Arm's Recent Pivot Will Power a New $15 Billion Market

A question frequently asked by Arm Holdings (NASDAQ: ARM) shareholders: If the company designs some of the world's best artificial intelligence (AI) chips, why doesn't it manufacture and sell them? That question went unanswered until recently, when Arm made the biggest pivot in the company's history. It revealed plans for the Arm AGI CPU -- the company's first production silicon.

When Arm released its quarterly financial results, investors were keen for information about the ongoing adoption of AI and an update on progress in its recent foray into chipmaking -- and Arm delivered.

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Like a broken record

For the company's fiscal 2026 fourth quarter (ended March 31), Arm reported record revenue that rose 20% year over year to $1.49 billion. That resulted in adjusted earnings per share (EPS) of $0.60, up 10%. It's worth noting that Arm exceeded the midpoint of its guidance despite record R&D spending to support its venture into chip production, which weighed on the bottom line.

For context, analysts' consensus estimates called for revenue of $1.47 billion and adjusted EPS of $0.58, so Arm surpassed both benchmarks.

Each of Arm's major segments contributed to the top-line growth. Royalty revenue of $671 billion climbed 11%, driven by strong adoption of Arm's chip designs and higher royalty rates for its top-of-the-line chip designs. The company noted that its Arm version 9 architecture and Arm Compute Subsystems (CSS) are seeing increasing deployment in AI data centers.

Arm's license and other revenue of $819 million jumped 29%, fueled by increasing adoption of the company's proprietary designs. Management cited timing related to several high-value license agreements and drawdown from the company's backlog.

Other metrics helped illustrate the broad-based strength of Arm's business. The company's annualized contract value (ACV) increased 22% to $1.66 billion.

One item of note was Arm's remaining performance obligation (RPO) -- or contractually obligated revenue that hasn't yet been recognized -- which actually decreased 7% year over year to $2.07 billion. While that might normally be cause for concern, in this case, it was the result of improvements in the timing of revenue conversion. Put another way, Arm earned some of this backlog revenue more quickly, helping fuel its stronger growth.

A chip off the old block

At an investor event in March, the company unveiled the Arm AGI CPU, the company's first production silicon, which it said was "purpose-built for Agentic AI." Arm said the cutting-edge processor will deliver more than two times the performance per AI rack system compared to those equipped with x86 architecture (the current standard). The major selling point is that data centers using the chip can reduce capital expenditures by up to $10 billion per gigawatt. Meta Platforms partnered with Arm to develop the chip and will be among the first to deploy it.

Customer response to the Arm AGI CPU has been robust, with signups rising to $2 billion between 2027 and 2028, more than double the $1 billion it announced at launch. The company listed several design wins for the new processor as agentic AI workloads increase. The company is on track to achieve $15 billion in sales of the Arm AGI CPU within five years, marking an entirely new revenue stream for the company. In all, the company expects to generate $25 billion and adjusted EPS of $9 in fiscal 2031.

Arm's forecast for its fiscal 2027 first quarter outpaced Wall Street's expectations. The company's outlook calls for revenue of $1.26 billion and adjusted EPS of $0.40 at the midpoint of its guidance, ahead of analysts' consensus estimates of $1.25 billion and $0.37, respectively.

Bears will suggest that Arm isn't cheap, and with good reason. The stock is currently selling for 81 times next year's expected earnings, which is lofty by any stretch of the imagination. Here's the thing: If management's estimates are correct, the stock is selling for less than 25 times estimated 2031 earnings. To me, Arm stock is at least worth a look.

To be clear, plenty of things will have to go right for Arm to achieve its lofty ambitions. However, given that demand for the Arm AGI CPU has doubled since its unveiling less than two months ago, I'd argue that it's off to a good start.

Danny Vena, CPA has positions in Meta Platforms. The Motley Fool has positions in and recommends Meta Platforms. The Motley Fool has a disclosure policy.