V9 And CSS Will Expand Global Industry Impact

Key Takeaways

• Strong AI demand and strategic partnerships with hyperscalers like AWS and NVIDIA will drive future revenue growth in smartphones, autos, and IoT.
  
• Increased R&D investments and CSS technology adoption are projected to enhance licensing revenues, royalty rates, and operating profits significantly.
  
• Arm faces financial uncertainty from the Qualcomm lawsuit, customer concentration risks, higher R&D expenses, potential delayed deal closures, and challenges with v9 adoption.

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.

• The significant AI demand, driven by the adoption of Arm's v9 and CSS technologies, sets the stage for robust future revenue growth as these become the backbone for enhanced capabilities in smartphones, autos, and IoT devices.
  
• Arm's deepening engagement with hyperscalers like AWS, Microsoft, Google, and NVIDIA, highlighted by AWS's notable Graviton deployment, is expected to substantially boost royalty revenues, especially with increasing cloud and data center reliance on Arm-based solutions.
  
• Arm's partnership in major AI projects such as Stargate and Cristal intelligence positions the company to capture increased earnings as AI's demand for scalable compute power grows, capitalizing on being the preferred CPU platform in these cutting-edge deployments.
  
• As Arm's investments in R&D and advanced technologies ramp up, guided by an accelerated licensing revenue outlook with projected 60% year-on-year growth in forthcoming quarters, both licensing revenues and non-GAAP operating profits are set to climb.
  
• The introduction and increasing complexity of CSS, and its subsequent adoption in leading-edge devices, is anticipated to double current royalty rates—hence driving higher net margins due to the compounded revenue impact on the company's financial statements.

Arm Holdings Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more optimistic perspective on Arm Holdings compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming Arm Holdings's revenue will grow by 27.3% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 19.8% today to 33.6% in 3 years time.
• The bullish analysts expect earnings to reach $2.8 billion (and earnings per share of $2.55) by about July 2028, up from $792.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 110.4x on those 2028 earnings, down from 208.8x today. This future PE is greater than the current PE for the US Semiconductor industry at 30.9x.
• Analysts expect the number of shares outstanding to grow by 0.81% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.67%, as per the Simply Wall St company report.

Arm Holdings Future Earnings Per Share Growth

Risks

• The ongoing Qualcomm lawsuit presents a risk of uncertainty in Arm's financial future as it involves critical licensing issues that might affect future royalty revenues.
  
• Arm's reliance on a few large customers such as AWS for a significant portion of data center revenue could expose it to revenue concentration risks if these customers alter their infrastructure plans or face competitive pressures.
  
• Increased investments in R&D, while necessary for future growth, have led to higher operating expenses, which could impact near-term profitability and put pressure on net margins if revenue growth does not keep pace.
  
• The potential for deal closures to slip into the next fiscal year creates uncertainty in revenue forecasts, which could impact investor confidence and future revenue perceptions.
  
• The flat growth in the relative v9 adoption as a percentage of total royalties signals possible challenges in transitioning customers to this new generation, potentially affecting future royalty revenue growth.

Valuation

• The assumed bullish price target for Arm Holdings is $209.34, which represents two standard deviations above the consensus price target of $142.28. This valuation is based on what can be assumed as the expectations of Arm Holdings's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $210.0, and the most bearish reporting a price target of just $76.54.
• In order for you to agree with the bullish analysts, you'd need to believe that by 2028, revenues will be $8.3 billion, earnings will come to $2.8 billion, and it would be trading on a PE ratio of 110.4x, assuming you use a discount rate of 10.7%.
• Given the current share price of $156.5, the bullish analyst price target of $209.34 is 25.2% higher.
• 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.