Arm Earnings Beat Expectations, Target Price Raised to $202

Overview

Morgan Stanley released Arm Holdings FY2026 Q4 earnings review report. Arm achieved slight beats on revenue and EPS in the quarter, with Cloud AI royalty revenue doubling year-over-year and strong signals in new CPU chip demand. However, TSMC advanced process wafer capacity remains the core bottleneck limiting its ability to fully capture growth opportunities in the short term. Based on the emergence of Cloud AI as a more significant growth driver, Morgan Stanley adjusted the IP business valuation multiple upward, raising the target price from previous levels to $202, but maintained Equal-weight (Neutral) rating.

Core views

Performance: Arm total revenue for Q4 was $1.49 billion (approx +20% YoY), slightly above guidance midpoint; Non-GAAP EPS reached $0.60 record high, exceeding market estimate of $0.58. Licensing revenue grew YoY 29% to $819 million, performing strongly, but royalty revenue of $671 million was about 4% below market expectation. Management attributed weak royalties to temporary factors such as mobile production disruptions (e.g., DRAM shortage). Full year FY26 revenue reached $4.92 billion, up 23% YoY, third consecutive year of 20%+ growth post-IPO. Core Growth Logic: Cloud AI is currently the most core growth driver. Management expects FY26 royalties and licensing revenue to grow approx 20% each, with Cloud AI royalties expected to double YoY in both FY26 and FY27. Behind this is increased adoption by hyperscalers for custom CPU design and xPU vendors, as well as Arm's penetration in DPU/SmartNIC areas. Demand for new CPU chips is growing rapidly among enterprise clients; their low-power design has structural advantages in Agent AI workload scenarios. Management estimates the chip's market opportunity in FY27-28 exceeds $2 billion (previously expected to be less than double this figure). Supply Side Bottleneck: TSMC advanced process wafer capacity is the core constraint on the scaling of Arm's chip business. Although TSMC expects to increase 3nm capacity in CY26-27, it is uncertain how much incremental capacity Arm will receive. This limits Arm's ability to fully capture the >$2 billion chip opportunity in FY27-28 in the short term, so management keeps guidance cautious until supply visibility improves. Valuation Level: Morgan Stanley adopts SOTP (Sum-of-the-Parts) valuation method, valuing IP business and Chip business separately. Considering Cloud AI becoming a more significant growth driver, IP business EV/EBIT multiples were raised to 50x (upper end of historical valuation range); Chip business multiples raised from 15x to 20x (below global chip manufacturer average but reflects growth potential). After discounting FY29 expected earnings with 11% WACC, base scenario target price raised to $202.

Analysis framework

Morgan Stanley follows the "Demand-Supply-Valuation" mainline for analysis: First confirm demand-side signals through quarterly earnings breakdown, pointing out growth momentum in licensing and Cloud AI royalties and strong demand for new CPU chips among enterprise clients; then shift analysis focus to supply side, highlighting TSMC advanced process wafer capacity as the gating factor (bottleneck) for short-term growth, thereby understanding the rationality of management's conservative guidance. When calculating CPU chip market space (TAM), Morgan Stanley specifically reminded to avoid "double counting": As Agent workflows become more complex, incremental CPU demand is reflected mainly in the increase of core count (orchestration capability improvement), rather than a mechanical rise in CPU:GPU chip ratio, so modeling should not simultaneously assume high chip ratio and high core count. Valuation Method: Adopted SOTP segment valuation method, pricing IP business and Chip business separately. IP business assigned 50x EV/EBIT, Chip business 20x, discounting FY29 earnings at 11% WACC to derive $202 target price. This framework helps investors understand that different business segments due to differing growth drivers and risk characteristics should be given differentiated valuation multiples.

Methodology notes

• Valuation MethodSOTP Segment Valuation

  Segment Valuation Method

  When a company has multiple fundamentally different business segments, apply different valuation multiples to each segment and sum them to derive total market cap. In this report, IP business is given 50x EV/EBIT (high margin, stable growth), while Chip business is given 20x (high growth potential but higher risk), reflecting the different business models and prospects of the two categories.

