Arm: Launches CPU Business as It Wants More of the Pie

Key Morningstar Metrics for Arm

• Fair Value Estimate
  : USD 135
• Morningstar Rating
  : ★★
• Morningstar Economic Moat Rating
  : Wide
• Morningstar Uncertainty Rating
  : High

After a year of rumors, Arm ARM finally revealed its intentions to move into the chip business, making the transition from an intellectual property provider to a fabless chip company.

Why it matters: Since its IPO, Arm has been pushing to capture more dollars across the industry, first by expanding into adjacent markets beyond smartphones and then by raising royalty rates with the introduction of v9 and compute subsystems.

• Selling finished chips is the ultimate step. Arm will now compete with some of its own customers like Nvidia, Qualcomm, Mediatek, and the hyperscalers while simultaneously licensing IP to them. This will transform Arm into a hybrid company with a capital-light division that will continue to collect royalties from customers and another division that will sell its own CPUs.

The bottom line: We raise our fair value estimate for wide-moat Arm to USD 135 per share from USD 80 as we incorporate the CPU business into our forecast. We model USD 24 billion in 2031 revenue, with roughly half coming from the new CPU division and half from the existing IP business. This results in adjusted earnings per share of USD 8.30, compared with USD 5 previously. By 2031, we estimate blended gross margin of around 70% and GAAP operating margin of 35%.

• We have been cautious on Arm’s valuation for more than two years, as we could not find a way to justify the roughly 100 times adjusted forward P/E for the royalty business. This update provides the revenue bridge to a higher valuation, but we still struggle to see a compelling risk/reward for investors at current prices, who are paying for earnings that are beyond 2030. CPU revenue won’t start growing meaningfully until 2028-29.
• Arm still needs to scale this business at a very fast pace over several years in an environment with multiple competitors, including Nvidia. Our fair value estimate already assumes aggressive revenue growth with clean execution, with revenue growing by 10 times in the next decade and EBIT by 16 times.