U.K. Tech Giant Worries About Growth

LONDON -- If you were looking for the leading U.K.-listed technology company, then I suspect ARM Holdings (NAS: ARMH) would be right at the top of your list.

Cambridge-based ARM is a great British success story. After listing in London in 1998, ARM has risen to become one of the world's leading chip designers, as well as a member of the blue chip FTSE 100 index of elite British businesses.

ARM designs and licenses (but doesn't manufacture) chips for the likes of Apple (NAS: AAPL) and, from June 2012, Microsoft (NAS: MSFT) . ARM's chips power the latest smartphones and tablet computers, two of the hottest tech sectors right now.

As it doesn't make chips, ARM relies on license sales and ongoing royalty payments when gadget makers use its chip designs. However, in its first-quarter results released this morning, ARM warned that its go-go growth is coming off the boil.

In the first three months of 2012, ARM's revenues exceeded $209 million (130 million pounds), up 13% year on year. In addition, its super-high operating margins climbed yet further to 44.5%, from 42.5% in the first quarter of 2011.

As a result, ARM's profit before tax surged 22% to nearly 62 million pounds, with earnings per share leaping 23% to 3.36 pence. This helped the high-tech firm to generate net cash of more than 58 million pounds in the quarter, versus 63 million pounds in Q1 2011.

High-tech hero
Despite these strong results, ARM's share price slipped as investors sold out. As I write, ARM shares trade at 539 pence, down almost 5% on Monday's close. This values the group at 7.3 billion pounds, which is a very hefty valuation for a business with total revenues below 500 million pounds in 2011.

Indeed, ARM's lofty valuation explains today's share slide. Investors in high-tech firms have high expectations of future growth, so are easily spooked when results aren't as sparkling as hoped. Hence, when ARM warned of "broadly flat" growth in revenues in this quarter, investors sold out.

In the first three months of this year, 1.1 billion ARM chips were placed in mobile phones and computers, broadly in line with a year ago. In addition, ARM shipped 0.8 billion chips in "consumer and embedded digital devices," up 15% in a year.

Then again, despite its disappointing forecasts for the second quarter, ARM expects "a good pick-up" in the second half of 2012, as the wider industry grows again.

ARMed and dangerous?
Like almost all of its high-tech peers, ARM enjoys ratings far above market norms.

At 539 pence, its shares trade on a forecast price-to-earnings ratio above 40 and offer a tiny prospective dividend of 0.7%, covered 3.4 times. While these fundamentals would be a sell signal in other sectors, they are fairly standard for top tech firms.

Even so, I can't recommend a purchase of ARM, as any further disappointments could see its shares dive below 500 pence. Then again, there have long been rumors that ARM could be taken over by its giant U.S. rival Intel (NAS: INTC) .

Hence, anyone buying into ARM now is taking a big punt on growth returning to previous levels, or on the U.K.'s No. 1 tech business falling into American hands. Rather you than me!

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At the time thisarticle was published Cliff D'Arcy owns no shares of the companies mentioned. The Motley Fool owns shares of Microsoft and Intel. The Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Intel, Microsoft, and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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