See below for assumptions of units versus ASP. We provide detailed forecasts with our underlying assumptions in Table 9. ! Development Systems & Services: For Development Systems as well as Services, we forecast a revenue CAGR of 5% between 2009 and 2014. Chart 14 : ARM revenue split Chart 15 : ARM revenue growth vs EBIT margin (%) 100% 900 50% 90% 800 45% 80% 700 40% 70% 35% 600 60% EBIT margin 30% 500 US$m 50% 25% 400 40% 20% 30% 300 15% 20% 200 10% 10% 100 5% 0% 0 0% 2008 2009F 2010F 2011F 2012F 2013F 2014F 2008 2009F 2010F 2011F 2012F 2013F 2014F Licensing Royalties Dev Sys Services Licensing Royalties Dev Sys Services EBIT margin Source: Company data, ABN AMRO estimates Source: Company data, ABN AMRO estimates PD royalty units The charts below show our forecasts for the PD segment, for which we expect overall unit sales growth of 19% yoy. ARM’s processors are used in four major segments: Wireless (mobile phones and portable equipment like MP3 players), Home (TVs, set-top boxes and DVD players), Enterprise (hard-disk drives, printers, WiFi) and Embedded (microcontrollers and SIM cards). We have split wireless into sub segments: traditional phones, converged devices, netbooks and notebooks. Chart 16 : PD royalty unit shipments Chart 17 : PD royalty revenues Chart 18 : PD ASP per segment 9,000 500 0.25 8,000 450 7,000 400 0.20 6,000 350 m of units 0.15 US cent 5,000 300 US$m 4,000 250 0.10 3,000 200 2,000 150 0.05 1,000 100 0 50 0.00 2008 2010F 2012F 2014F 0 2008 2010F 2012F 2014F 2008 2010F 2012F 2014F Traditional phones Converged devices Traditional phones Converged devices Traditional phones Converged devices Netbooks Notebooks Netbooks Notebooks Netbooks Notebooks Home Entreprise Home Entreprise Home Entreprise Embedded Embedded Embedded Source: Company data, ABN AMRO forecasts Source: Company data, ABN AMRO forecasts Source: Company data, ABN AMRO forecasts ARM | Forecasts & Assumptions | 7 October 2009 20
  • ! Traditional phones: We forecast unit sales growth of 3% per year between 2009 and 2014, mainly in the low-end segment and in emerging markets. Also, we model in an increase in the number of ARM cores per handset from the current average of 1.98 (baseband and bluetooth or media processor) to three (baseband, bluetooth and/or WiFi and/or GPS and/or media processor) by 2014. ! Converged devices: We expect the proliferation of smartphones to continue unabated over the next few years, driven by an increase in end-demand and more aggressive competition from handset OEMs such as Nokia, Motorola, Samsung and LG, who have narrowed the gap with Apple and RIM. We assume a CAGR of 24% between now and 2014 in converged devices. Also, we expect the number of ARM cores per converged device to increase from 2.94 (baseband, apps processor and bluetooth for the most part) in 2009 to 4.1 (baseband, apps processor, bluetooth, WiFi and GPS) by 2014. Chart 19 : Converged devices to drive ARM’s unit sales Chart 20 : iPhone 3G uses 6 ARM cores 1,200 4.50 4.00 1,000 3.50 # of ARM cores per device 800 3.00 m of units 2.50 600 2.00 400 1.50 1.00 200 0.50 0 0.00 2004 2006 2008 2010F 2012F 2014F Traditional mobile phone units Converged device units # of cores/trad. Handset # of cores/converged device Source: Company data, ABN AMRO forecasts Source: Semiconductor Insights ! Netbooks: With the launch of ARM’s Cortex-A9 chip, which addresses the netbook market, we forecast a sales CAGR of 96%, from 2m units in 2009 to 44m units by 2014. We see the number of ARM cores per netbook increasing from 0.06 in 2009 to 0.65 by 2014. ! Notebooks: Cortex-A9 also addresses the low-end consumer notebook market, and in time, by adding extra cores to Cortex-A9, ARM will also be able to address the high-end consumer notebook market. We do not see ARM cracking the enterprise notebook market any time soon, due to the traditional slow adoption by CIOs of new architectures and concerns about legacy. We forecast that ARM’s shipments for consumer notebook manufacturing