“Arm is getting the credit it deserves for the current, and future, state of the computing market.”
In one of the biggest stories in tech this week, Arm Holdings
ARM,
a company that only recently returned to being a public company last September, saw a huge spike in its stock, nearly 60% at one point, after its quarterly earnings report. As recently as the end of October, Arm shares traded below $50, yet broke $120 on Thursday.
To most observers, the sudden valuation increase doesn’t match up to the earnings statements and forward projections. Arm reported $824 million of revenue for the fourth-quarter, up 14% year-over-year, with two unique business models covering it all. The licensing business, where Arm gives access to its various IP for designing CPUs, graphics, AI engines and more, brought in $354 million of that revenue, up 18% year-over-year, while the royalty business, where Arm earns a fee for every physical chip sold using its IP, generated $470 million in revenue, up 11% year-over-year. Next quarter revenue pointed up $100 million over previous guidance and full-year guidance went to $3.2 billion from $3.0 billion in revenue.
In all, an impressive “beat and raise” that the tech field absolutely loves, as it tends to be a leading indicator to a larger trend.
What should investors make of this stock price jump, and is Arm’s growth sustainable?
Some of the worry about Arm’s long-term prospects were that it was aligned too closely with the cyclical smartphone market across the world, and in particular in China. But the quarterly results from the royalty division show that Arm isn’t dependent on smartphones to grow.
Of the total royalty revenue from this quarter, 35% of it was sourced from smartphone chips. Back in 2016 that number was around 70%. Even when the global smartphone market is down, Arm had royalty revenue increase 11% thanks to the company’s expansion into servers, automotive, and even consumer laptops. If the smartphone market has a resurgence thanks to AI and general upgrade cycles, as indicators from companies such as Apple
AAPL,
and Qualcomm
QCOM,
indicate, then Arm has even more opportunity for this number to grow.
But to justify the huge spike in Arm’s stock price, investors need something more than just “we see some evidence of diversification.” What is the bull case that shows Arm can keep this going?
Royalty flush
The key to me is the royalty revenue stream and its growth over the next one- to three years. The most advanced architecture IP that Arm offers is called “Armv9”. It accounted for 15% of the royalty revenue this past quarter. This Armv9 architecture royalty rate is double that of the previous generation Armv8 based IP, cores and other products. As more of the Arm product mix moves towards this more advanced, more capable, and more profitable Armv9 architecture, then royalty revenue for the company stands to increase at a higher rate than individual unit growth.
It’s the growth areas for Arm that are most likely to use the Armv9 architecture as well. Because it offers the best performance of the Arm product stack, it is utilized in new server chips from Nvidia
NVDA,
Amazon.com
AMZN,
and Microsoft
MSFT,
It is also utilized by more of the automotive segment as that market continues to see need for higher performance and processing of on-vehicle data and AI. Even the growing PC laptop market, driven by new products like the Qualcomm Snapdragon X-Elite coming later this year, use Armv9.
Read: Arm’s stock explodes 50% higher as company proves itself an early AI winner
“The transition to a higher mix of products is the way to drive revenue.”
Arm partners and customers collectively ship north of 7 billion chips each quarter, but the average royalty per chip is measured in single digit cents when you do the math on Arm’s $470 million in royalty revenue for this past quarter. The vast majority of those shipped products are using older architectures, smaller designs, and are designed into internet-of-things products around the world. But the royalty on a single high-performance, custom server chip that uses the Armv9 architecture could be in the tens or hundreds of dollars. It’s easy to see how the transition to a higher mix of Armv9 products is the way to drive revenue.
Arm knows that to continue to get that royalty rate (or grow it further) it can’t stand still and needs to continue to improve its product capabilities. A recent analyst report referencing a project called “Blackhawk” that aims to be “the highest-performance CPU core for smartphones later this year” directly from Arm is an example of this strategy. More advanced technologies like that are part of the uniqueness of the company’s business model that strongly incentivizes R&D investment in new IP.
“Arm’s meteoric rise in value has interesting implications for the rest of the technology sector.”
Because Arm is essentially the corporate personification of an entire ecosystem, many of them actually, the stock’s meteoric rise in value has interesting implications for the rest of the technology sector. The custom silicon market, most notably huge cloud companies like Microsoft, Alphabet
GOOGL,
and Amazon, along with dozens of smaller design houses, are building custom AI accelerators to compete with Nvidia and AMD
AMD,
graphics processing units, driving the most profitable segment of Arm’s royalty business. Even Nvidia is part of that dynamic, with its Grace Hopper Superchip integrating both GPU cores and high-performance Arm cores.
For now, while a surprise to most investors, it seems that Arm is getting the credit it deserves for the current, and future, state of the computing market.
Ryan Shrout is president of Signal65 and founder at Shrout Research. Follow him on X @ryanshrout. Shrout has provided consulting services for AMD, Qualcomm, Intel, Arm Holdings, Micron Technology, Nvidia and others. Shrout owns shares of Intel.
Also read: Arm’s stock surge burns short sellers, to the tune of $445 million in paper losses
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