Arm Beats Q3 Estimates but Warns of Smartphone Slowdown, Reinforcing Valuation Risks

What happened

Arm Holdings reported Q3 earnings that exceeded both revenue and profit expectations, continuing its streak of strong performance driven by AI-related data-center royalties. However, management cautioned that smartphone royalty growth could slow next year, highlighting a key vulnerability in its business model. This warning aligns with the DeepValue report's concerns about Arm's heavy reliance on mature smartphone markets, which still contribute roughly 46% of royalty revenue. Despite the earnings beat, Arm's stock trades at a lofty 143x P/E, implying sustained mid-20s growth that may be jeopardized by this slowdown. The disconnect between near-term results and long-term guidance underscores the stock's sensitivity to any growth deceleration, as previously noted in bearish analyses.

Implication

The warning on smartphone royalties directly challenges Arm's ability to maintain the high growth rates priced into its valuation, increasing the likelihood of multiple compression. With data-center growth needing to offset mobile softness, any delays in hyperscaler adoption or pricing pressures from RISC-V could further strain royalty trajectories. Arm's elevated P/E of 143x and EV/EBITDA of 127x leave no margin for error, making the stock vulnerable to sharp declines if growth moderates as guided. SoftBank's margin loans and China concentration add additional downside risks that could amplify selling pressure in a downturn. Therefore, while near-term results are positive, investors should prioritize risk management and consider trimming positions unless data-center growth accelerates beyond current expectations.

Thesis delta

The smartphone royalty slowdown warning does not shift the core 'POTENTIAL SELL' thesis but increases the urgency by validating a key downside risk. It raises the probability of the bear case where royalty growth slips below 15%, potentially triggering multiple compression sooner than anticipated. Investors should closely monitor next quarter's guidance for any further deterioration in growth projections.