The Investment Column; ARM looks to extend its reach

ARM HOLDINGS, the designer of semi-conductor chips for 75 per cent of the world's mobile phones, has been on a roll during the past year with its share price tripling.

Minor profit taking yesterday, which still leaves the company with a market capitalisation of pounds 1.8bn, followed a near doubling in interim pre- tax profits to pounds 7m on a 48 per cent rise in sales to pounds 27.5m. The question is whether this undoubtedly explosive advance in the business offers reason to buy the shares or whether the performance is already in the price.

To judge that it's necessary to understand ARM's business model. For designing an embedded chip, it receives an upfront licence payment of $2m to $5m. When the chip is manufactured by an affiliated semi-conductor maker, ARM gets an average royalty payment of 14 cents a chip. These two streams account for two-thirds of revenue. Other revenue sources include consulting and support fees, and the sale of software tools.

The company gets high marks for executing well. It has also had the good fortune of being in the right place at the right time as mobile phone sales have outpaced the estimates made just six months ago by manufacturers such as Ericsson and Nokia. ARM's design of the low powered chips used in the digital mobile market gives it a natural inroad into the developing market for personal digital assistants and other handheld devices. However, other sectors, such as the fast growing set-top box market, where performance is more important than low power usage, will prove a more difficult nut to crack.

Still, the deployment of embedded chips is a fast growth market. Current production of 3.5 billion chips annually is expected to expand to 13 billion chips by the middle of the next decade. ARM clearly has first mover advantage in providing cheap, efficient designs for a range of RISC processors.

Through a leveraged partnership strategy ARM has drawn together design, tool and software partners featuring the biggest players in the electronics industries. Management claims this is the biggest barrier to others entering what is essentially a knowledge, not capital, intensive business.

US investors, used to fancy technology ratings, are likely to stand back from buying ARM despite yesterday's 42.5p fall from a record high to 985p. Perhaps 20 per cent of the price is based on bid speculation that chief executive Robin Saxby has denied. There is still tremendous near-term upside in ARM's business, but it is likely to be impatient investors who chase the shares at these levels. Wait and buy closer to 800p.

Medeva

THERE IS one investment philosophy that says more money can be made by picking companies undergoing restructuring at the right time, than by looking for companies with competitive products or services.

Medeva, the pharmaceuticals company rumoured to be a target for takeover by rival Shire Pharmaceuticals, yesterday said it was taking the axe to it head office and other operations. The move may mark a turn in the fortunes of Medeva's shares.

Medeva's problem is that it is losing out to competitors in the market for its hyperactivity drug, Methylphenidate. Sales in the half year were down 60 per cent year on year. The company expects them to decline further.

Overall, drugs aimed at the central nervous system delivered just pounds 9.5m in profit, down from pounds 30m. Fortunately for Medeva, the company also has a range of other drugs which contributed pounds 23.8m in profits in the first half. Sales growth here was a rather pedestrian 7 per cent, however. Going forward, Medeva's fortunes rest on its pipeline. These include Heppagene, a vaccine and possible treatment for hepatitis B, and Relaxin, a treatment for scleroderma. In earlier stages of development is Nicotine, a treatment for inflammatory bowel disease. While these may hold some promise, revenues are several years away.

Sceptics may say that Medeva's restructuring has come just as it is seeking to advertise its future as an independent company now that bidders are circling. Even so, it should deliver annual cost savings of around pounds 10m from 2000. Analysts expect pre-tax profits of pounds 39m and earnings of 9.3p per share this year, rising to pounds 44m and around 10.2p the year after. The shares, which closed down 4.5p at 120.5p, are on a forward rating of 13. Despite the restructuring benefits, the shares look unexciting.

London Forfaiting

IF ANY company has fallen victim to the crisis in the emerging markets, it is London Forfaiting. The group acts as middle-man between importers and exporters to countries such as Russia and Indonesia. Its shares soared to almost 500p in mid 1998 on the back of improved perceptions of the credit rating of the Russian banks which underwrite the country's importers. In the event, the collapse of the rouble meant neither Russian importer nor Russian bank was able to cover the risk London had taken on. The shares now sit at 42p.

London could not have predicted the Russian economic crisis. But the company claimed to have a niche in assessing emerging market risk and a close knowledge of the banking sector in those countries. That specialist knowledge has left it with a pounds 50m first-half loss and analysts expecting little more than pounds 2m profits in the second half, leaving it in the red for the year.

Merrill Lynch expects the group to enter profitability next year. While that may not be over-optimistic, the reasons that made London such an attractive proposition a couple of years ago no longer exist and the shares are best avoided.