AI agents awaken CPU demand, but the incremental earnings still cannot justify Arm's (ARM.US) expensive valuation; Goldman Sachs Group, Inc. reiterates "Sell"

Title context: AI agents awaken CPU demand, but the incremental earnings still cannot justify Arm's (ARM.US) expensive valuation; Goldman Sachs Group, Inc. reiterates "Sell" Text: After Arm (ARM.US), the owner of the ARM instruction set architecture, released its earnings report and future outlook, Goldman Sachs Group, Inc. issued a negative rating research report, with the Wall Street financial giant maintaining a "Sell" rating on Arm and a target price of only US$160. The Goldman Sachs Group, Inc. analyst team acknowledged Arm's strong growth opportunity in the AI CPU field, a market worth hundreds of billions of dollars, but questioned whether the revenue associated with new AI chips can offset pressure on the royalty business and support the current excessively expensive valuation. Under Goldman Sachs Group, Inc.'s US$160 target price, that implies about 16.6% downside from the latest closing price of US$191.80. Throughout October, Arm's share price fell 28.9%, significantly underperforming the Nasdaq 100 Index's decline of about 6.6% and the Philadelphia Semiconductor Index's decline of 15.4%. On November 4, Arm closed down 5.28% at US$191.80 before the earnings release; after the earnings report and earnings call were published, as of the pre-market session for U.S. stocks on November 5 Beijing time, the pre-market quote was US$180.60, down another 5.84%. This performance reflects that, after being hit hard by the surge in AI financing costs and severe valuation pressure on AI trades, investors have become increasingly demanding about Arm's growth prospects, shifting comprehensively from mere revenue growth to an accelerated focus on the long-term sustainability of growth, profit conversion, and the commercialization progress of the company's exclusively launched AI CPU. In the second quarter of fiscal 2027 ended September 2026, Arm's revenue reached US$1.443 billion, up 27.1% year over year, above the Wall Street consensus of US$1.377 billion shown by Visible Alpha used by Goldman Sachs Group, Inc.; adjusted earnings per share were US$0.52, above the Wall Street consensus of about US$0.48, and the adjusted operating margin was 44.2%, also exceeding Wall Street analysts' consensus of about 41.6%. However, the team led by Goldman Sachs Group, Inc. senior analyst James Schneider pointed out that the beat came mainly from licensing revenue, while royalties, which actually reflect the monetization of customers' chip shipments, again fell short of expectations; improved AGI CPU demand and supply visibility are not yet sufficient to eliminate doubts about pressure in the mobile phone business, the competitiveness of its own chips, and valuation, so the share price is expected to remain range-bound in the near term. Goldman Sachs Group, Inc.'s US$160 target price implies about 16.6% downside from the US$191.80 closing price; based on the latest disclosed period-end share capital of 1.070 billion shares, that corresponds to a market value of about US$171.2 billion. In the view of the Goldman Sachs Group, Inc. analyst team, Arm's revenue sources are expanding, but whether the new business can command the valuation premium of the original high-margin IP business and a valuation range overall far above that of the Philadelphia Semiconductor Index still needs to be proven by sustained strong earnings delivery. Licensing first, royalties lagging: AI growth has not yet fully taken over the baton from the smartphone business Goldman Sachs Group, Inc.'s research report shows that Arm's strong licensing-related revenue reflects customers' investment in future product roadmaps; royalty performance reveals the massive memory chip cost constraints currently facing smartphone end-demand. Arm's overall licensing and other revenue in the third calendar quarter (the second quarter of fiscal 2027 ended September 2026) was US$773 million, up 50% year over year and 15.8% above consensus; royalty revenue was US$670 million, up 8% year over year, but unexpectedly about 5.4% below market consensus. Goldman Sachs Group, Inc.'s research report shows that data center royalties doubling and physical AI royalties growing 50% are still not enough to offset the drag from mobile phones: memory price increases are raising total device costs and