Arm Holdings Stock: A Wide Moat, but We Think It’s Expensive

Key Morningstar Metrics for Arm Holdings

• Fair Value Estimate: $34.00
• Morningstar Rating: 2 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

We initiate coverage of Arm Holdings ARM with a wide moat rating and a $34.00 fair value estimate, implying an enterprise value to EBIT multiple of 41 and 31 times for fiscal years 2024 and 2025, respectively. Despite its good growth prospects, we struggle to justify the firm’s lofty IPO valuation of $51 per share. At that price, the EBIT multiples would be 59 times for 2024 and 41 times for 2025.

Our forecasts remain slightly below FactSet consensus, and we see Arm’s shares as overvalued. Despite its very strong business model, Arm does not come free of risks, and thus we assign the company a High Uncertainty Rating. We model an 11% revenue compounded annual growth rate over the next decade, with operating margins expanding from 23% in fiscal 2023 to 39% in 2026 due to operating leverage. Our terminal operating margin is 43%.

Our wide moat is underpinned by the firm’s switching costs and intangible assets. Once a company develops a chip in a certain architecture, it implicitly accepts that further versions of the chip will be done in that same architecture. Even large companies like Apple AAPL can take years and millions of dollars to switch architectures, as happened with Mac laptop CPUs switching from using Intel to Arm-based chips.

Arm has long-standing relationships with its customers, which gives the firm visibility into its clients’ future designs, facilitating R&D innovation. Arm products also have very long shelf lives, with 46% of company revenue still coming from products released between 1990 and 2012.

Arm does not sell chips; it develops chip architecture and IP that it licenses to clients. On top of licensing fees, the company gets a royalty percentage of the value of the chips shipped (1.7% on average). If a $1,000.00 smartphone has $200.00 of ARM content, the firm gets $3.40 (1.7%). On top of volume growth, we believe Arm has the potential to steadily increase its royalty rates as it introduces new features that improve chip performance. We model a blended 2.5% royalty rate in 2030, compared with 1.7% today.