will jump to 106m units by 2014, implying a CAGR of 84% over 2009-14. Also, we model the number of ARM cores per notebook increasing from 0.03 in 2009 to 0.45 by 2014. ! Home: We forecast ARM shipping 241m units in 2009 and see this figure rising to 402m by 2014, a CAGR of 11%. This is likely to be driven primarily by set-top boxes, TVs and gaming consoles. ! Enterprise: We see ARM’s penetration to be the lowest in the enterprise segment, with a forecast CAGR of 8% between now and 2014, again due to the historical slow adoption by CIOs. ! Embedded: In the embedded market, which is composed mainly of lower-performing MCUs for smartcards and automotives (microcontrollers made of 4-bit, 8-bit, 16-bit and 32-bit units), we foresee ARM gaining 24% of the market by 2014 with unit sales growing from 509m in 2009F to 2,711m in 2014F. This implies a CAGR of 40%. Currently the MCU market is evenly split on number of units between 8-bit and 16-bit shipments; looking to 2014, we see most of the growth occurring in 16-bit, with 8-bit applications being upgraded to 16-bit at low costs but increased performance. ARM | Forecasts & Assumptions | 7 October 2009 21
  • Chart 21 : Embedded market opportunity is huge Chart 22 : Microcontroller market outlook 18,000 80.0% 18,000 16,000 70.0% 16,000 14,000 60.0% Market share (%) 14,000 12,000 50.0% m of units 10,000 12,000 40.0% m of units 8,000 10,000 30.0% 6,000 20.0% 8,000 4,000 2,000 10.0% 6,000 0 0.0% 4,000 2004 2006 2008 2010F 2012F 2014F 2,000 Total MCU market 0 ARM market share of the 16/32-bit MCU market 2004 2006 2008 2010F 2012F 2014F ARM market share of the overall MCU market 16/32-bit MCU units as a % of total units 4-bit 8-bit 16-bit 32-bit Source: WSTS, Company data, ABN AMRO forecasts Source: WSTS, ABN AMRO forecasts PD ASP We believe ASPs for Traditional Phone, Home, Embedded and Enterprise segments will keep declining as they have done historically (this is common in consumer electronics where ASPs decline over time when no new technology innovation occurs). However, we forecast rising ASPs for segments such as Netbooks, Notebooks and Converged Devices, where a lot of innovation is taking place with new IP and functionality being added. Chart 23 : PD ASP outlook 9 9 8 8 7 US$ cent 7 6 6 5 5 4 2004 2005 2006 2007 2008 2009F 2010F 2011F 2012F 2013F 2014F Source: Company data, ABN AMRO estimates The following table shows the overall ASP for ARM, which we forecast will fall 1% yoy, from 5.71c in 2009 to 5.38c in 2014. This 1% yoy decline in ASP is compensated for by much faster growth in unit sales of 19% yoy. ARM | Forecasts & Assumptions | 7 October 2009 22
  • Table 9 : PD royalty split by end markets US$m 2004 2005 2006 2007 2008 2009F 2010F 2011F 2012F 2013F 2014F Mobile 84 97 118 128 164 148 209 257 300 344 401 ASP (US$c) 0.10 0.09 0.07 0.07 0.06 0.07 0.07 0.08 0.08 0.08 0.09 Traditional phones 75 72 78 68 94 51 57 58 56 54 51 ASP (US$c) 0.09 0.08 0.06 0.04 0.04 0.03 0.03 0.02 0.02 0.02 0.02 Converged devices 8 25 40 61 70 97 151 197 241 283 338 ASP (US$c) 0.18 0.18 0.18 0.18 0.18 0.19 0.20 0.21 0.21 0.21 0.22 Netbooks 0 0 0 0 0 0 0 1 2 3 4 ASP (US$c) n.m. n.m. n.m. n.m. n.m. 0.01 0.04 0.05 0.07 0.08 0.09 Notebooks 0 0 0 0 0 0 0 0 2 4 7 ASP (US$c) n.m. n.m. n.m. n.m. n.m. n.m. 0.01 0.02 0.03 0.05 0.07 Home 4 8 11 12 16 12 12 12 13 13 13 ASP (US$c) 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.04 0.04 0.04 0.03 Enterprise 17 24 29 26 30 26 24 22 20 19 17 ASP (US$c) 0.07 0.07 0.07 0.07 0.06 0.05 0.04 0.04 0.03 0.03 0.02 Embedded 2 3 6 11 16 12 17 20 22 23 24 ASP (US$c) 0.03 0.03 0.03 0.03 0.03 0.02 0.02 0.02 0.01 0.01 0.01 Total 107.0 130.7 164.1 176.6 226.5 198.5 261.5 311.3 355.7 398.5 454.7 PD royalty average (US$c) 8.41 7.87 6.70 6.11 5.69 5.71 5.84 5.75 5.60 5.44 5.38 Source: Company data, ABN AMRO forecasts Margins analysis ! Cost of sales: We forecast ARM’s gross margin in 2009 at 91%, rising to 92.5% by 2014. The company’s high gross margin is due to its licensing business