Why Singer invested in Arm Holdings.
Billionaire Paul Singer and his fund, Elliott Investment Management, are making waves: The fund is in active talks with Starbucks about a turnaround plan that has resulted in the company appointing a new CEO, and it’s also in a public feud with Southwest Airlines, having just appointed 10 new members to the airline’s board of directors.
Meanwhile, in the technology industry, the fund sold its shares in Nvidia. (NVDA 4.35%) New position at Arm Holdings (arm 1.54%).
The Nvidia sale is not surprising, as Elliott said in a shareholder letter earlier this month that artificial intelligence (AI) is “overvalued.” He added that AI technology consumes too much energy and will never become cost-effective. Nvidia is currently in a “bubble,” he added in the letter.
Instead, Singer and company appear to be betting on fellow chipmaker Arm in the tech space.
What makes Arm different?
While Nvidia stands to benefit greatly from increased spending on building AI infrastructure, Arm stands to benefit greatly from smartphone adoption — Arm’s technology is in nearly every smartphone in the world.
Arm’s business model is also very different from Nvidia’s. While Nvidia designs its own chips, Arm licenses its technology to other chipmakers. It then collects royalties based on the number of chips shipped that are built based on its architecture. Once its technology is built into a product, Arm can collect royalties for years or even decades. The company says nearly half of its royalty revenue comes from products released between 1990 and 2012.
More recently, Arm has been moving customers to a subscription model to gain access to a broad range of the company’s intellectual property: At the end of the second quarter, there were 33 customers using the Arm Total Access platform and 241 customers using the Arm Flexible Access platform.
While the company is a leader in the smartphone sector, it is now looking to grab a large share of the Windows-based personal computer (PC) market, where it aims to have at least 50% market share.
The technology is already in all Mac-based computers and is looking to capitalize on PC makers trying to make their laptop designs more similar to the MacBook Air, and it’s also gaining share in the automotive market, where it expects 28% growth in the second quarter.
Elliott recently said that AI is overvalued, but Arm is also benefiting from AI buildouts: The company said in its second-quarter earnings call that it is seeing an increase in AI data center licenses that require Arm-based chips due to the need for customization.
The company is also working with NVIDIA on a chip called Grace Hopper, which combines an Arm-based central processing unit (CPU) with the NVIDIA Hopper graphics processing unit (GPU), and will also be featured in NVIDIA’s next-generation Grace Blackwell chip.
Additionally, Arm technology is used in new CPU datacenter chips from both Alphabet and Amazon. Arm hasn’t benefited as much as Nvidia from the buildout of AI infrastructure, but it’s still benefiting from it. Meanwhile, cloud computing companies continue to pour money into building this infrastructure.
Image source: Getty Images.
Is it time to buy an Arm?
Elliott’s investment in Arm could extend beyond the company to its largest shareholder, SoftBank. (SFTBF 0.92%)The company owns about 90% of the chipmaker. In June, it was revealed that Elliott had acquired more than $2 billion in shares in the Japanese investment firm. Elliott had been seeking $15 billion in share buybacks from SoftBank, which recently announced a smaller $3.4 billion share buyback plan.
Judging by Elliott’s comments on AI, the fund likely wants SoftBank and Arm to abandon plans to develop their own AI chips and build AI data centers around the world, and Elliott’s anti-AI stance may be intended to persuade SoftBank and Arm to buy back their own shares instead.
Elliott owns shares in both SoftBank and Arm, so it’s unclear where the fund will ultimately invest. Looking at Arm alone, the company is trading at a forward price-to-earnings multiple of 63.5 times analysts’ 2025 estimates. That’s significantly higher than Nvidia, but the length of time it will collect royalties on its products and the licensing revenue it generates make Arm one of the most attractive business models in the chip industry.
ARM PE Ratio (1-Year Ahead) data from YCharts.
Given Arm’s recent share price decline, I believe the stock is more attractive than before. Still, given the company’s valuation, I would be better off dollar-cost averaging in advance to protect against future share price declines rather than buying more now. On the other hand, if Elliott is right that AI is overvalued, his investment in Arm is not immune to an AI downturn.
John Mackey, former CEO of Amazon subsidiary Whole Foods Market, is a member of The Motley Fool’s board of directors. Suzanne Frey, an Alphabet executive, is a member of The Motley Fool’s board of directors. Jeffrey Saylor has invested in Alphabet. The Motley Fool has invested in and recommends Alphabet, Amazon, NVIDIA, and Starbucks. The Motley Fool recommends Southwest Airlines. The Motley Fool has a disclosure policy.
