As Arm's stock slides, these analysts say to keep the faith

By Emily Bary

Royalty revenue missed in the latest quarter, but analysts note 'robust' licensing sales that will lead to royalty revenue down the road

Analysts still see reason to be upbeat about Arm Holding PLC's potential, despite a miss on royalty revenue that's sending the chip designer's stock down about 17% in Thursday trading.

"Assuming Arm will be part of whoever comes out on top of AI seems like less of a risk than almost anything else, other than maybe Nvidia," Guggenheim analyst John DiFucci wrote.

He noted that the company's licensing business saw "robust" growth, and licenses now tend to lead to royalties down the line. "We think it's safe to say that a customer wouldn't purchase licenses without a plan to convert them into products for sale," DiFucci wrote.

See also: Arm earnings mostly beat expectations, but chip designer falls short in a key segment

The royalty business overall is a gem for Arm (ARM), as it boasts high margins. "The only thing better than a software business that we know of is a software royalty business," he added. "But it starts with licenses of designs or foundational blueprints to create those final designs to be put into production. "

The company's licensing business beat expectations in the latest quarter. Also encouraging, "management said that the license pipeline was slightly greater than it was 90 days ago," DiFucci noted.

He rates the stock a buy with a $169 target price.

BofA's Vivek Arya took a similar long-term view, saying that if you block out the "quarterly noise," Arm's "big picture [is] on track."

He wrote that "the surge in licensing revenues, growing double digits annually is a strong leading indicator of Arm tech adoption and eventual conversion to recurring royalty revenues."

On the whole, the company continues to be "uniquely exposed to growing computing complexity, cloud custom chip [opportunities] and edge AI," according to Arya, who has a buy rating and $180 target price on Arm's stock.

Evercore ISI's Mark Lipacis didn't see reason to change his long-term thesis either.

"Arm is the dominant processor solution in handsets and [internet of things], and is taking share in client and data-center compute at the same time that processing demand is growing exponentially, translating to higher core-count (ASP) processors and higher royalty rates," he wrote.

The company's track record of licensing beats means good things for the royalty business within three to five years, Lipacis added.

But the report was validation of sorts for HSBC analyst Frank Lee, who downgraded the stock to reduce earlier this week.

Don't miss: Why Arm's stock just got a downgrade after its big rally

"Arm management remains more bullish on [the] Arm-based AI CPU narrative for both PCs and AI servers driving long-term royalty upside," he wrote WHEN, referring to central processing units. But the total addressable market for AI CPUs "remains difficult to quantify and is unlikely to have a significant earnings impact despite higher royalty payment per chip with new customers," he added.

-Emily Bary

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08-01-24 1423ET

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