The recent sell-off in artificial intelligence (AI) stocks has been broad, impacting even established tech giants. , Microsoft shares are down more than 20% from their October peak, reflecting a growing investor skepticism about the immediate returns on substantial AI investments. However, not all AI-related companies are equally vulnerable, and one in particular – Arm Holdings ((NASDAQ: ARM)) – is positioned for a potentially faster recovery, according to analysts.
Arm Holdings often gets lumped together with traditional semiconductor manufacturers like Nvidia, Intel, and Advanced Micro Devices. However, this categorization is misleading. Unlike these companies that *make* chips, Arm designs high-performance processors and the chipsets that accompany them. This distinction is crucial, as Arm’s designs are renowned for their power efficiency – a critical factor in the rapidly expanding field of AI computing.
The increasing demand for power-efficient computing is driving adoption of Arm’s designs by major players like Amazon, Google, and Apple. AI workloads are notoriously energy-intensive, and minimizing power consumption is a significant challenge and cost-saving opportunity. Amazon, for example, is increasingly relying on Arm-based Graviton processors in its data centers, with the latest Graviton 5 chip becoming a key component of Amazon Web Services.
However, the primary driver behind Arm’s potential for outperformance isn’t simply the demand for power efficiency, but its unique business model. While companies like Intel and Nvidia generate revenue through direct chip sales, Arm primarily earns income through licensing fees and royalties. Tech companies pay an upfront fee for the right to utilize Arm’s intellectual property in their chip designs, and then pay royalties based on the number of chips manufactured and sold. This model provides a recurring revenue stream and positions Arm to benefit from the broader adoption of its technology, even if individual chip sales fluctuate.
A key detail currently underestimated by investors is the growing backlog of licensing agreements that haven’t yet translated into substantial royalty revenue. The agreements with companies like Amazon, Google, and Apple are multi-year contracts, meaning the full financial impact of these partnerships is still unfolding. Google’s Tensor Processing Units, specifically designed for AI, are also based on Arm architecture, and their usage is expanding rapidly. Apple, a more recent entrant into the AI race, is also heavily reliant on Arm’s designs.
Arm’s stock experienced a dip after reporting disappointing third-quarter licensing numbers and less-than-expected fourth-quarter guidance. However, these results don’t fully reflect the existing, yet-to-be-realized, revenue from its licensing agreements. The company’s customers are already committed to utilizing Arm’s technology, and the corresponding royalty payments are expected to increase steadily over the coming years.
Analysts currently project a modest 7% top-line growth for Arm’s fiscal year ending in March , but anticipate a significant acceleration in growth – exceeding 23% – in the following year. This projected growth is predicated on the increasing realization of revenue from existing licensing deals and the continued expansion of Arm’s ecosystem.
The current market conditions present a potential opportunity for investors. While Arm’s recent financial results may have caused concern, they don’t fully capture the long-term potential of its business model and the growing demand for its technology. The royalty-based revenue stream, coupled with the increasing adoption of Arm’s designs by major tech companies, positions the company for a potentially faster recovery than other AI-focused stocks.
The Motley Fool recently released a report highlighting a little-known company described as an “Indispensable Monopoly” that provides critical technology needed by both Nvidia and Intel. This company, while not directly named in this report, underscores the importance of foundational technology providers in the AI ecosystem, a category in which Arm Holdings clearly resides.