model. ! R&D: We assume R&D expenses will grow at 40% of the company’s overall growth rate (in US$ terms) in 2010 and at 50% in 2011 and thereafter. ! S&M: We assume ARM’s S&M expenses will grow at 40% of the company’s overall growth rate (in US$ terms) in 2010 and at 50% in 2011 and thereafter. ! G&A: We model ARM’s G&A expense will grow at 50% of the company’s overall growth rate (in US$ terms) in 2010 and at 33% in 2011 and thereafter. Chart 24 : Gross margin Chart 25 : EBIT margin 600 93.0% 300 50.0% 45.0% 500 92.0% 250 40.0% 91.0% 35.0% 200 400 30.0% 90.0% £m 150 25.0% £m 300 89.0% 20.0% 100 15.0% 200 88.0% 10.0% 50 100 5.0% 87.0% 0 0.0% 2004 2005 2006 2007 2008 2009F 2010F 2011F 2012F 2013F 2014F 0 86.0% 2004 2005 2006 2007 2008 2009F 2010F 2011F 2012F 2013F 2014F R&D Expenses Sales & marketing Expenses Total sales Total Gross Margin (%) General and administration EBIT margin Source: Company data, ABN AMRO estimates Source: Company data, ABN AMRO forecasts ARM | Forecasts & Assumptions | 7 October 2009 23
  • Financial statements Table 10 : Revenue model, FY2007A – FY2014F, in £ millions FY07 FY08 1Q09 2Q09 3Q09F 4Q09F FY09F FY10F FY11F FY12F FY13F FY14F PD licences (£m) 83.439 79.330 19.600 16.800 18.182 19.394 73.976 80.023 84.024 88.225 92.637 97.268 YoY Change 10% -5% 7% 10% -5% -27% -7% 8% 5% 5% 5% 5% PIPD licenses (£m) 27.492 24.196 5.400 5.200 6.061 6.667 23.327 25.291 26.555 27.883 29.277 30.741 YoY Change -21% -12% -8% -19% 8% 6% -4% 8% 5% 5% 5% 5% PD royalties Units (m) 2,890 3,981 834 728 882 1,032 3,476 4,479 5,414 6,355 7,325 8,449 YoY Change 18% 38% -6% -18% -12% -14% -13% 29% 21% 17% 15% 15% ASP (p) 3.08 3.08 4.28 3.52 3.40 3.37 3.61 3.54 3.48 3.39 3.30 3.26 ASP (c) 6.11 5.69 6.03 5.67 5.62 5.55 5.71 5.84 5.75 5.60 5.44 5.38 Unit split Wireless 1931 2616 525 473 565 646 2209 2877 3355 3756 4158 4577 YoY Change 20% 35% -16% -20% -13% -14% -16% 30% 17% 12% 11% 10% Total phone shipments 1094 1244 305 255 268 286 1114 1214 1275 1339 1406 1476 YoY Change 17% 14% -9% -14% -12% -8% -10% 9% 5% 5% 5% 5% # of cores/trad. Handset 1.76 2.10 1.72 1.86 2.10 2.25 1.98 2.35 2.60 2.75 2.88 3.00 PD unit shipments in cell phones (m of units) 1931 2616 525 473 563 644 2209 2854 3315 3681 4048 4428 Converged device units 110 154 48 38 41 51 178 216 255 293 331 381 YoY Change 46% 40% 24% 12% 12% 16% 16% 21% 18% 15% 13% 15% % of total handset market 10% 12% 16% 15% 15% 18% 16% 18% 20% 22% 24% 26% # of cores/converged device 3.10 2.59 2.80 2.90 3.00 3.05 2.94 3.50 3.75 3.90 4.00 4.10 PD unit shipments in Converged Devices 340 397 134 110 123 156 524 756 956 1,144 1,325 1,562 ASP (US$) 0.18 0.18 0.19 0.19 0.20 0.21 0.21 0.21 0.22 Traditional mobile phone units 984 1,090 257 217 227 235 936 998 1,020 1,045 1,074 1,095 # of core/cell phone 1.62 2.03 1.52 1.67 1.94 2.08 1.79 2.10 2.31 2.43 2.53 2.62 PD unit shipments in trad. phones (m of units) 1,591 2,219 391 363 440 487 1,678 2,098 2,359 2,538 2,723 2,865 Netbook market (m of units) 5.00 6.00 7.00 7.00 25.0 33.0 45.0 51.0 59.0 67.0 ARM-based % of total 0% 1% 4% 6% 3% 15% 20% 25% 30% 35% ARM-based netbooks (m of units) 0.00 0.06 0.28 0.42 0.8 5.0 9.0 12.8 17.7 23.5 # of ARM-based chips per netbook 0.03 0.04 0.07 0.09 0.06 0.23 0.34 0.45 0.55 0.65 ASP (US$) 0.00 0.00 0.01 0.01 0.01 0.04 0.05 0.07 0.08 0.09 Incremental units (m) 0 0 0 1 2 8 15 23 32 44 Incremental US$m PD royalties 0.00 0.00 0.01 0.01 0.02 0.28 0.78 1.51 2.60 4.09 Notebook PC market (m of units) 38.00 39.00 44.00 47.00 168 180 192 206 220 236 ARM-based % of total 0% 0% 0% 0% 0% 0% 1% 3% 5% 30% ARM-based notebooks (m of units) 0.00 0.00 0.00 0.00 0 0 2 6 11 71 # of ARM-based chips per notebook 0.03 0.03 0.03 0.03 0.03 0.09 0.13 0.25 0.35 0.45 ASP (US$) 0.00 0.00 0.00 0.00 0.00 0.01 0.02 0.03 0.05 0.07 Incremental units (m) 1 1 1 1 5 16 25 51 77 106 Incremental US$ PD royalties 0.00 0.00 0.00 0.00 0.01 0.14 0.43 1.60 3.85 7.32 Non-wireless 959 1365 309 255 317 387 1267 1602 2059 2599 3167 3872 YoY Change 14% 42% 16% -16% -9% -13% -7% 26% 29% 26% 22% 22% PD royalty split by end markets (US$m) Mobile 128 164 38 31 37 42 148 209 257 300 344 401 ASP (c) 0.07 0.06 0.07 0.07 0.07 0.07 0.07 0.07 0.08 0.08 0.08 0.09 Sources: Company data; ABN AMRO forecasts ARM | Financial Statements | 7 October 2009 24
