After Earnings, is Arm Holdings Stock a Buy, Sell or Hold?

•
Current
price:
$126.40

•
Morningstar
Rating:
1
stars

•
Morningstar Economic
Moat
Rating:
Wide

•
Morningstar Uncertainty
Rating:
High

What
We
Thought
of
Arm
Earnings

Results
came
ahead
of
expectations,
and
management
raised
guidance
for
the
year,
which
finishes
in March.

Arm
is
gaining
market
share
across
many
verticals,
and
this
is
helping
the
company
diversify
outside
the
mobile
market,
which
has
moved
from
two-thirds
of
revenue
a
few
years
ago
to
one-third
today.
The
main
growth
drivers
are
the
cloud
and
automotive.

Arm
is
raising
its
royalty
rates.
It
was
already
known
that
the
firm
would
do
this,
but
management
confirmed
the
royalty
rates
for
its
newest
architecture,
v9,
are
double
that
of
v8,
which
was
a
surprise.
The
company
will
be
able
to
capture
more
value
thanks
to
this,
which
together
with
more
chips
and
more
content
per
chip
will
be
positive.
This
raise
will
let
Arm
grab
a
larger
piece
of
the
value
chain.
It
has
historically
taken
very
little
compared
to
the
value
it
provides
to
chip
designers.

But
we
don’t
think
the
positive
news
justifies
a
50%-60%
increase
in
Arm’s
stock
price.
We
have
raised
our
fair
value
estimate
by
32%
to
$45,
mainly
to
incorporate
higher
royalty
rates
in
the
medium
and
long
term,
but
shares
remain
highly
overvalued.
We
believe
there
is
little
to
win
and
a
lot
to
lose
by
buying
shares
now,
as
expectations
are
exorbitant.

ARM
Bulls
Say

• We
expect
Arm
will
keep
gaining
market
share
in
the
data
center
business
from
x86
architecture,
as
its
chips
consume
less
power
and
data
centers
need
to
minimize
their
energy
consumption.

•We
also
expect
share
gains
in
the
automotive
segment,
thanks
to
the
transition
to
electric
vehicles.
The
overall
trend
toward
the
Internet
of
Things
and
battery-powered
devices
is
a
long-term
tailwind
for
Arm,
as
it
has
the
most
energy-efficient
architecture.

•
If
Arm
manages
to
change
its
business
model
and
charge
royalties
on
a
per-device
basis,
this
would
provide
huge
revenue
and
margin
upside.

ARM
Bears
Say

•
If
Arm
manages
to
charge
royalties
on
a
per-device
basis,
or
if
it
were
to
meaningfully
increase
its
royalty
rates
per
chip,
it
could
become
a
double-edged
sword.
Too
much
royalty
revenue
may
encourage
customers
to
adopt
open-source
RISC-V
instead.

•
Arm
China
is
one
of
Arm’s
largest
clients,
representing
more
than
20%
of
revenue.
Its
financial
reporting
has
historically
been
opaque,
and
there
could
be
attempts
to
steal
Arm’s
intellectual
property.

•
Arm’s
revenue
concentration
is
very
high,
with
its
top
five
customers
representing
close
to
60%
of
sales.

Is
Arm
Stock
Fairly
Valued?

With
its
1-star
rating,
we
believe
Arm’s
stock
is
significantly
overvalued
compared
with
our
long-term
fair
value
estimate.
Our
increased
fair
value
estimate
comes
from
higher
licensing
revenue
and
royalty
rates
over
the
longer
term.
We
estimate
royalty
rates
for
v9
could
be
3%-4%,
compared
with
the
1.7%
blended
rate
the
firm
reported
in
its
IPO
filing
for
2022.
Adoption
of
v9
keeps
increasing
mainly
thanks
to
adoption
in
smartphones
and
the
data
center,
and
management
sees
it
increasing
in
the
following
year.
Our
fair
value
estimate
represents
an
EBIT
multiple
of
42
times
for
fiscal
2024
and
38
times
for
fiscal
2025.

Overall,
we
model
Arm’s
revenue
seeing
a
13%
compound
annual
growth
rate
over
the
next
10
years.
We
expect
royalty
revenue
will
grow
in
the
high-single-digit
or
double-digit
range,
while
licensing
revenue
will
grow
by
the
mid-single-digits.
Arm’s
average
royalty
rate
in
2022
was
1.7%,
and
we
expect
that
to
expand
to
more
than
3%
in
2030
after
the
introduction
of
v9
and
future
architecture
improvements.
After
our
10-year
explicit
period,
we
model
double-digit
returns
on
new
invested
capital
and
mid-single-digit
growth
in
profits
for
another
10
years,
in
line
with
the
modeling
for
a
wide-moat
firm.

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