Arm Holdings: A Look at Its Expanding Business Strategy
Arm Holdings plc (NASDAQ: ARM) has built its reputation by supporting other companies in designing processors. Recently, the company made a move to sell its own data center CPUs, aiming to increase its revenue from each system. However, this shift could alter its relationship with clients who currently license its technology. Investors are now left to determine whether this change strengthens Arm’s competitive edge or makes it harder to sustain.
In a recent analysis, we noted that NVIDIA sold its shares in Arm but continues to rely on its architecture. This raises questions about what this separation between ownership and dependence means for Arm’s competitive position. Furthermore, Arm’s new chip strategy brings it closer to understanding hardware economics in a market where the availability of artificial intelligence (AI) resources might give customers more power in negotiations.
New Revenue Possibilities Come with Challenges
On July 29, Arm reported its financial results for the first quarter of fiscal 2027, revealing a revenue of $1.29 billion. This figure included $715 million from royalties — a 22% increase — and $574 million from licensing and other sources, which rose by 23%. Notably, revenue from data center royalties more than doubled, reflecting a thriving business rather than one in need of rescue.
Arm announced that its new AGI CPU has already reached initial customers, and it is targeting a $1 billion revenue opportunity for fiscal years 2027 and 2028, with demand reportedly exceeding $2 billion during that time. However, it’s important to clarify that this demand figure is not equivalent to guaranteed sales.
By licensing its technology, Arm had previously passed many manufacturing and commercialization costs onto its customers. But by selling chips directly, it will need to share in these expenses, meaning revenue growth needs to be weighed against profit and cash investment. Revenue from chips and royalties cannot simply be treated as equal.
In the second quarter of 2026, 52 hedge funds were reported to hold Arm shares, up from 46 in the first quarter. However, the impact of this activity on the company’s long-term profitability is still unclear.
Success Requires More Than Just a Product Launch
As of the end of September, Arm’s stock was trading at approximately 59 times its enterprise value relative to trailing revenue and around 205 times its free cash flow. These figures suggest that the market is optimistic about future growth. The first-quarter revenue, annualized, stands at about $5.16 billion, although this is not a forecast for the entire year.
Given Arm’s enterprise value of about $306 billion, a future scenario where it generates $10 billion in revenue at a 30% operating margin would translate to an operating profit of $3 billion. However, even in this case, the stock might be valued at over 100 times that profit. These scenarios indicate that simply having a new product opportunity is not enough to justify the current stock valuation.
Arm had over 15.5 million shares sold short by mid-September, and its smaller publicly traded float means that even small changes could have a significant impact on market exposure.
The best case for Arm extends beyond just direct chip sales. The company could continue to earn royalties from its customers’ processors while using its products to advance the architecture’s adoption and showcase its competitive edge. Continued growth in licensing and royalties would support this positive outlook.
On the other hand, there are risks involved. As Arm moves closer to being a direct competitor with its customers, those clients might be less inclined to share their future plans or depend on a supplier that is also vying for the same market share. While there’s no evidence yet of customers leaving, the risk becomes relevant if Arm’s chip business grows while its licensing or royalty revenue weakens.
Arm Holdings has the potential to expand its business by launching competitive data center systems. However, its stock performance could improve only if these expansions lead to increased profits, while licensing and royalties continue to grow. If the chip segment expands but comes at the cost of weaker customer licensing or higher capital needs, this could significantly alter its competitive position.
While Arm presents an interesting investment opportunity, some analysts believe other AI stocks might offer better potential with lower risks. Investors may want to explore undervalued AI stocks that could benefit from current market trends.