  • Table 10 : Revenue model, FY2007A – FY2014F, in £ millions (cont’d) FY07 FY08 1Q09 2Q09 3Q09F 4Q09F FY09F FY10F FY11F FY12F FY13F FY14F Home 12 16 3 2 3 4 12 12 12 13 13 13 ASP © 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.05 0.04 0.04 0.04 0.03 Enterprise 26 30 6 6 6 8 26 24 22 20 19 17 ASP © 0.07 0.06 0.05 0.05 0.05 0.05 0.05 0.04 0.04 0.03 0.03 0.02 Embedded 11 16 3 2 3 4 12 17 20 22 23 24 ASP © 0.03 0.03 0.03 0.03 0.02 0.02 0.02 0.02 0.02 0.01 0.01 0.01 Total 176.6 226.5 50.3 41.3 49.5 57.3 198.5 261.5 311.3 355.7 398.5 454.7 PD royalty average 6.11 5.69 6.03 5.68 5.62 5.55 5.71 5.84 5.75 5.60 5.44 5.38 PD royalties (£m) 87.6 125.4 35.100 26.8 30.01 34.7 126.7 158.5 188.6 215.6 241.5 275.6 YoY Change -1% 43% 26% 4% 3% -18% 1% 25% 19% 14% 12% 14% PIPD royalties (£m) 16.339 21.789 5.518 4.900 5.455 6.273 22.1 26.203 28.823 31.705 34.876 38.363 YoY Change -15% 33% 17% 0% -8% -7% 2% 18% 10% 10% 10% 10% Development systems (£m) 27.956 31.297 10.000 6.500 7.879 8.485 32.9 33.027 34.679 36.413 38.233 40.145 Total licensing (£m) 110.9 103.5 25.0 22.0 24.2 26.1 97.3 105.3 110.6 116.1 121.9 128.0 Total royalties (£m) 103.9 147.2 40.6 31.7 35.5 41.0 148.8 184.7 217.5 247.3 276.4 313.9 Total products 242.8 282.0 75.6 60.2 67.6 75.6 279.0 323.0 362.7 399.8 436.5 482.1 YoY Change -1.8% 16.1% 18% -1% 0% -16% -1.1% 15.8% 12.3% 10.2% 9.2% 10.4% Services 16.434 16.552 4.285 4.576 4.848 4.848 18.558 19.394 20.000 20.606 21.212 21.818 YoY Change 2% 1% 5% 8% 22% 14% 12% 5% 3% 3% 3% 3% Total sales 259.233 298.957 79.903 64.776 72.435 80.409 297.523 342.440 382.722 420.421 457.731 503.896 YoY Change -1.5% 15.3% 18% 0% 1% -15% -0.5% 15.1% 11.8% 9.9% 8.9% 10.1% Sources: Company data; ABN AMRO forecasts Table 11 : Income statement, FY07A – FY2014F, in £ millions FY07 FY08 1Q09 2Q09 3Q09F 4Q09F FY09F FY10F FY11F FY12F FY13F FY14F Total sales 259.233 298.957 79.903 64.776 72.435 80.409 297.523 342.440 382.722 420.421 457.731 503.896 Total Gross Profit 232.171 267.158 72.058 59.081 66.119 73.579 270.837 310.603 349.438 385.631 421.371 465.900 Total Gross Margin (%) 89.6% 89.4% 90.2% 91.2% 91.3% 91.5% 91.0% 90.7% 91.3% 91.7% 92.1% 92.5% R&D Expenses 61.872 65.820 21.846 22.487 22.214 22.214 88.762 95.174 100.772 105.735 110.427 115.995 Sales & marketing Expenses 43.038 47.357 12.380 11.571 11.431 11.431 46.812 50.194 53.146 55.764 58.238 61.175 General and administration 45.922 56.426 14.281 9.038 13.830 13.830 50.979 55.582 57.762 59.658 61.423 63.488 Total operating expenses 150.832 169.603 48.507 43.096 47.475 47.475 186.553 200.951 211.680 221.157 230.088 240.659 EBIT 81.339 97.555 23.551 15.985 18.644 26.104 84.284 109.652 137.758 164.474 191.283 225.242 EBIT margin 31.4% 32.6% 29.5% 24.7% 25.7% 32.5% 28.3% 32.0% 36.0% 39.1% 41.8% 44.7% Acquisition-related charge -18.400 -18.400 Interest 5.402 3.246 0.373 0.291 0.300 0.310 1.274 1.550 1.810 2.200 2.400 2.600 PBT 86.741 100.801 23.924 16.276 18.944 26.414 85.558 111.202 139.568 166.674 193.683 227.842 Tax 22.920 28.076 6.332 4.017 4.831 6.735 21.915 29.469 37.683 45.002 52.294 61.517 Tax rate 26% 28% 26% 25% 26% 26% 26% 27% 27% 27% 27% 27% Earnings 63.821 72.725 17.592 12.259 14.114 19.678 63.643 81.734 101.885 121.672 141.389 166.324 Number of shares 1362 1289 1278 1290 1290 1290 1287 1275 1275 1275 1275 1275 EPS Norm 4.68 5.64 1.38 0.95 1.09 1.53 4.94 6.41 7.99 9.54 11.09 13.05 Exchange rate assumptions GBPUS$ 1.98 1.85 1.41 1.61 1.65 1.65 1.58 1.65 1.65 1.65 1.65 1.65 Sources: Company data; ABN AMRO forecasts ARM | Financial Statements | 7 October 2009 25
  • ARM | Financial Statements | 7 October 2009 26
  • ARM | Financial Statements | 7 October 2009 27
