Is IQE plc worth some of your ARM Holdings winnings?

Although the takeover of British technology company ARM Holdings by Japan's SoftBank led to a good return for ARM's shareholders, many investors lament ARM's passing, including me.

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My plan was to hold the technology leader for the long term, and now that ARM has gone from the London market I'm looking for new homes for my technology money. One possible contender is AIM company IQE (LSE: IQE), the global supplier of advanced wafer products and services to the semiconductor industry.

High levels of intellectual property

IQE's core business is 'Epitaxy', which the firm describes as the first stage in the process of manufacturing critical components in a range of devices from mobile handsets to solar cells and LEDs.

I worried that the business could be providing a commodity product, which would be a less attractive business model than ARM's intellectual property-driven one. However, IQE insists that its manufacturing process requires high specification cleanrooms, sophisticated production tools and high levels of intellectual property.

ARM's ongoing high double-digit profit margins reveal the strength of the firm's niche in its markets. IQE's net margin has been modest in comparison -- single digits from 2011 through to 2014 then ballooning to around 17% during 2015.

Building licensing revenues

IQE's chief executive said in an interim statement last month that the firm's continuing strong financial performance reflects progress in diversifying revenues and growing a portfolio of intellectual property. To me, that suggests that IQE could be developing its business to become less commodity-style and more like a well-defended niche operator with similarities to ARM. The recent improvements in net margin add weight to that theory but it's too early to be sure.

The great strength of ARM's business is its licensing and royalty model that enables the firm to reap the rewards of marketing its intellectual property. IQE is moving in that direction too. The firm has developed a portfolio of intellectual property for advanced semiconductor materials and generated £3.5m of license income in the first half of this year. IQE's IP portfolio is helping the company to differentiate itself, and to create a platform for growth, according to the top director. However, City analysts following the firm expect the company to post overall revenue around £124m this year, so there's a long way to go before license revenue becomes a big part of IQE's business.

In transformation?

IQE could be in the early stages of transforming itself from a mediocre business with humble profit margins into something a little more special. If higher margins prove to be enduring, the firm could make a good investment from here. The chief executive reckons that several growth areas could help propel IQE forward.

At today's share price of 30.5p, you can pick up IQE shares on a forward price-to-earnings ratio of just over 10 for 2017, which seems undemanding, although the shares have recently rerated up to adjust for better margins and higher profits. I reckon IQE is one to keep a close eye on.

Emerging growth

Searching for emerging growth in firms that have yet to re-rate to heady valuations can be a lucrative strategy. IQE is interesting, but so is a retail play identified by the analysts here at The Motley Fool.

They set out their research in a document called A Top Growth Share From The Motley Fool. The Fool's analysts believe this firm could multiply its value several times over the next few years because the market seems to be undervaluing growth potential.

You can download details of this market opportunity, free of charge, by clicking here.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.