We value ARM using a ~1.9x PEG based on discounted FY27 earnings, which leads to our target price of $170. Given the strong multi-year growth forecast for ARM, we have decided to look further out than 2025 to capture the growth potential. We use our 2027 EPS estimates and discount them back two years to 2025. We think this approach better captures the long-term exposure to artificial intelligence, semiconductor capex and other structural growth areas.

ARM is High Risk based upon our quantitative model but assigning a High Risk rating is not supported by qualitative factors such as the fact that it is a well-established company that the company has been already trading prior to 2016, and so a High Risk rating has not been applied. 

We highlight the following downside risks factors for ARM. If the impact of these risk factors is more or less negative than we anticipate, the share price could deviate significantly from our target price:  

Rate of cyclical recovery: We currently forecast Arm to begin to see some cyclical recovery in F3Q24 (C4Q23), in line with Citi’s forecasts for its main production partner TSMC. If this recovery is delayed, it could result in revenue below our expectations for FY24.

Technological: Challenges in pushing royalty rates upwards, given lower technological benefit or if customers don't adopt the latest technology, could result in lower revenue growth and lower margins.

Competition: A gain/loss in chip design market share would result in upside/downside risk to our estimates. We view the primary competitive risk to come from RISC-V, which is a free open-source instruction set architecture targeted at the microcontroller market. 

Concentration of Ownership: Softbank currently holds ~90% of Arm shares, which may be an overhang for the stock given the potential for future stock sales following the post-IPO lock-up agreement.

Customer Risk: ARM derives significant share of its revenues from three largest customers, and an increase/cut in their chip volumes could result in risk to our estimates. In particular, Arm China is Arm’s biggest customer (24% of FY23 sales).

Macroeconomic: A weak macroeconomic environment and/or escalation in geopolitical tensions resulting in subdued semiconductor growth/increase in cadence could cause downside to our estimates.