  • Income statement £m FY07A FY08A FY09F FY10F FY11F Revenue 259.2 299.0 297.5 342.4 382.7 Cost of sales -27.1 -31.8 -26.7 -31.8 -33.3 Operating costs -123.9 -143.0 -159.6 -174.0 -184.7 EBITDA 108.2 124.2 111.3 136.7 164.8 DDA & Impairment (ex gw) -26.9 -26.6 -27.0 -27.0 -27.0 EBITA (1) 81.3 97.6 84.3 109.7 137.8 Goodwill (amort/impaired) n/a n/a n/a n/a n/a EBIT 81.3 97.6 84.3 109.7 137.8 Net interest (2) 5.40 3.25 1.27 1.55 1.81 Associates (pre-tax) (3) n/a n/a n/a n/a n/a Other pre-tax items (4) 0.00 0.00 0.00 0.00 0.00 Reported PTP 86.7 100.8 85.6 111.2 139.6 Taxation -22.9 -28.1 -21.9 -29.5 -37.7 Minority interests n/a n/a n/a n/a n/a Other post-tax items 0.00 0.00 0.00 0.00 0.00 Reported net profit 63.8 72.7 63.6 81.7 101.9 Tot normalised items 0.00 0.00 0.00 0.00 0.00 Normalised EBITDA 108.2 124.2 111.3 136.7 164.8 Normalised PTP 86.7 100.8 85.6 111.2 139.6 Normalised net profit 63.8 72.7 63.6 81.7 101.9 Source: Company data, ABN AMRO forecasts year to Dec Balance sheet £m FY07A FY08A FY09F FY10F FY11F Cash & market secs (1) 51.3 78.8 105.5 141.6 196.2 Other current assets 90.2 114.9 98.4 110.6 121.2 Tangible fixed assets 12.0 16.2 17.0 17.0 17.0 Intang assets (incl gw) 384.0 507.1 475.1 475.1 475.1 Oth non-curr assets 19.0 22.0 18.0 18.0 18.0 Total assets 556.7 739.1 714.0 762.2 827.5 Short term debt (2) 0.00 0.00 0.00 0.00 0.00 Trade & oth current liab 27.9 60.8 56.3 56.6 57.0 Long term debt (3) 0.00 0.00 0.00 0.00 0.00 Oth non-current liab 35.0 48.2 n/m n/m n/m Total liabilities 62.9 109.0 48.5 45.9 43.2 Total equity (incl min) 493.7 630.1 665.5 716.3 784.3 Total liab & sh equity 556.7 739.1 714.0 762.2 827.5 Net debt -51.3 -78.8 -105.5 -141.6 -196.2 Source: Company data, ABN AMRO forecasts year ended Dec Cash flow statement £m FY07A FY08A FY09F FY10F FY11F EBITDA 108.2 124.2 111.3 136.7 164.8 Change in working capital -6.03 24.5 -5.63 -11.8 -10.4 Net interest (pd) / rec 5.40 3.25 1.27 1.55 1.81 Taxes paid -22.9 -28.1 -21.9 -29.5 -37.7 Other oper cash items -24.9 -23.4 -20.0 -20.0 -20.0 Cash flow from ops (1) 59.8 100.5 65.0 77.0 98.5 Capex (2) -4.66 -7.24 -5.00 -5.00 -5.00 Disposals/(acquisitions) 0.00 0.00 0.00 0.00 0.00 Other investing cash flow 32.2 -5.44 -5.00 -5.00 -5.00 Cash flow from invest (3) 27.5 -12.7 -10.0 -10.0 -10.0 Incr / (decr) in equity -109.7 -34.7 0.00 0.00 0.00 Incr / (decr) in debt n/a n/a n/a n/a n/a Ordinary dividend paid -27.2 -28.4 -31.1 -33.9 -37.3 Preferred dividends (4) 0.00 0.00 0.00 0.00 0.00 Other financing cash flow -18.5 -26.4 -28.3 -30.9 -33.9 Cash flow from fin (5) -155.5 -89.4 -59.5 -64.8 -71.3 Forex & disc ops (6) n/a n/a n/a n/a n/a Inc/(decr) cash (1+3+5+6) -68.1 -1.61 -4.45 2.15 17.3 Equity FCF (1+2+4) 55.1 93.3 60.0 72.0 93.5 Lines in bold can be derived from the immediately preceding lines. year to Dec Source: Company data, ABN AMRO forecasts ARM | Key Financial Data | 7 October 2009
  • Standard ratios ARM CSR Wolfson Microelectronics Performance FY07A FY08A FY09F FY10F FY11F FY09F FY10F FY11F FY09F FY10F FY11F Sales growth (%) -1.53 15.3 -0.48 15.1 11.8 -13.4 32.3 12.1 -36.0 20.0 16.0 EBITDA growth (%) -1.49 14.7 -10.4 22.8 20.6 -51.6 159.5 23.6 n/a n/a 96.6 EBITA growth (%) -2.18 19.9 -13.6 30.1 25.6 -72.8 409.9 31.5 n/a -56.1 n/a Normalised EPS growth (%) -7.60 20.4 -12.4 29.7 24.7 -73.4 229.2 27.3 n/a -61.7 n/a EBITDA margin (%) 41.8 41.5 37.4 39.9 43.0 7.71 15.1 16.7 -0.25 4.00 6.79 EBITA margin (%) 31.4 32.6 28.3 32.0 36.0 2.95 11.4 13.3 n/m n/m 2.82 Net profit margin (%) 24.6 24.3 21.4 23.9 26.6 3.08 8.85 10.1 -6.83 -2.18 2.66 Return on avg assets (%) 9.90 10.9 8.63 10.9 12.7 2.09 7.18 8.41 -4.83 -2.12 1.68 Return on avg equity (%) 11.9 12.9 9.82 11.8 13.6 3.02 8.84 10.2 -5.03 -1.99 2.81 ROIC (%) 11.3 12.6 11.6 12.9 14.2 6.24 18.1 20.4 10.4 14.8 20.5 ROIC - WACC (%) 2.31 3.63 2.58 3.92 5.23 -2.76 9.14 11.4 -0.62 3.77 9.43 year to Dec year to Dec year to Dec Valuation EV/sales (x) 6.90 5.89 5.83 4.96 4.30 1.14 0.85 0.67 1.05 0.80 0.66 EV/EBITDA (x) 16.5 14.2 15.6 12.4 9.98 14.8 5.64 4.01 n/m 20.1 9.69 EV/EBITDA @ tgt price (x) 