Adoption Of V9 Architecture And AI Demand Will Strengthen Future Market Position

Key Takeaways

• Adopting Arm's v9 architecture and expanding CSS licensing in key sectors drive royalty revenue and market reach, boosting future earnings.
  
• Growing data center engagements and AI demand bolsters Arm's market share and long-term revenue, enhancing overall financial prospects.
  
• Unresolved legal challenges and market dependencies pose significant risks to Arm's revenue stability and growth prospects, particularly in AI and smartphone sectors.

Catalysts

Arm Holdings plc architects, develops, and licenses central processing unit products and related technologies for semiconductor companies and original equipment manufacturers rely on to develop products.

• Accelerating adoption of Arm's v9 architecture in multiple sectors, including smartphones, PCs, and data centers, is expected to drive increased royalty revenue due to higher pricing per chip. This impacts overall revenue growth positively.
  
• Significant increases in CSS licensing, especially in smartphones and automotive sectors for ADAS and IVI applications, suggest higher royalty rates and expanded market reach, enhancing future earnings and revenue prospects.
  
• Strong growth in data center engagements, particularly with cloud service providers like Microsoft Azure and Google GCP deploying Armv9-based data centers, indicates potential for increased market share and revenue growth, impacting overall revenue scaling.
  
• Continued expansion in the largest software ecosystem supporting Arm's hardware, such as the integration with GitHub Copilot, could improve efficiencies and reduce costs, potentially increasing net margins over time.
  
• Increased demand for AI capabilities across devices, from the edge to the cloud, supports higher revenue opportunities through Arm's performance-efficient compute platform, impacting long-term revenue growth and sustainability.

Arm Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Arm Holdings's revenue will grow by 22.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 18.1% today to 34.3% in 3 years time.
• Analysts expect earnings to reach $2.2 billion (and earnings per share of $2.05) by about December 2027, up from $641.0 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $2.8 billion in earnings, and the most bearish expecting $1.7 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 90.7x on those 2027 earnings, down from 234.1x today. This future PE is greater than the current PE for the US Semiconductor industry at 31.9x.
• Analysts expect the number of shares outstanding to grow by 1.1% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.85%, as per the Simply Wall St company report.

Arm Holdings Future Earnings Per Share Growth

Risks

• Continued weakness in industrial sectors due to an ongoing inventory correction is impacting revenue projections in this part of the semiconductor industry.
  
• The decline in licensing revenue by 15% year-over-year, despite being better than expected, indicates potential fluctuations in revenue streams due to the timing and size of license agreements.
  
• The unresolved litigation with Qualcomm and the related cancelation notification of their architecture license could pose revenue risks if legal outcomes do not favor Arm.
  
• Dependence on a successful market expansion for AI technologies to drive demand may not materialize as expected, impacting long-term revenue and growth projections.
  
• Macro risks in China, specifically the smartphone market and reliance on local entities, may lead to inconsistencies in royalties and market share, impacting net earnings.

Valuation

• The analysts have a consensus price target of $144.11 for Arm Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $200.0, and the most bearish reporting a price target of just $66.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $6.5 billion, earnings will come to $2.2 billion, and it would be trading on a PE ratio of 90.7x, assuming you use a discount rate of 8.8%.
• Given the current share price of $142.8, the analyst's price target of $144.11 is 0.9% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.