Arm royalty growth weakens, while the CPU opportunity is increasingly reflected in valuation

Overview

This report is Morgan Stanley's update on the results and conference takeaways for ARM HOLDINGS PLC. The core conclusion is that Arm's Q1 performance was solid and Q2 guidance was favorable, but near-term royalty growth is under pressure from a worsening smartphone mix; the AGI CPU opportunity remains attractive over the long term, but supply, differentiation, customer acceptance of higher input costs, and the extent to which valuation has already reflected the opportunity will determine the risk-reward.

Core views

The report maintains an Equal-weight rating. Morgan Stanley recognizes Arm's leading position in semiconductor IP, structural opportunities in data center and AI-related computing, and the potential for long-term incremental growth from AGI CPUs; however, it believes the share-price re-rating following Arm Everywhere in March has already largely reflected the 2030 CPU opportunity. Near-term pressure mainly comes from weaker-than-expected smartphone royalty growth, continued increases in R&D investment, and the need to validate the commercialization path for the chip business.

Analysis framework

The analysis focuses on earnings guidance, royalty growth, licensing revenue, AGI CPU demand and supply, data center royalties, operating expense investment, and sum-of-the-parts valuation. The valuation separates the mature IP business from the emerging chip business, assigns different EV/EBIT multiples to each, and assesses risk-reward using FY27-FY29 earnings forecasts, WACC discounting, and bull and bear scenarios.

Methodology notes

• Valuation frameworkSOTP sum-of-the-parts valuation

  Values the IP business and chip business separately

  The report applies a 50x EV/EBIT multiple to the IP business and a 20x EV/EBIT multiple to the chip business, discounts the FY29 valuation at an 11% WACC, and derives a US$212 target price.

• Earnings forecastsMorgan Stanley ModelWare

  A modeling framework based on revenue, margins, EPS, and cash flow forecasts

  Unless otherwise stated, the key financial metrics in the report are based on the Morgan Stanley ModelWare framework, incorporating company guidance and consensus-expectation methodologies.

• Scenario analysisBull and bear scenarios

  Assesses upside and downside based on different growth, valuation, and execution assumptions

  The bull-case target is US$370, reflecting the realization of infrastructure, AI, cloud growth, and higher royalty rates; the bear-case target is US$65, reflecting chip-business losses, weaker royalty rates, adverse litigation outcomes, and lost competitive share.

Asset mapping & comparison

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

• ARM HOLDINGS PLC

  Core covered security

  Strengths

  A semiconductor IP leader with more than 60% of global semiconductor IP sales share, broad smartphone penetration, and exposure to AI, data centers, automotive, PCs, and v9/CSS architecture upgrades.

  Weaknesses

  Still dependent on smartphone royalties, with the near-term mix weakening; operating expense investment is high, the chip business is still in the early stages of transformation, and earnings conversion remains to be validated.

  Comparison

  The IP business is valued near the upper end of its historical range, while the chip-business multiple remains below those of global chip manufacturers, reflecting its low-margin but long-term growth potential characteristics.

  Risks

  Insufficient supply, CPU platform competition, inadequate product differentiation, TCO pressure, litigation, geopolitics, uncertainty around revenue from the Chinese joint venture, and competitors gaining share.

• Semiconductor IP business

  Primary revenue and profit foundation

  Strengths

  The royalty model has high-gross-margin characteristics, while Armv9 and CSS penetration can support higher royalty rates over the medium to long term.

  Weaknesses

  In the short term, it is affected by changes in the smartphone mix, and Q2 royalty growth guidance is weaker than expected.

  Comparison

  Compared with the emerging chip business, the IP business is more mature and has higher margins, supporting the use of a 50x EV/EBIT valuation multiple.

  Risks

  A weaker-than-expected mobile recovery, declining royalty rates in key markets, and competition from open-source ecosystems and other CPU architectures.

• AGI CPU and chip business

  Long-term incremental opportunity

  Strengths

  FY27-28 sales are expected to exceed US$1bn, with a demand pipeline above US$2bn; use cases are expanding from agentic applications to head-node system CPUs and traditional servers.

  Weaknesses

  Supply coverage is not yet fully visible, and progress is still required across wafers, memory, substrates, and testing; it remains uncertain whether higher input costs can be successfully passed on to customers.

  Comparison

  The valuation uses a 20x EV/EBIT multiple, below that of mature global chip manufacturers, while reflecting long-term growth potential.

  Risks

  Supply bottlenecks, insufficient customer acceptance, power consumption and TCO burdens associated with deploying independently orchestrated CPUs, and differentiation pressure from competing CPU platforms.

Key data

• RatingEqual-weightRating maintained.
• Target priceUS$212.00Raised from US$202.00.
• Current share priceUS$224.89As of the close on 2026-07-29.
• Q1 revenue/EPSUS$1.29bn / US$0.45Above consensus expectations.
• Q1 licensing revenue/royalty revenueUS$574m / US$715mBoth slightly above market expectations.
• Q2 revenue guidanceUS$1.33-1.43bnThe midpoint is approximately 7% above consensus expectations.
• Q2 EPS guidanceUS$0.47Above the consensus expectation of US$0.44.
• Q2 non-GAAP operating expense guidanceApproximately US$780mR&D investment continues to increase.
• FY27 EPS forecastUS$2.06Previously US$1.93.
• FY28 EPS forecastUS$3.69Previously US$3.51.
• AGI CPU sales expectationAbove US$1bn in FY27-28The demand pipeline exceeds US$2bn, with supply as the key constraint.
• 2030 CPU TAM estimateApproximately US$125bnMorgan Stanley maintains this estimate of the long-term market opportunity.

Impact & implications

For investors, Arm's long-term narrative remains driven by AI, data centers, Neoverse, v9/CSS penetration, and its chip transformation, but the short-term risk-reward is no longer clearly skewed to the upside. Slower royalty growth could weigh on expectations for a smartphone recovery, while data center growth, although strong, is not yet large enough to fully offset smartphone volatility. The higher target price primarily reflects modest earnings-forecast adjustments and continuation of the valuation framework, rather than a shift in rating stance.

Risks

• A shift in the smartphone mix toward mid-range Android causes royalty growth to slow.
• Insufficient AGI CPU supply coverage prevents full fulfillment of the demand pipeline above US$2bn.
• High investment in the chip business fails to translate into revenue and gross profit as expected.
• Customer acceptance of passing through higher input costs remains uncertain.
• Competing CPU platforms, open-source ecosystems, and incumbent chip manufacturers could weaken Arm's share.
• Adverse litigation outcomes, geopolitical uncertainty, and revenue volatility at the Chinese joint venture.
• Current valuation already reflects much of the long-term CPU opportunity; if execution or TAM realization falls below expectations, downside risk to the share price is substantial.

What to watch

• At the time of Q3 results, whether management can confirm complete supply coverage for the AGI CPU demand pipeline above US$2bn.
• Whether data center royalties can continue to grow by at least 100% annually and gradually reach a scale sufficient to offset smartphone volatility.
• Whether high-teens FY27 royalty growth and 25%-30% year-over-year licensing revenue growth can be achieved.
• After operating expenses continue to increase sequentially through FY27, whether this can translate into sustainable chip revenue and gross profit.
• Whether customers accept Arm's pass-through of higher input costs for wafers, memory, substrates, and testing.
• When Arm will separately disclose silicon revenue, and whether it will reach more than 10% of group revenue in FY28.
• The penetration pace of growth drivers including Armv9, CSS, Neoverse, AI, automotive, and PCs.