20.9 18.0 19.9 15.9 12.9 18.6 7.10 5.19 n/m 12.4 5.78 EV/EBITA (x) 22.0 18.1 20.6 15.5 11.9 38.8 7.51 5.02 n/m n/m 23.3 EV/invested capital (x) 2.63 2.18 2.03 1.88 1.72 1.88 1.59 1.37 0.69 0.64 0.57 Price/book value (x) 3.95 2.93 2.77 2.55 2.32 1.39 1.47 1.33 1.34 1.36 1.33 Equity FCF yield (%) 2.83 5.06 3.26 3.95 5.13 4.38 0.97 6.85 0.35 -1.74 1.99 Normalised PE (x) 30.5 25.3 28.9 22.3 17.9 58.5 17.8 14.0 n/m n/m 47.9 Norm PE @ tgt price (x) 38.4 31.9 36.4 28.1 22.5 68.0 20.7 16.2 n/m n/m 37.9 Dividend yield (%) 1.40 1.54 1.69 1.86 2.05 0.00 0.00 0.00 0.00 0.00 0.00 year to Dec year to Dec year to Dec Per share data FY07A FY08A FY09F FY10F FY11F Solvency FY07A FY08A FY09F FY10F FY11F Tot adj dil sh, ave (m) 1362 1289 1287 1275 1275 Net debt to equity (%) -10.4 -12.5 -15.9 -19.8 -25.0 Reported EPS (p) 4.68 5.64 4.94 6.41 7.99 Net debt to tot ass (%) -9.22 -10.7 -14.8 -18.6 -23.7 Normalised EPS (p) 4.68 5.64 4.94 6.41 7.99 Net debt to EBITDA -0.47 -0.63 -0.95 -1.04 -1.19 Dividend per share (p) 2.00 2.20 2.42 2.66 2.93 Current ratio (x) 5.07 3.19 3.62 4.45 5.57 Equity FCF per share (p) 4.05 7.24 4.66 5.64 7.34 Operating CF int cov (x) -14.3 -38.6 -67.2 -67.7 -74.3 Book value per sh (p) 36.2 48.9 51.7 56.2 61.5 Dividend cover (x) 2.34 2.56 2.06 2.38 2.70 year to Dec year to Dec Priced as follows: ARM.L - £1.43; CSR.L - £4.30; WLF.L - £1.23 Source: Company data, ABN AMRO forecasts Valuation methodology Economic Profit Valuation £m % Discounted Cash Flow Valuation £m % Adjusted Opening Invested Capital 135.3 6 Value of Phase 1: Explicit (2009 to 2010) 81.9 4 NPV of Economic Profit During Explicit Period 75.3 3 Value of Phase 2: Value Driver (2011 to 2017) 545.1 24 NPV of Econ Profit of Remaining Business (1, 2) 894.6 40 Value of Phase 3: Fade (2018 to 2042) 1100.4 49 NPV of Econ Profit of Net Inv (Grth Business) (1, 3) 1128.6 51 Terminal Value 511.8 23 Enterprise Value 2233.7 100 Enterprise Value 2239.1 100 Plus: Other Assets 0.0 0 FCF Grth Rate at end of Phs 1 implied by DCF Valuation 5.8 Less: Minorities 0.9 0 FCF Grth Rate at end of Phs 1 implied by Current Price 3.5 Less: Net Debt (as at 06 Oct 2009) -78.8 -4 Equity Value 2311.6 103 Returns, WACC and NPV of Free Cash Flow No. Shares (millions) 1287.2 100% 90 Per Share Equity Value 1.80 90% 80 Current Share Price 1.43 80% 70 70% 60 Sensitivity Table No of Years in Fade Period 60% 50 #REF! 20 25 30 35 40 50% 40 7.0% 1.88 2.30 2.81 3.39 3.91 40% 30 WACC 8.0% 1.68 2.02 2.43 2.88 3.27 30% 20 9.0% 1.52 1.80 2.12 2.46 2.77 10.0% 1.38 1.60 1.85 2.12 2.35 20% 10 11.0% 1.25 1.43 1.64 1.85 2.02 10% 0 0% (10) 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 Performance Summary Phase 2 Avg 2009 2010 2011 (2011 - 2017) Phase 1 NPV of FCF (RHS) Phase 2 NPV of FCF (RHS) Invested Capital Growth (%) -10.4 9.0 16.9 16.9 Phase 3 NPV of FCF (RHS) Total Business ROIC Growth Business ROIC Remaining Business ROIC Operating Margin (%) 28.2 36.9 36.0 42.7 WACC Capital Turnover (x) 2.0 2.3 2.7 2.7 Source: ABN AMRO 1. In periods following the Explicit Period i.e. Phase 2 and Phase 3 2. Remaining Business is defined as Capital as at the end of Phase 1 and capex = depreciation thereafter 3. Net Investment is defined as capex over and above depreciation after Phase 1 ARM | Performance and Valuation | 7 October 2009
  • Company description Buy Price relative to sector ARM is the world's leading semiconductor IP company focusing on the market for embedded microprocessors. 200 ARM designs and supports IP cores for microprocessors and sells development kits for system development. 180 ARM's revenue streams are based on a licence fee up-front for the IP, then a royalty stream based on chips shipped with their IP in the design. 160 140 120 100 80 Oct Jan May Aug Dec Mar Jul Nov Feb Jun Sep 06 07 07 07 07 08 08 08 09 09 09 Strategic analysis Average SWOT company score: 4 Revenue split, FY08 Strengths 5 16% Highly cash-generative business model; strong long-term growth driven by portable electronics and digital 35% convergence requiring low power consumption and higher performance; undisputed 16/32 embedded processor IP company with 90% market share in cell phones among others. 