Arm's Data Center Royalty Boom Confirms Growth but Highlights Valuation Excess

What happened

Arm Holdings announced that data center royalty revenue more than doubled in its most recent quarter, driven by robust adoption of Neoverse-based CPUs in hyperscaler deployments like AWS Graviton and Google Axion. This surge aligns with the company's strategic R&D investments in higher-royalty products such as Compute Subsystems (CSS) and AI accelerators, aiming to diversify beyond mature smartphone markets. However, the DeepValue master report notes that Arm's stock trades at extreme valuations—143x P/E and 127x EV/EBITDA—embedding unrealistic growth expectations. The report cautions that data center gains must offset persistent risks, including 46% royalty reliance on smartphones, China exposure contributing 19% of revenue, and rising competition from RISC-V. Moreover, management's guidance points to revenue growth moderating toward the low-20s percent, which may not justify the premium multiples amid execution and geopolitical headwinds.

Implication

Arm's doubling of data center royalties validates its strategic pivot to AI and cloud markets, supporting potential for sustained double-digit growth from hyperscaler ramps. However, the stock's lofty valuation leaves no margin for error, with any slowdown in royalty growth likely triggering severe multiple compression. Critical risks include SoftBank's $18.5 billion margin loans against Arm shares, which could force collateral-driven sales and amplify downside, along with customer conflicts from Arm's own chip initiatives. Geopolitical tensions and RISC-V adoption threaten key revenue streams, particularly in China and smartphone segments. Therefore, while the business is executing well, the investment case at current prices is weak, with the DeepValue report suggesting a more attractive entry near $85.

Thesis delta

The new article confirms Arm's data center royalty growth, but it does not alter the core investment thesis. The DeepValue report already accounted for this strength while highlighting that valuation multiples are unsustainable given moderating growth guidance and significant risks. No material shift is warranted; the call remains a 'POTENTIAL SELL' with an attractive entry at $85.