Over the past year, discussions around artificial intelligence (AI) have been reverberating across various industries. The consensus is that the recent advancements are groundbreaking and have the potential to significantly enhance human productivity by automating numerous time-consuming tasks. As businesses race to capitalize on these breakthroughs, concerns about an AI bubble lurking in the markets have begun to surface.
CEO Rene Haas of Arm Holdings (NASDAQ: ARM) is resolute in his stance amidst these debates. He adamantly refutes claims that AI is merely a passing fad, boldly stating, “AI is not in any way, shape, or form a hype cycle. We believe that AI is the most profound opportunity in our lifetimes, and we’re only at the beginning.”
While this may sound like grandiose rhetoric, the tech community as a whole is increasingly subscribing to this viewpoint. Estimates vary, but the potential economic implications are vast. McKinsey & Company, a global management consulting firm, estimates that Generative AI alone could amount to between $2.6 trillion and $4.4 trillion annually, signifying significant opportunities for companies at the forefront of this transformative wave. Arm Holdings stands tall among these companies, strategically positioning itself to capitalize on the AI revolution.
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Arm’s Repository of Intellectual Property
To comprehend Arm’s significance within the expansive AI ecosystem, it is essential to delve into the company’s strategic undertakings. Established in 1990 with a vision to revolutionize the computing industry, Arm Holdings underwent a pivotal transformation following a product setback in 1993. Shifting its business model, Arm transitioned to developing and licensing chip designs rather than the chips themselves, thereby solidifying its pivot to intellectual property (IP).
Across the subsequent two decades, Arm emerged as a dominant force in the semiconductor sector, crafting and licensing blueprints for some of the most ubiquitous chips globally. Its prowess resonates across a spectrum of devices, from smartphones and tablets to personal computers and smart TVs. Notably, Arm estimates that its processors are employed by a staggering 70% of the global population, with its AI-centric designs prominently featured in cloud computing, hyperscale computing, and data centers.
Operating via the creation and licensing of processor designs endows Arm with substantial economies of scale, enabling it to achieve cost efficiencies far superior to those within the industry.
The Expansive AI Potential
While Nvidia is often heralded as the sovereign of AI, Arm Holdings arguably assumes the position of royalty. Nvidia’s GPUs are renowned as the standard for training and operating AI models; however, Arm’s high-end CPUs play a pivotal role in AI processing. For example, Nvidia’s GH200 Grace Hopper Superchip, integrating accelerated CPU and GPU technologies to address AI’s computational demands, incorporates 144 Arm version 9 (V9) CPU cores.
Arm’s newest processor isn’t solely significant for Nvidia; Microsoft’s latest AI-focused server chips also integrate over 100 of these processors. In a recent conversation, Haas highlighted the growing adoption of the V9 core. Apart from furnishing enhanced processing capabilities, this core commands twice the royalty compared to its predecessor, promising a lucrative stride for Arm.
The AI momentum is beginning to reflect in Arm’s financials. In the fiscal 2024 third quarter (ended Dec. 31, 2023), Arm recorded record revenue, surging 14% year over year to $824 million. An 18% spike in licensing revenue and a 11% boost in royalty revenue underpinned this growth, resulting in an adjusted EPS of $0.29, marking a 32% rise. Notably, Arm’s remaining performance obligation (RPO) surged to $2.43 billion – a 38% increase year over year – hinting at an accelerated revenue trajectory.
Projections from the management reinforce this trajectory. For the fourth quarter, Arm anticipates revenue between $850 million and $900 million, translating to a growth rate between 34% and 42% – more than double the 14% growth witnessed in the third quarter.
Nvidia’s recent introduction of the Blackwell architecture at the GPU Technology Conference (GTC) signifies a monumental leap in AI processing. The Blackwell GB200 superchip featuring two B200 GPUs and an Arm-based Grace CPU is poised to solidify Arm’s standing within the AI realm.
Traditionally valued at 109 times forward earnings and 34 times next year’s sales, evaluating Arm through conventional metrics might be perplexing. Nonetheless, considering its substantial growth trajectory, the forward price/earnings-to-growth (PEG) ratio stands at less than 1, an indicative marker of undervaluation.
Endowed with decades of expertise, widespread chip blueprints, and surging AI demand, Arm emerges as a rare investment prospect of this generation.
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