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Nomura gives ARM Holdings shares a good kicking

Does not believe in miracles

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Amazing what a research note can do to a company's shares: yesterday chip designer ARM Holdings fell eight per cent on publication of a sell recommendation from Nomura.

In a note to clients, "Do you believe in miracles", Nomura said: "The key element of our negative stance is the unrealistic market share assumption in the current valuation. The issue is the finite number of potential licensees and the low (probably falling) average unit of royalty earned by the company. In addition there are several serious competitive threats at both ends of ARM's target market."

And just to make sure we get the message Nomura says: "It would be little short of miraculous if ARM achieved the share assumptions implicit in the share price." Analysts like this ARM can do without. However, Nomura has injected a useful dose of reality into coverage of this awesomely priced business, still worth £8.6 billion after yesterday's fall.

Its analysts may be unduly bearish on the limited number of potential licensees. The market which ARM designs for - low-powered and embeds for mobile phones, handhelds and the like - should expand exponentially, probably for ever (so long as human beings walk this planet).

And ARM may succeed in its aim to branch out into different sectors and applications - the company is making a big play for automotive sector, for instance. It could also scoop up other chip intellectual property plays - in the UK, there is Imagination, for example. Alternatively, it could go out and buy a subbie - the major one here is Cadence - which make heaps of money doing the dirty design work for the Intels and the IBMs, but do not own the IP rights.

Low Power Play

ARM owns great technology and vendors are happy to license the technology from a friendly, unthreatening company, in a way that they wouldn't if it were, say, Intel that was doing the licensing. But the company is also a classic momentum stock - it shares this characteristic with Qualcomm and Rambus, two more patent-heavy, license-doling companies ARM's share price goes up because it goes up.

The company depends on a steady stream of good news to keep the share price heading in the right direction, as we wrote last year (Story: ARM, Lucent and Pavlov's Dog).

Some of this good news is fluff: last week, for instance, ARM's share price jumped because of news of an upbeat reception from Japanese analysts to an upbeat company presentation. And some of this good news is very real: quarter in, quarter out, sales and profits head north with relentless monotony. This is why analysts, mostly, love the company.

However, anyone with two eyes and a brain in their head can see ARM is over-valued - even if it didn't face competitive pressures, real or (as in Transmeta) implied, and even if it did maintain royalty unit values. The company would have to be the best-run company in the world, and the luckiest,if it were to be worth the forward multiples its current share price indicates. ®

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