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Announcement on 21 November, 2024
ARM Shows Resilient Growth As More Industries Adopt Their Chip Architecture
- ARM is guiding for a 22% growth midpoint over FYE 2024.
- The company expects to deliver the bulk of its growth in the last two quarters of FYE 2025.
- Cloud, auto, and mobile were the largest drivers between FYE’22 and FYE’24.
- The company has escalated their dispute with QCOM while some investors are hoping for a settlement.
- ARM is still in a speculative phase and I’m maintaining my $53B forward value for 2029.
In Q2’25 ARM reported revenues of $844M, up 5% YoY. Sales were down 10% from Q1, as the company marked its first sequential drop after Q4’FY23.
The company made $3.5B in revenues over a 12-month period, and is up by 18% on a TTM basis. This is close to my revised 16% CAGR estimate, and I maintain my 2029 $7.3B revenue target for ARM.
Management issued Q3 and FYE 2025 guidance at the $945M, and $3.95B respective midpoints. The implied quarterly growth is 17% YoY, and 22% on a full year basis. According to this forecast, the Q4 FYE 2025 revenue will be around $1.22B, up by 32% YoY. This means that management expects a larger near-term growth bump in the last 2 quarters of the year. In my view, this is reasonable but it’s still worth monitoring customers for signs of demand growth.
ARM’s internal estimates (p. 5) reflect an 8% CAGR in the semiconductor industry, indicating that the company is currently outpacing industry growth. I believe that ARM’s thermal efficiency and v9 architecture will continue gaining traction in the cloud and auto markets, which will enable the company to maintain above-industry growth rates.
ARM: royalty increases in market share and value by industry
The remaining performance obligations are relatively stable at $2.385B, indicating a persistent demand and a solid revenue basis.
In the conference call management noted some key developments:
- Apple’s iPhone 16 and 16 Pro will use armv9 architecture.
- AI is still driving demand, and NVIDIA’s Blackwell is integrated with ARM’s Grace CPUs. The Grace-Blackwell chips are now in full production and shipment.
- ARM had new shipments from Microsoft’s Azure Cobalt, and Google’s GCP Axion, both of which are latest gen datacenter chips.
- META collaborated with ARM to optimize Llama 3.2 and enable faster processing.
The ARM v.s. Qualcomm Entanglement
ARM has a court date in mid-December regarding the development of Qualcomm’s chips under Nuvia technology. ARM is suing Qualcomm alleging that their IP rights did not transfer when Qualcomm bought Nuvia in 2021. ARM started suing Qualcomm shortly after the acquisition. Essentially, Qualcomm has been developing highly effective chips enabled by this acquisition, while ARM feels that this isn’t covered by their existing contract.
ARM escalated the issue and sent a 60-day notice to Qualcomm, informing them that they will cancel the license to use ARM’s chip architecture.
Both parties stand to lose should this turn into a full court battle, which is why some analysts are hoping that this gets settled.
My first impression of this issue is that ARM has the upper-hand in enforcing the IP license. However, the company must tread carefully to not jeopardize the technology access to end-partners like Microsoft that may decide to look at long-term alternatives.
Valuation Implications
I am maintaining my $7.3B revenue target for 2029, along with the 28% profitability margin estimate. My forward PE of 25x implies a future value of $52.5B or $63 per share. Discounting back to today at a 7% rate, I get a present value of $37B or $44 per share.
In my view, ARM is still in a speculative phase, trading above my estimated 5-year premium.
Key Takeaways
- ARM is a leader with a saturated number of customers limiting future growth.
- It’s in a highly competitive landscape and needs to innovate beyond patent expirations in the 2030s.
- As a controlled entity of SoftBank, I expect the board to push for buybacks in a bid to maximize returns.
- I expect SoftBank to slowly unload its stake, while ARM buys back their stock - this may initially sustain the price.
Catalysts
Prospects Are Still Solid After IPO
ARM designs and licenses processors to manufacturers, it is the engineering company behind the world’s CPUs.
About 70% of the world’s population uses Arm-based products. More than 30 billion ARM-based chips (smartphones, small electronics, data centers, networking equipment) were shipped in FY '23, representing an approximately 70% increase since 2016.
