Arm Holdings: Does the 42% Drop Signal an AI Buying Opportunity?

August 05, 2024 at 12:28 PM EDT

Person holding mobile phone with logo of British semiconductor company Arm Ltd. on screen in front of business webpage.

Arm Holdings (NASDAQ: ARM) stock plummeted on its fiscal Q1 2025 earnings results as investors were treated to a nasty dose of reality concerning the artificial intelligence (AI) boom. The company designs, develops, and licenses semiconductor architectures. It doesn’t manufacture or produce chips. Instead, it collects licensing fees and royalties on its architectures and IPs. This makes it the ultimate asset-light business.

Hot Expectations Face Cold Reality

The rollout of its ARMv9 architecture came with lofty expectations, enabling devices to perform artificial intelligence (AI) on the edge. Rather than sending queries to a central server, AI applications would process directly in the device. This sent shares up to $188.75 on July 9, 2024, as investors let their imaginations run wild about the potential upside. Unfortunately, shares have plunged over 42% in less than a month as the promise of outsized growth may have been over-assumed. On the other hand, this could be an overreaction presenting a buying opportunity. Arm's results were very strong. However, the market was overzealous in its valuation, with shares trading over 90x fiscal full-year 2025 EPS estimates.

Arm Holdings operates in the computer and technology sector, competing with chip makers like Intel Co. (NASDAQ: INTC), Samsung Electronics (OTCMKTS: SSNLF), and Texas Instruments Inc. (NASDAQ: TXN).

Arm Holdings Dominates with a 99% Market Share of Mobile Chips

When thinking about market-dominant companies, names like Taiwan Semiconductor Manufacturing Co. Ltd. (NYSE: TSM), with a 62% market share of the global foundry market, or NVIDIA Co. (NASDAQ: NVDA), with a 94% market share of AI chips, come to mind. ASML Holdings has over a 90% market share of the ultraviolet (UV) lithography market. However, these companies pale in comparison to the 99% market share dominance in mobile chips that Arm Holdings commands.

Arm’s legacy architecture makes CPUs extremely energy efficient compared to x86 architecture. Mobile devices like smartphones rely on optimizing the limited battery power. Arm’s next-generation v9 architecture enables edge AI with its power-efficient compute platform, which requires even more power to operate and, thus, better energy efficiency.

ARM Holdings stock chart

ARM Stock Triggers a Head and Shoulders Breakdown

The daily candlestick chart for ARM illustrates a head and shoulders breakdown pattern. This pattern is comprised of three peaks. The left shoulder peaked at $177.31 and pulled back to the neckline at $149.50. The head has the highest peak at $188.75, and it is pulled back to the neckline at $152.22. The right shoulder is the final peak at $172.36, which triggered the breakdown through the neckline. The neckline breakdown occurred when ARM fell under $154.30 on July 26, 2024, ahead of its July 31, 2024, earnings release. The fiscal Q1 2025 results accelerated the selling, causing shares to plunge another 21% in the following days. The daily relative strength index (RSI) has plunged to the 31-band. Pullback support levels are at $102.09, $94.00, $85.61, and $77.71.

Arm Holdings Q1 2025 Earnings Results Were Great, But Royalty Revenues Lagged

The company reported fiscal Q1 2025 EPS of 40 cents, beating consensus estimates by 6 cents. Revenues surged 39.1% YoY to $939 million, beating $905.52 consensus estimates. License revenues surged 72% YoY to $472 million, but royalty revenues were up just 17% YoY. Licensing fees are the upfront payment that all customers pay, followed by royalties for each chip they produce. The royalty payments are the recurring element that analysts were underwhelmed by as they are the most important figures in the long term.

One-Two Punch to the Gut on Horrible Intel Earnings Report

Arm Holdings shares tumbled 15.7% following its earnings results. However, a sizeable earnings miss and guidance cut from Intel Co. (NASDAQ: INTC) caused further selling in the chip sector, adding another 6% loss to Arm shares. The positive sentiment in AI and the semiconductors took a 180-degree turn as investors signaled their anger that the lofty expectations for the AI boom may have been overstated.

A Buying Opportunity Emerges for Patient Investors Driven by ARMv9

However, the jump in licensing revenues almost assures that royalty revenue will rise as its chip company customers produce more chips using ARM architecture. It’s also important to note that its ARMv9 architecture pays nearly double the royalty rate of its legacy architectures. In other words, this may be a case of short-term pain for long-term gain. It can take months to several years to go from licensing payment to royalty collection due to the complexity of the chip design. Arm shares have fallen from trading at 92x 2025 EPS targets to 69x.

ARMv9 adoption continues to accelerate, accounting for 25% of royalty revenue, up from 20% in the previous quarter. Arm licensed ARMv9 to Alphabet Inc. (NASDAQ: GOOGL) Google’s Axion Processor and Amazon.com Inc. (NASDAQ: AMZN) AWS Graviton4 and enables Edge AI for Microsoft Co. (NASDAQ: MSFT) Windows Copilot.

Arm Takes a Conservative Approach to Guidance

Arm Holdings provided in-line guidance for fiscal Q2 2025 EPS of 23 cents to 27 cents versus 27 cents consensus estimates. Revenues for Q2 2025 are expected to be between $780 million and $830 million. It reaffirmed the full-year 2025 EPS of $1.45 to $1.65 versus $1.57 consensus estimates. Full-year 2025 revenues are expected to be between $3.8 billion and $4.1 billion versus $3.99 billion.

Arm Holdings CEO Rene Hass commented, “Now our long-term growth drivers remain consistent. Every chip being designed today requires a CPU and these are being designed with Arm in mind with our strong tie into all the world's software. Now, that has driven significant royalty revenue growth. More value per chip, v9 up to 25% now royalty revenue overall, that's up 20% from the previous quarter. More importantly, our smartphone royalty revenue was up 50% year-on-year. That's against a single-digit increase in units.”

Arm Holdings analyst ratings and price targets are at MarketBeat. There are 27 analyst ratings on ARM stock, comprised of 15 Buys, 10 Holds, and two Sells.

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