• Valuation MethodEV/EBITDA valuation

  EV/EBIT Multiples and WACC Discounting

  Morgan Stanley uses Enterprise Value / EBIT multiples to measure relative valuation of each business segment, and uses 11% Weighted Average Cost of Capital (WACC) to discount future fiscal year (FY29) earnings back to present, to derive target price. This reflects a discounted cash flow thought process regarding long-term profitability of growth companies.

• Industry/Industrial Analysis FrameworkSupply-demand framework

  Supply-side Capacity Constraints

  In some capital-intensive industries (such as semiconductor manufacturing), even if demand is strong, actual output is constrained by capacity. In the report, Arm chip demand is robust, but TSMC advanced process wafer capacity becomes the gating factor (key constraint) deciding how much revenue can actually be realized, which is a core entry point for analyzing its short-term performance ceiling.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Arm Holdings plc (ARM.US)

  Core analysis subject of research report

  Strengths

  Global semiconductor IP leader (share >60%), ubiquitous in smartphones; Cloud AI royalty growth robust; New CPU chips have structural advantage in low-power Agent AI workloads; FY24-28 estimated EPS CAGR approx 29%.

  Weaknesses

  Short-term royalty revenue below market expectation; Chip business scaling constrained by TSMC wafer capacity; Faces operational uncertainty as a new entrant in chip market.

  Risks

  Litigation risk, geopolitical uncertainty, intensified competition, slowed sales in China, chip business losses.

• Taiwan Semiconductor (TSMC)

  Upstream capacity key supplier

  Risks

  Uncertainty regarding proportion of advanced process (3nm) capacity increment allocated to Arm.

Key data

• Q4 Revenue$1.49 billionApprox +20% YoY, slightly above guidance midpoint
• Q4 EPS (Non-GAAP)$0.60Exceeded market estimate of $0.58
• Cloud AI Royalty RevenueApproximately doubled YoYManagement expects FY26 and FY27 both to double YoY
• FY27-28 New CPU Chip OpportunityOver $2 billionDouble previous expectation
• Target Price$202.00Current stock price $237.30, implied approx -14.9% decline
• FY31 Long-term Revenue Target$25 billionWhere AGI CPU $15B, IP Business $10B
• IP Business Valuation Multiple50x EV/EBITAt upper end of historical range, reflects Cloud AI growth driver
• Chip Business Valuation Multiple20x EV/EBITBelow global chip vendor average, reflects growth potential

Impact & implications

The research report believes Arm's mid-term growth logic is constructive; the core IP business is expected to maintain approx 20% annual growth driven by Cloud AI royalties, hyperscaler custom CPU, and DPU penetration. The low-power advantage of new CPU chips in Agent AI workloads builds long-term growth space. However, uncertainty in TSMC wafer capacity allocation in the short term limits market confidence in the scaling pace of its chip business. Morgan Stanley's conservative adjustment and valuation multiple revision reflect the judgment that "short-term performance is supply-constrained, long-term value is revalued by AI drivers". For the market, core focus lies on whether royalty revenue will restart acceleration, sustainability of licensing growth, and implementation of chip capacity.

Risks

• TSMC advanced process wafer capacity insufficient, limits Arm chip business scaling
• Recent royalty weakness may reflect structural portfolio shift rather than being temporary
• Licensing revenue growth fails to convert below expectation in FY26 and H2
• Cloud AI royalties unable to maintain YoY doubling growth trend
• Litigation risk, geopolitical risk, intensified competition and slowed sales in China
• Chip business may incur losses

What to watch

• Whether royalty revenue can resume acceleration, confirming recent weakness is temporary
• Visibility of TSMC advanced process wafer capacity allocation
• Sustainability of FY26 licensing revenue growth and H2 weighted conversion
• Whether Cloud AI royalties can continue approx YoY doubling growth momentum