Royalty rate increase is the main growth driver
No doubt about it, the smartphone market will be weaker than expected. However, higher royalty
rate per chip from migration to 64-Bit / Multicores / big.LITTLE is the main growth driver for ARM,
not unit volumes. The recent sell-off opens a great buying opportunity.
Cutting our smartphone market forecasts
Our Telecom Equipment team has updated its forecasts for the global smartphone market post
Gartner’s Q2 15 update. It now expects a 13% rise in smartphone volumes to 1.4bn units
(previously +15% to 1.48bn) and a modest 6% growth in 2016 to 1.48bn. This essentially translates
the impact of a weaker Chinese market but also a weaker US market in 2016 as lower operator
subsidies will depress the replacement rate.
Fine tuning our model: EPS cut by 4% on 2016 and 3% on 2017
We have cut our 2016–17 EPS to reflect the weaker smartphone market. Importantly, the biggest
hit to smartphone volumes will be at the low end (3G China), where royalties are 3–4x lower than
at the high end. We assume the high-end smartphone market will hold roughly flat this year and so
have made negligible changes at Apple and only minor cuts at Samsung.
Investment thesis unchanged
Despite fears on end-demand, namely in China, we reiterate our view that ARM’s revenue growth
will be driven essentially by 64-Bit migration in 2015–16 and by Octacore in 2016–17. Beyond that,
we see Networking as the most promising and substantial opportunity for ARM and expect it to
constitute the next source of growth. The stock is now trading at 26.3x 2016 EPS; a level not seen
since 2009. We view the sell-off as a great buying opportunity. We have cut our DCF-based TP by
4% to 1,300p and reiterate our Outperform rating.