Most of ARM’s IP sales are in the United States, however a good combined portion are in East Asia, including China (PRC), Taiwan and South Korea:
ARM’s geographical revenue streams
The business model of the company is to design ARM-chips and license them out to manufacturers. It sells the intellectual property behind chips, but doesn’t produce the hardware. This is an engineering-first company, with approximately 80% of global employees focused on research, design, and innovation. The company reaches scale with the ability to license out each CPU product to multiple companies.
ARM is a high performing company, with a gross margin of 80% and operating margins of 25%. The company made $2.7 billion in revenues in 2022 that stagnated in the IPO year.
ARMs key financial performance between 2021 - 2023
Despite stagnating in its IPO year, it’s future prospects from here are still solid as demand for their IP continue to grow. But I don’t believe it’ll grow revenues as fast as analysts are expecting (14% per year), which I’ll get into shortly.
Arm’s Earnings and Revenue Growth Forecasts
ARM’s Market Share May Suffer As Patents Expire
Arm has an addressable market of $202.5 billion, and expects it to grow at a 6.8% annual rate to $246.6 billion by the end of 2025. The company estimates the aggregate value of chips containing Arm technology to be approx. $98.9 billion in 2022, representing 48.9% market share.
This market share is large even for a market leader. Competitors and expiring patents can become significant forces driving down the market share for ARM in the future. Notably most of the key ARM patents are expected to expire in the 2030s:
ARM’s patent portfolio expirations in 2020
The expiration of these patents can open the door for more companies to design and manufacture ARM-based chips.
Limited New Customer Growth, But Opportunities in Smart Devices
More than 260 companies reported that they had shipped Arm-based chips in 2023, including:
- Mobile computing: Apple, Guangdong OPPO, Samsung, Vivo Mobile, Xiaomi.
- Cloud computing: AWS and Alibaba
- Industrial IoT: Cruise and Mercedes-Benz, Raspberry Pi, Schneider Electric, and Siemens.
ARM also entered into a long-term agreement with Apple that extends beyond 2040 allowing the company to use Arm architecture for their CPUs.
The customer base for ARM is well established, and the company is at a phase where it will have a harder time acquiring new customers, rather it will have to rely on industry growth and innovation in order to increase revenue.
One of the highest-potential growth avenues for ARM is the smart devices vertical. ARM’s CPU architecture fits well in small devices, giving it an advantage over peers with larger CPUs. As compute power increases, it will become more practical for consumers to rely on mobile devices and wearables instead of larger devices for everyday needs, this has the potential to widen the TAM.
Another growth avenue for the company is the market adoption of electronically rich vehicles and EVs as well as the capitalizing on government programs subsidizing EVs. Vehicles have an increasing number of processing demands both in central systems, and IoT linked sensors.
Selling Pressure From SoftBank May Limit Price Appreciation
ARM is a controlled entity owned by SoftBank Group with approximately 90.6% of their outstanding ordinary shares following the completion ARMs IPO:
ARM’s IPO is pushed by SoftBank who is looking to cash-in on their investment or escape with minimal losses. One scenario is to expect a continuous selling from SoftBank, which means that there may be selling pressure for some time keeping price appreciation moderate until the stock flips to a diversified investor base.
Assumptions
- Business: I estimate that ARM will have difficulties increasing the number of large customers and market penetration. Because of this, I expect ARM to grow roughly at 10% - along the projected TAM expansion while keeping market share constant around 50%.
- Margins: I assume that operating margin gradually converges from 25% to 35% by 2029. I expect the profit margin to be 80% of operating profit.
- Projection: This translates to 2028 sales of $4.3 billion, $1.5 billion in operating profit and $1.2 billion in net profit.
- Outstanding shares: ARM has 1.025 billion shares. It is already investing in R&D, and has a board that is interested in maximizing their return (SoftBank). For this reason, I expect ARM to repurchase shares and reduce the share count by 4% annually, leading to 843 million in 2028 outstanding shares.
Risks
- ARM may continue to innovate and open new growth channels offsetting the potential decline from patent expirations.
- ARM may find ways to protect its IP, and make generic technology dependent on its new IP.
- ARM has lasting partnerships in place that will continue to generate revenue for years to come (like the one past 2040 with Apple). There’s a chance ARM establishes more long term partnership like this with other key customers.
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