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An AI Stock with Huge Ambitions

June 17, 2024

A short chart but a strong one. This index is cap-weighted, has 34 constituents led by Nvidia, and is blazing higher. Is it suddenly going to top out? Anything is possible but it looks most unlikely. This is not one stock on a roll (not entirely, anyhow) but a whole sector bursting with vigour.

Data centres were built for the world of the cloud, for storing and retrieving information. The world we are moving to is vastly more ambitious and requires a wholesale reinvention of the world’s computing infrastructure, which has barely begun.

Arm Holdings Bristles with Ambition

We architect, develop, and license high-performance, low-cost, and energy-efficient CPU products and related technology, on which many of the world’s leading semiconductor companies and OEMs rely to develop their products. Our energy-efficient CPUs have enabled advanced computing in over 99% of the world’s smartphones and more than 287 billion chips, cumulatively, powering everything from the tiniest of sensors to the most powerful supercomputers.

Arm Holdings, website

I remember Arm’s origins as part of a company which made Acorn Computers. It has come a long way since then. It is a phenomenally exciting company.

“We finished our financial year achieving over $3bn in revenue for the first time, and with strong tailwinds heading into FYE25 as AI is driving increased demand for Arm-based technology across all end markets,” said Rene Haas, CEO. “From cloud to edge, all AI software models, from GPT to Llama, rely and run on the Arm compute platform. As these models become larger and smarter, their requirements for more compute with greater power efficiency can only be realized through Arm.”

Arm Holdings, shareholder letter, Q4 2024, 8 May 2024

The valuation is eyewatering. Current year revenue will be $3bn-plus [see below] but that compares with a market value of over $160bn! The shares are a tight market with Softbank owning a 90-stake. What a deal that was. My impression is that Arm is a terrific company, maybe even in the priceless category like Nvidia.

So, we announced our V3 Neoverse CSS [Arm Compute Subsystems] this quarter, which will give increased performance and benefits to customers. The first automotive CSS is now in discussions with our key partners to customers in terms of time to market and efficiency. And our first customer in the Neoverse space doing a design, Microsoft, their Cobalt chip is now ramping. But probably from a more exciting standpoint, we are oversubscribed on this compute subsystem strategy.

We have far more demand for the product than anticipated, and we are anticipating growing that significantly over time. Every end market that we approach has a need for CSSs, and we’re very excited about talking about them in the future. All of this is also being driven by AI. What we are seeing is, because Arm has the largest installed base of CPUs [central processing units] on the planet and has over 70pc of the world’s population using those CPUs, it’s natural that, as these AI workloads are now being moved anywhere from the edge devices to the training data centre, that they need support from an Arm CPU standpoint.

So, whether it’s from cloud Edge, from GPT to Llama, all AI workloads rely and run on Arm. And we only see this increasing. Our licensing activity is probably the best proxy for that. The way to think about licensing revenue as it applies to AI is, as software is moving faster than hardware, the hardware designs need to be upgraded quickly to make sure they can capture the needs of these new AI workloads.

So, because of that, we have seen huge growth in our licensing activity. We talked about that last quarter and it continued this quarter. So, based upon this, we are very, very confident of our growth outlook for the upcoming year. This past year was over 20pc revenue growth, and we expect that to be even better than that in this year and the upcoming years.

Our growth has been accelerating. It took Arm 20 years to get to $1bn in revenue. It took us 10 years to get to $2bn. This year, we passed $3bn in only two years after our first $2bn year, and we expect to be near $4bn this year.

The future is very bright, and will run in Arm, and I could not be more excited about the future that we have.

Rene Haas, CEO, Arm Holdings, Q4 2024, 8 May 2024

Another amazing statistic is that Arm has around, 7,100 employees. This values each employee at $23m. Net profit margin is 24pc which I could easily imagine going higher given the royalty-based business model. I don’t know the right price for Arm but I would rather be a holder than not, given the outstanding prospects. No wonder Nvidia tried so hard to buy the company.

Strategy – Buy Arm, Maybe in Stages

One way to deal with a share which looks exciting but is scarily pricy is to expect volatility and stagger your buying so you buy some lower and some higher but hopefully around a strong secular uptrend. The much-respected US share commentator, Jim Cramer, is saying it may be time to take profits on AI stocks. The danger with that is that they carry on steaming higher and you stress about whether to repurchase your shares or not. I think when the fundamentals are as explosive as this it is best to just ‘stay long, stay strong’ as they say in the chat rooms.

There is a fear that what is happening with AI and all the related infrastructure is a one-off spike in demand. Maybe people worried about that with Henry Ford and his cars. He launched that car, any colour as long as it is black, in 1908, and demand was strong.