49% Weaknesses 3 Licenses Royalties Others Despite its fundamental role for the semiconductor industry, we believe ARM does not capture enough of the revenue opportunity related to its business. Source: Company data Opportunities 4 With the Artisan acquisition, ARM will expand its scope outside of the embedded processor space and address Market data the majority of SoC design outside of the DSP. This should help accelerate ARM's long-term growth rate and improve margin and cash generation. Headquarters 110 Fulbourn Rd, Cambridge, UK CB1 9NJ. Threats 4 Website Beyond MIPS, there is little competition for ARM's processor, as it is now the de facto standard. Risks are more www.arm.com associated with the success of the Artisan acquisition and the perceived longer design cycle putting pressure on Shares in issue 1287.2m the royalty rate. Freefloat Scoring range is 1-5 (high score is good) 100% Majority shareholders Janus (13%), Thornburg (8%), Capital Group (6%) Sector view Underweight Sector rel to Europe We have reduced our Underweight on IT but remain concerned about a number of issues. It has re-rated to a 110 substantial premium against the market and other cyclical sectors. With de-stocking yet to fully play out and 105 consumer demand in question, we prefer other sectors for cyclical exposure. 100 The sector view is set in consultation with the relevant company analyst but is the ultimate responsibility of the Strategy Team. 95 90 85 80 Oct Jan May Aug Dec Apr Jul Nov Feb Jun Sep 06 07 07 07 07 08 08 08 09 09 09 Industry competitive position Average competitive score: 3- Broker recommendations Supplier power 3- 14 Chip suppliers have little pricing power in general, except when global capacity is tight. The pricing of application- 12 specific chips tends to be less volatile than that of general-purpose chips. 10 Barriers to entry 2+ 8 6 Barriers to entry have come down within the past five years due to the emergence of the fabless/foundry model. 4 Customer power 2- 2 Customers of the chip industry have increased their pricing power due to the consolidation of several OEMs, 0 distributors and EMS. Buy Hold Sell Substitute products 5+ Source: Bloomberg There are no substitute products for semiconductor chips. Rivalry 2- There is intense competition within this industry. Scoring range 1-5 (high score is good) Plus = getting better Minus = getting worse ARM | Strategic and Competitive Overview | 7 October 2009
  • Recommendation structure Absolute performance, short term (trading) recommendation: A Trading Buy recommendation implies upside of 5% or more and a Trading Sell indicates downside of 5% or more. The trading recommendation time horizon is 0-60 days. For Australian coverage, a Trading Buy recommendation implies upside of 5% or more from the suggested entry price range, and a Trading Sell recommendation implies downside of 5% or more from the suggested entry price range. The trading recommendation time horizon is 0-60 days. Absolute performance, long term (fundamental) recommendation: The recommendation is based on implied upside/downside for the stock from the target price. A Buy/Sell implies upside/downside of 10% or more and a Hold less than 10%. For UK Small/Mid-Cap Analysis a Buy/Sell implies upside/downside of 10% or more, an Add/Reduce 5-10% and a Hold less than 5%. For UK-based Investment Funds research the recommendation structure is not based on upside/downside to the target price. Rather it is the subjective view of the analyst based on an assessment of the resources and track record of the fund management company. For listed property trusts (LPT) or real estate investment trusts (REIT) the recommendation is based upon the target price plus the dividend yield, ie total return. Performance parameters and horizon: Given the volatility of share prices and