suppressing demand for low- and mid-range phones, and the per-chip royalty uplift from Armv9 and compute subsystems (CSS) has not yet fully offset shipment pressure. The earnings call further disclosed that licensing revenue included about US$209 million in technology licensing and design services revenue contributed by SoftBank Group, Arm's largest shareholder, while annualized contract value grew only 12%, indicating that the single-quarter 50% licensing growth was also affected by the timing of contract signing and revenue recognition. In Goldman Sachs Group, Inc.'s view, licensing growth still has forward-looking value. In the third quarter, three new Arm Total Access agreements were added, active subscriptions exceeded 60, and four new CSS licenses were added, two each for data centers and mobile phones; however, these massive investments in ARM architecture chip design need to go through development and mass production before they can be converted into subsequent royalties. The Goldman Sachs Group, Inc. analyst team pointed out that the major issue behind this is that short-term guidance does not yet show a clear acceleration in royalties: the next quarter is expected to grow only at a low single-digit percentage year over year. The midpoint of the company's revenue guidance is US$1.540 billion and the midpoint of adjusted earnings per share is US$0.56, slightly above the market consensus of US$1.519 billion and US$0.55 used in Goldman Sachs Group, Inc.'s report, but below Goldman Sachs Group, Inc.'s previous forecasts of US$1.569 billion and US$0.60; adjusted operating expenses are expected to rise to US$825 million. Therefore, in the view of the Goldman Sachs Group, Inc. analyst team, this is a report with positive licensing demand and overall guidance slightly above the market, but it has not yet formed a royalty growth inflection point sufficient to drive a significant upward revision in earnings expectations. From collecting technology royalties to delivering CPUs: the revenue pool is expanding, and the valuation formula changes accordingly The new information on AGI CPU is that customer demand is gradually gaining support from purchase orders and supply agreements. Management's confidence has increased in achieving up to US$2 billion in combined revenue for fiscal 2027 and 2028, with the first commercial deliveries still planned for January-March 2027, and customers expanding from Meta to more buyers. Goldman Sachs Group, Inc. therefore raised its fiscal 2028 CPU revenue forecast from US$1 billion to US$1.5 billion, and fiscal 2029 from US$2 billion to US$2.2 billion, while maintaining US$100 million for fiscal 2027. It can be seen that Goldman Sachs Group, Inc. has substantially raised its judgment on CPU commercialization, but its forecast of US$1.6 billion combined for the first two fiscal years is still below the up to US$2 billion opportunity discussed by the company. The key execution points are also not limited to wafers, but also include substrates, testing, memory, and final system delivery. The most important valuation clue in Goldman Sachs Group, Inc.'s research report is that the upward revision to revenue forecasts is far greater than the upward revision to earnings forecasts. Goldman Sachs Group, Inc. raised its fiscal 2027-2029 revenue forecasts to US$6.173 billion, US$8.674 billion, and US$10.458 billion, up 1.4%, 8.3%, and 3.6%, respectively; earnings per share were raised only to US$2.26, US$3.00, and US$3.80, increases of 0.5%, 1.7%, and 1.3%. The reason is that higher licensing forecasts, lower royalty forecasts, and a rising share of CPU sales changed the profit structure: the fiscal 2028 overall gross margin forecast was cut from 90.9% to 87.1%. Arm's earnings call revealed that the first-generation AGI CPU gross margin is expected to be in the roughly low-to-mid 30s to low 40s percent range, with exceeding 50% being a target for subsequent products, so Goldman Sachs Group, Inc. emphasized that investors cannot directly apply the original IP business's gross margin of nearly 98%. Goldman Sachs Group, Inc. accordingly used normalized earnings per share of US$3.20 and a 50x price-to-earnings ratio to arrive at the US$160 target price; its US$360 bull case and US$88 bear case valuations are scenario analyses. To change the "Sell" judgment, royalties need to reaccelerate, or CPU scale, competitiveness, and operating leverage need stronger