The Model T was so popular Henry Ford once said: “There’s no use trying to pass a Ford, because there’s always another one just ahead.” By the early 1920s more than half of the registered automobiles in the world were Fords. More than 15,000,000 Model T’s were built and sold. The current global population of cars is around 1.5bn so any hype was more than justified. By 1929, Americans owned 23m cars. The best known was the Ford Model T car.

Ford Corporate

Just in passing it makes you realise how unnecessary was the 1929 crash and ensuing depression. They needed a Ben Bernanke [Federal Reserve chairman during the 2008 banking crisis] to flood the economy with dollars and they would have been fine but sadly they didn’t know and the money supply turned viciously negative as the banking system collapsed.

The effect of the car was amazing.

The car industry was important because:

  • it pioneered new techniques of production which other industries copied;
  • Henry Ford’s standardisation of machine parts was also imitated;
  • it led to the expansion of cities and the development of suburbs;
  • it enabled people to travel to cinemas, which in turn stimulated the movie industry;
  • it resulted in a vast national network of roads. (During the 1920s, about $1bn a year was spent on highways);
  • it encouraged the construction industry – petrol stations were built, as were hotels and restaurants;
  • it helped other industries to grow rapidly. For example, cars used 90pc of America’s petrol, 80pc of the country’s rubber and 75pc of its glass;
  • the car changed people’s lives. It gave them more freedom and it made them feel confident in and proud of America;
  • big manufacturers, such as Henry Ford, were so rich and famous that they were able to influence government policy;
  • many of the rich businessmen became philanthropists Henry Ford built a hospital and a museum and gave millions to schools, colleges and orphanages.

The boom led to:

  • the electrification of America;
  • the building of a massive road network;
  • the expansion of towns and the extension of suburbs;
  • the growth of the construction and chemical industries;
  • new mass production techniques;
  • increases in the number of chain stores and mail-order businesses;
  • the development of hire purchase schemes and expansion of the stock market;
  • the spread of popular entertainment;
  • new consumer goods, often made out of new materials;
  • sophisticated advertising.

The iPhone was a similar story of disruptive change.

The revolutionary first iPhone was released on June 29, 2007. Revealed as a device that was capable of iPod, Phone, and Internet functionalities, the iPhone marked the large first step towards the smartphone market we know today.

17 May 2024

The effect was similarly transformative.

The iPhone, introduced by Apple in 2007, stands as one of the most groundbreaking and transformative technological innovations of the 21st century. Its impact on the way we live, communicate, work, and play cannot be overstated.

Before the iPhone’s inception, the mobile phone landscape was vastly different. These devices were primarily tools for voice communication, simple text messaging, and, at best, basic web browsing. The notion of a handheld device that could seamlessly combine a phone, music player, camera, and computer was a futuristic dream.

In the pre-iPhone era, mobile devices were often clunky and offered limited functionality. People carried a multitude of gadgets to meet their various needs: flip phones for calls, digital cameras for photography, MP3 players for music, and personal digital assistants (PDAs) for basic productivity. The iPhone was a game-changer, bringing all these functions into a single, sleek device.

It seamlessly integrates phone calls, text messaging, email, web browsing, and an ever-expanding array of applications within a beautifully designed package. This convergence of technologies not only simplified our lives but also opened the door to countless new possibilities, culminating thus far in the iPhone 15 Pro.

When Steve Jobs made iPhone’s introduction, it marked a turning point in human interaction with technology. It redefined the way we access information, communicate with one another, and engage with the digital world.

The App Store, introduced in 2008, gave birth to a thriving ecosystem of third-party applications that catered to nearly every aspect of our lives. From entertainment and productivity to healthcare and education, the iPhone became a versatile tool that empowered individuals and industries alike.

Seamgen, 23 November 2023

Since 2007 Apple shares have risen over 70 times. Everybody knew the iPhone was a big deal but nobody grasped how big.

I suspect that Generative AI is the same but bigger, maybe much bigger and the stock market impact will be seismic. Investors are reeling at Nvidia’s rapid advance to a $3T valuation and baulk at buying Arm on over 40 times sales but if we are at the dawn of an era of explosive technological change these shares may still be in the bargain basement.

Suppose the data centre build-out is not a one-off spike in spending but a massive effort by humanity to turn spaceship Earth into an organism with computer technology at its beating heart powering everything rather like the all-seeing computer, HAL, in the film 2001. If that is where we are going this infrastructure spending and associated hardware could snowball for years, even decades.

The Internet and the wired (metaphorically speaking) world seem incredible to people of my generation but maybe it is just a primitive stage on a fantastic journey of ever-accelerating technological change.

Share Recommendations

ARM Holdings. ARM. Buy @ $158.5

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