Arm’s annual guidance fails to impress, stoking fears that some AI stocks may be overpriced

Shares of the U.K.-based computer chip designer Arm Holdings Plc were tracking lower in after-hours trading today after the company posted quarterly results that edged past Wall Street’s estimates, only to disappoint with somewhat conservative guidance for the coming financial year.

The company reported fiscal 2024 fourth-quarter earnings before certain costs such as stock compensation of 36 cents per share, beating the analyst forecast of 30 cents per share. Revenue for the period rose 21%, to $928 million, coming in streets ahead of Wall Street’s $866 million target.

All told, the company reported a net profit of $224 million, after having essentially broken even on that metric in the year-ago period.

Arm is a chip design firm whose intellectual property underlies the processors in the vast majority of the world’s smartphones, and an increasing number of chips for personal computers, laptops and vehicles, working with customers such as Nvidia Corp. and Qualcomm Inc. In addition, its chip designs are becoming more common in data center servers, with public cloud infrastructure giants such as Amazon Web Services Inc., Google Cloud and Microsoft Corp. all offering access to customized virtual machines powered by Arm technology.

The company derives the bulk of its revenue from licensing royalties, where its customers pay fees to use and implement its designs to build their own processors. These royalties amount to only a small fraction of the chips’ overall price. During the quarter, Arm’s royalty-based revenue set a new company record at $514 million, up 37% from a year earlier and well ahead of Wall Street’s forecast of $495 million.

Arm also has a fast-growing licensing business, through which it sells access to more complete designs that can be plugged directly into silicon chips with minimal work. By licensing complete chip designs in this way, chipmakers can then focus on the customizations that set their offerings apart, as opposed to utilizing resources on the design process.

This business is more lucrative for Arm than the royalty business and the numbers show it. During the quarter, the unit hauled in more than $414 million in sales, up 60% from the same period last year. The company said this was thanks to “multiple high-value license agreements” tied to chips earmarked for artificial intelligence applications.

The company said its full-year revenue came to $3.23 billion, up 21% from last year, with royalty revenue growing 8% and licensing revenue up 43%.

Arm Chief Executive Rene Haas (pictured) said the company managed to surpass the $3 billion annual revenue milestone for the first time and goes into the new financial year with strong tailwinds driven by AI. “AI is driving increased demand for Arm-based technology across all end markets,” Haas said. “”From cloud to edge, all AI software models, from GPT to Llama, rely and run on the Arm compute platform. As these models become larger and smarter, their requirements for more compute with greater power efficiency can only be realized through Arm.”

Looking to the current quarter, Arm’s guidance was somewhat bullish, with the company calling for earnings of between 32 and 36 cents per share on sales of $857 million to $925 million, well ahead of Wall Street’s consensus estimates of 31 cents per share and $866 million, respectively.

However, the long-term outlook was less-than-optimistic, with officials projecting earnings of between $1.45 and $1.65 per share on sales of $3.8 billion to $4.1 billion. That was more or less in-line with the Street’s targets of $1.54 per share and $3.97 billion in sales.

The cautious guidance sent Arm’s stock into a tailspin, and it was down more than 9% in the hours after the report. Analysts say investors are worried about the pace of the buildout in AI computing, fearing that associated stocks have been lifted more than is justified by their actual growth rates.

Arm Chief Financial Officer Jason Child told Reuters that the company wanted to set an annual target that ties to its high confidence in what it will actually be able to deliver. “The timing of some of the company’s licensing deals can be hard to pin down,” he added.

Summit Insights analyst Kinngai Chan said Arm’s stock fell precisely because of the long-term outlook. “Arm is priced for outperformance, not this,” he said.

Investors have been making big bets that Arm will be one of the prime beneficiaries of the growth of AI computing, and its share price has more than doubled since it went public via an initial public offering in September. The company was spun out of SoftBank Group Corp., initially priced at $51 per share, and the stock soared at the beginning of the year, hitting an all-time intraday high of $164 in February.

Recently, though, the stock has began to pull back, pressured by extremely high valuation metrics relative to its actual profitability and sales. Arm’s shares were recently trading at almost 70 times its expected earnings, compared with just 35 times in the case of the industry’s leading AI chipmaker, Nvidia Corp. Arm stock closed at $106.07 in regular trading today.

SoftBank continues to maintain a strong influence on Arm, controlling about 90% of its outstanding shares.

Photo: Arm/YouTube