validation. CPU becomes a core growth point of AI computing infrastructure: How does Arm convert agent workloads into revenue? Arm's basic business is to provide customers with intellectual property such as instruction set architectures, processor designs, and compute subsystems, charge licensing fees, and receive royalties as customers' chips ship; AGI CPU adds a revenue path from directly selling its own designed chips. The ARM architecture CPU benefits from the underlying mechanism of agents in that software execution workloads outside the model expand significantly: GPUs and dedicated accelerators handle intensive model computation, while CPUs handle tool calls, code execution, data access, task scheduling, and runtime environment management. The more persistently agents operate and the more concurrent tasks there are, the greater the demand for CPU throughput, memory bandwidth, and resource isolation. In power-constrained data centers, higher performance per watt and rack computing density help increase effective output under existing power supply conditions. Arm has two paths that can be monetized in parallel: customer custom chips expand IP and royalty revenue, while its own AGI CPU increases the revenue capturable per system. Traditional licensing customers include Apple Inc., Qualcomm, MediaTek, and Samsung; cloud growth is mainly tied to Amazon.com, Inc. Graviton, Alphabet Inc. Class C Axion, Microsoft Corporation Cobalt, and the NVIDIA Corporation Arm CPU platform. The company expects Arm's server share among leading hyperscale cloud providers to exceed 60% by the end of 2026; this measure does not represent overall global server share. On its own chips, Meta is the main co-development partner and customer, Oracle Corporation plans to offer AGI CPU instances in 2027, and Taiwan Semiconductor Manufacturing Co., Ltd. Sponsored ADR and server partners support manufacturing and system deployment. Arm participates both in the growth of cloud giants' custom CPUs and attempts direct supply; the investment value ultimately depends on how much profit the two paths together create and whether direct supply can generate sustainable returns. As for the latest target prices from other Wall Street institutions, after Arm's earnings release, Barclays maintained "Overweight" but cut its target price from US$360 to US$325, implying 69.4% upside and a market value of about US$347.8 billion; Piper Sandler maintained "Overweight" and cut its target from US$320 to US$270, implying 40.8% upside and a market value of about US$288.9 billion. Barclays' judgment and Goldman Sachs Group, Inc.'s have a consensus on the profit mechanism: AGI CPU revenue forecasts were raised, but hardware gross margins and R&D investment limit the magnitude of earnings upgrades, and the main disagreement between the two is how high a valuation they are willing to pay for long-term growth. Wells Fargo & Company maintained "Overweight" and cut its target price from US$280 to US$255; Needham maintained "Buy" and a US$255 target price, both implying 33.0% upside and a market value of about US$272.9 billion. Wells Fargo & Company raised revenue forecasts for the next three fiscal years while lowering its target price due to valuation contraction in the semiconductor sector; Needham placed more emphasis on the realization of AGI CPU supply and demand and is waiting for the next earnings call for updates on deliveries and the fiscal 2028 outlook. JPMorgan also maintained "Overweight" and cut its target price from US$255 to US$245, implying 27.7% upside and a market value of about US$262.2 billion, with the cut mainly reflecting lower valuation multiples among peers. HSBC analyst Frank Lee maintained "Hold" and cut his target price from US$230 to US$215, implying 12.1% upside and a market value of about US$230.1 billion. HSBC believes that the clearer earnings catalyst over the next 12 months remains server royalties: market expansion, Arm's share gains, and an increase in chip core counts together raise the royalty revenue potential. Combined with Goldman Sachs Group, Inc.'s cautious US$160 valuation, the core of the Wall Street disagreement is already very clear - the AI agent frenzy is expanding CPU demand, but Arm's sustained share price recovery requires both high-margin royalty growth and chip supply profits to be delivered; the scale of new revenue alone is not enough to eliminate valuation disagreements.