6. Arm Holdings (NASDAQ:ARM)
Year To Date Share Price Gain: 119.76%
Number of Hedge Fund Investors in Q2 2024: 38
Arm Holdings (NASDAQ:ARM) is a British semiconductor design IP company. While the firm does not sell its own processors, its blueprints power the vast majority of the world’s smartphone processors. Arm Holdings (NASDAQ:ARM) also offers designs and cores for GPUs and other chips. Its exposure to the AI industry comes particularly because of custom chips. Advances in semiconductor fabrication have meant that while traditionally x86 processors were more powerful due to instruction set architecture (ISA) differences, newer chip manufacturing technologies enable manufacturers to increase core counts within a small package size to maintain efficiency and increase performance. As a result, Arm Holdings (NASDAQ:ARM)’s designs, which were originally used for efficiency requiring applications such as smartphones, are now a mainstay of custom data center chip designs for big ticket names such as Amazon, Google, and Alibaba. This means that Arm Holdings (NASDAQ:ARM) has a wide moat and exposure to AI data centers, making it unsurprising that at one point, NVIDIA was interested in buying the firm. However, a long term threat could come from the open source RISC-V model disrupting the firm’s business.
Bireme Capital mentioned Arm Holdings (NASDAQ:ARM) in its Q4 2023 investor letter. Here is what the fund said:
“Another stock we bet against in the second half of 2023 was ARM Holdings. We find the valuation to be far too rich at more than 20x sales and 100x FY 2023 operating income. To garner such a large multiple in the public markets, majority owner Softbank seems to have pulled out all the short-term levers at its disposal. From the FT:
Arm is seeking to raise prices for its chip designs as the SoftBank-owned group aims to boost revenues ahead of a hotly anticipated initial public oering in New York this year. The UK-based group, which designs blueprints for semiconductors found in more than 95 per cent of all smartphones, has recently informed several of its biggest customers of a radical shift to its business model, according to several industry executives and former employees. These people said Arm planned to stop charging chipmakers royalties for using its designs based on a chip’s value and instead charge device makers based on the value of the device. This should mean the company earns several times more for each design it sells, as the average smartphone is vastly more expensive than a chip.
In our view this was a transparent attempt to boost revenue growth ahead of the IPO. This might work as a one-time boost to sales, but it is not sustainable and will anger and alienate customers. ARM’s largest customers increasingly choose to license just the ARM instruction set architecture (ISA) rather than purchase ARM’s o-the-shelf chip designs. They prefer to design their own chips so they can better optimize their hardware with their software, as Apple has done to great effect with its custom silicon. It is hard to imagine ARM getting significantly more revenue share while their value-add diminishes.”
. . . .We believe ARM’s short-term price increases are unlikely to be converted to long-term revenue growth, but this is what is required to justify the current valuation.”
