V9 And CSS Technologies Will Advance AI Integration

Key Takeaways

• Strong AI demand and strategic partnerships drive revenue growth across diverse markets, enhancing Arm's overall revenue streams and market position.
  
• Investment in R&D and customized silicon adoption boost Arm's data center share, supporting sustained revenue growth and favorable earnings projections.
  
• Arm grapples with licensing deal uncertainties, elevated R&D costs, stalled v9 royalty growth, potential legal issues, and dependence on Arm China amidst geopolitical risks.

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.

• Strong AI demand, with adoption and deployment of Arm's v9 and CSS technologies, is contributing to record royalty revenue growth. This demand is expected to drive future revenue growth across multiple end markets, such as smartphones, automotive, and IoT, enhancing overall revenue streams.
  
• Arm's strategic partnerships and projects, like Stargate for AI infrastructure and Cristal intelligence for enterprise AI, position the company to capitalize on significant AI investments globally. These partnerships are expected to expand Arm's reach and capability in the AI industry, supporting long-term revenue and earnings growth.
  
• The increased complexity of modern chips is prompting top hyperscalers to customize silicon using Arm's latest Armv9 and CSS technologies, indicating that Arm is gaining share in the data center. This trend is likely to lead to sustained revenue increases and potentially higher margins from premium offerings.
  
• Arm's continued investment in R&D aims to foster long-term growth by accelerating the development of next-generation technologies. This strategic focus is anticipated to enhance the company's future revenue potential significantly, supporting bullish growth projections for the company’s earnings.
  
• Arm's guidance for increasing licensing revenues, driven by high-value deals related to AI and CSS, suggests robust future revenue growth. The expected increase in licensing revenue by 30% year-on-year supports optimistic expectations for earnings expansion in the coming fiscal periods.

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 27.7% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 21.8% today to 37.2% in 3 years time.
• The bullish analysts expect earnings to reach $2.9 billion (and earnings per share of $2.74) by about April 2028, up from $806.0 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 102.2x on those 2028 earnings, down from 115.9x today. This future PE is greater than the current PE for the US Semiconductor industry at 21.7x.
• Analysts expect the number of shares outstanding to grow by 1.31% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.95%, as per the Simply Wall St company report.

Arm Holdings Future Earnings Per Share Growth

Risks

• Arm faces risks from uncertainties in the timing and closure of large licensing deals, which could impact its future revenue growth.
  
• Increased R&D spending, while necessary for long-term growth, is resulting in the highest level of non-GAAP operating costs, which could compress near-term net margins.
  
• Potential legal issues with Qualcomm could influence Arm's earnings stability, though the company has anticipated no major financial effects.
  
• The overall royalty contribution from v9 technology has stalled at 25% for several quarters, which could pose a risk to anticipated revenue acceleration if growth does not resume.
  
• Arm's revenue is significantly tied to Arm China, which represents a considerable portion of its total royalties and may introduce geopolitical risks affecting revenue diversification.

Valuation

• The assumed bullish price target for Arm Holdings is $200.88, which represents one standard deviation above the consensus price target of $156.77. 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 $225.0, and the most bearish reporting a price target of just $73.0.
  
• In order for you to agree with the bullish analysts, you'd need to believe that by 2028, revenues will be $7.7 billion, earnings will come to $2.9 billion, and it would be trading on a PE ratio of 102.2x, assuming you use a discount rate of 9.9%.
  
• Given the current share price of $88.63, the bullish analyst price target of $200.88 is 55.9% 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.