Jahanara Nissar

Anxious to shed its image of being overly dependent on the mature smartphone market, the narrative from ARM management at the earnings call last night leaned heavily towards cloud server CPUs. However, we think the strength in royalty revenue in the December quarter was driven by the more mundane ‘annual refresh cycle’ of premium smartphones as smartphones ‘returned to strong growth in Q3’.

We believe the y/y increase in royalty revenue is based largely on Apple’s return to growth, a prospect few on the Street are willing to embrace. Into an environment of overarching negative investor sentiment, we turned the corner on AAPL in December (link) as we raised our PT to $220. We reiterated our constructive view into Apple’s earnings event (link). Strength in ARM royalty revenue gives us more confidence not only in iPhones but also in a possible turn-around in iPad.

We think the strength in royalty revenue was anticipated by ARM management. On the other hand, the upside surprise to print/guide, in our view, came from licensing revenue from the cloud server CPU market – specifically, from NVDA’s GH200. However, we do not expect NVDA’s licensing agreement with ARM to translate into material revenue for NVDA’s ARM server product, in the medium term, as Microsoft is yet to complete porting its Windows Server OS onto NVDA’s cpu.

ARM’s royalty revenue growth driven by Apple’s emergence from the doldrums:

While management talked up share gains in server CPU, the role of smartphones, contributing 35% to ARM’s royalty business, cannot be de-emphasized.

ARM’s FQ3 royalty revenue was up 11% y/y, even though overall chip units shipped was down 3% y/y. While not calling it out by name, ARM’s royalty growth in FQ3 had a lot to do with Apple iPhone’s return to y/y growth, in our view.

ARM’s FQ4 guidance of royalties up 30% y/y is also strongly influenced by Apple, in our view. That may come as a surprise to many given Apple’s soft guidance for its March quarter.

We believe Apple started a strong ramp of ARM-based M3 wafers in January at TSM’s 3nm node in preparation for the launch of next generation iPads likely in the June quarter. We think TSM’s strong January revenue reflects strength at its 3nm node and gives credence to our iPad thesis. ARM’s royalty growth in March quarter and beyond, we think in part is due to Apple’s iPad refresh and the higher royalties of ARMv9 at 3nm vs. the previous generation of iPads at 5nm.

The surprise upside to print/guide driven by NVDA: The upside to ARM’s print/guide is due to unexpected strength in its licensing business, in our view. ARM cfo spoke of upside to print/guide from selling ‘additional licenses’ to AI end-market that was ‘just not in our plan and not anticipated’. We think the upside surprise in Q3 print and to Q4 guide comes from the licensing revenue from NVDA’s GH200 superchip. We believe the GH200 is targeted for shipment to Microsoft.

According to our checks, NVDA is licensing ARM in advance of actual shipment of GH200 servers. The timing of the shipment will depend on when Microsoft is done porting Windows Server OS onto NVDA’s ARM platform. We believe Microsoft is not ready with the solution. The timing of the shipment of GH200 to Microsoft is not clear.

Net/Net:

• ARM management appears confident of its royalty revenue growth. We expect to see ARM’s royalty strength translate into revenue growth at Apple.
• ARM management appears circumspect in its licensing business outlook beyond the current quarter. We do not expect upside surprise in ARM’s licensing business to translate into strength at NVDA’s ARM server business in the medium term.