our pre-disposition not to change recommendations frequently, these performance parameters should be interpreted flexibly. Performance in this context only reflects capital appreciation and the horizon is 12 months. Sector relative to market: The sector view relative to the market is the responsibility of the strategy team. Overweight/Underweight implies upside/downside of 10% or more and Neutral implies less than 10% upside/downside. Target price: The target price is the level the stock should currently trade at if the market were to accept the analyst's view of the stock and if the necessary catalysts were in place to effect this change in perception within the performance horizon. In this way, therefore, the target price abstracts from the need to take a view on the market or sector. If it is felt that the catalysts are not fully in place to effect a re-rating of the stock to its warranted value, the target price will differ from 'fair' value. Distribution of recommendations The tables below show the distribution of ABN AMRO's recommendations (both long term and trading). The first column displays the distribution of recommendations globally and the second column shows the distribution for the region. Numbers in brackets show the percentage for each category where ABN AMRO has an investment banking relationship. Long Term recommendations (as at 06 Oct 2009) Trading recommendations (as at 06 Oct 2009) Global total (IB%) Europe total (IB%) Global total (IB%) Europe total (IB%) Buy 509 (4) 152 (12) Trading Buy 1 (0) 0 (0) Add 0 (0) 0 (0) Hold 383 (3) 154 (6) Reduce 0 (0) 0 (0) Sell 129 (0) 45 (0) Trading Sell 0 (0) 0 (0) Total (IB%) 1021 (3) 351 (8) Total (IB%) 1 (0) 0 (0) Source: ABN AMRO Source: ABN AMRO Valuation and risks to target price ARM (RIC: ARM.L, Rec: Buy, CP: £1.43, TP: £1.80): Downside risks to our investment case and target price include: 1) substantially weaker end-demand than we model, particularly in the smartphone market; 2) Less succesful uptake of Google's operating system (OS) in the PC market, hindering ARM's progress; 3) inventory build-up in the supply chain leading to much weaker-than-expected 2010 semiconductor industry growth (our estimate +14.5%), and 4) materially higher GBP/USD rates than our assumption of 1.65x. ARM coverage data Stock performance, recommendations and coverage (as at 6 Oct 2009) Trading recommendation history (as at 06 Oct 2009) Date Rec Analyst n/a Source: ABN AMRO Didier Scemama started covering this stock on 18 Aug 04 Moved to new recommendation structure between 1 November 2005 and 31 January 2006 Source: ABN AMRO Regulatory disclosures Subject companies: ARM.L RBS expects to receive, or intends to seek, compensation during the next three months for investment banking services from this company, its subsidiaries or affiliates.: ARM.L ABN AMRO currently maintains a market in the security of this company and otherwise purchases and sells securities of this company as principal: ARM.L ARM | Disclosures Appendix | 7 October 2009
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On a general basis, the efficacy of recommendations is a factor in the performance appraisals of analysts. ____________________________________________________________________________________________________________________________________________________ For a discussion of the valuation methodologies used to derive our price targets and the risks that could impede their achievement, please refer to our latest published research on those stocks at www.abnamroresearch.com. Disclosures regarding companies covered by ABN AMRO group can be found on ABN AMRO's research website at www.abnamroresearch.com. ABN AMRO's policy on managing research conflicts of interest can be found at https://www.abnamroresearch.com/Disclosure/Disclosure.AspX?MI=5. Should you require additional information please contact the relevant ABN AMRO research team or the author(s) of this report. ARM | Disclosures Appendix | 7 October 2009