Edge AI will be an important trend with AI-powered PCs allowing more people to access the full benefit of AI-powered applications. This, in turn, will help AI developers build a bigger ecosystem. There is a bottleneck right now for AI applications to where client devices are not powerful enough or energy efficient enough to leverage AI capabilities. We’ve discussed this previously in our Memory and PC analysis with details on the upcoming Windows 12 upgrade, and also in the Memory and PC stocks write-up
Inference is also pushing forward the need for AI Edge devices and networks to be more powerful, but also more energy efficient. Inference takes batches of real-world data and quickly comes back with an answer or prediction. This is best done at the edge, which includes the edge network that a company like Cloudflare provides, and edge devices, such as smartphones and laptops. In the inference stage, the compute intensive neural networks are modified for speed and to improve latency. In order to do this, inference is optimized for runtime performance. This allows the computation tasks to be as close to the data source as possible. In many cases, data is produced at the edge, and it’s more efficient and faster to run inferencing at the edge. We’ve covered this in the past in our Cloudflare analysis.
Arm-based PCs are sparking competition, and this will be more evident this time next year (Q1 2025). The analysis below expands on the topic of Edge AI devices to discuss what 2024 will bring, and how we want to be positioned for 2025.
x86 versus Arm versus RISC-V
If Arm-based PCs stick this time, it will mark a massive shift in edge devices. X86 dominates PCs as it stands today, yet AI leaders have their roadmaps loaded with Arm-based releases over the next year. This will be Qualcomm in 2024, followed by Nvidia and AMD in 2025.
x86 and x64 Computer and Laptop Processors:
x86 is a set of design instructions and the architecture for nearly every desktop and laptop computer except MacBooks. The x86 architecture has been around for decades and is considered the standard in personal computers and servers due to its high clock speed and ability to execute multiple instructions per clock cycle. When it comes to performance, the x86 architecture is superior with additional features such as hyper-threading and turbo boost, which assists with tasks that require high computational power. In the early 2000s, x64 was built on top of x86 and is the dominant complex architecture.
Arm-Based Architecture:
A few years ago, MacBooks switched from Intel’s x86-64 processors to Apple’s system on a chip (SoC) based on Arm 64 architecture. Arm offers much lower power consumption and generates less heat due to being a Reduced Instruction Set. The M2 is built on Taiwan Semi’s 5nm process with 100GB/s memory bandwidth and 24 GB of unified memory. When the M2 was released in 2022, Apple claimed 1.9X CPU performance at the same power. At the same performance level, Apple claims the M2 uses ¼ the power as x86.
Source: Apple
The M3 MacBook Air is hitting stores this month with Apple stating it’s 13X faster than an x86 Intel powered MacBook. The Arm-based system on a chip (SoC) combines a CPU and a GPU with a 16-core Neural Engine for what Apple is calling the “World’s Best Consumer Laptop for AI.”
To understand why Apple chose to go with Arm-based architecture and why Microsoft Windows has to play catch up in 2024, it’s important to understand what Arm offers.
The name Arm stands for “Acorn RISC Machine” with RISC standing for reduced instruction set computer. Reduced instruction set leads to lower power consumption and less heat. Decades ago, in the early 1980s, founders Sophie Wilson and Steve Furber discovered that a CPU can run faster on a small set of instructions. This means the operating system breaks down tasks rather than add more instructions to the processor. While most CPU designs were adding more instructions to chips, Arm patented the technique of using fewer instructions that run more quickly and efficiently.
CPUs require instruction sets that tell the processor to move data between registers and memory or to perform calculations with a specific execution unit. Architecture is defined by providing the link between instructions and processor hardware designs. Here’s what Arm’s instruction set looks like.
However, a major difference is that Intel maintains its IP in-house and sells chips while Arm licenses its IP. Revenue is generated from licenses for Arm’s technology and royalties that come from the sale of a licensees’ chips that contain Arm’s technology.
Arm Dominates Mobile, and AI May be the Catalyst for Arm to Dominate PCs:
Around 2012, mobile phones began using the 64-bit architecture that PCs had been using for some time. Arm introduced the ARMv8 64-bit architecture for mobile in 2011. This architecture has two execution states to run 32-bit code and 64-bit code. To run on both Arm and Intel architectures, a developer might compile native code for both or run code emulation, although it is more common to choose one and stick with that choice. This is why we see near ubiquity with Arm on mobile whereas Intel and AMD have done quite well in the data center. Due to power constraints of the mobile device, which was introduced much later, Arm found a massive market where it dominates at 99% market share of smartphones.
Today, Arm offers the most popular CPU architecture in the world with 250 billion chips shipped since inception, of which 30.6 billion were shipped in FY2023. As stated, Arm is most dominant in mobile CPUs with 99% market share, and is at 40.8% in automotive. The overall share of Arm’s related markets is 48%. The company’s dominant market share is achieved through its developer ecosystem.
For mobile, Arm’s design known as “heterogenous compute” has helped facilitate lower power requirements as the architecture allows different CPU parts to work together for improved efficiency. This enables workloads to work across both high-performance and low-performance CPU cores to lower energy by balancing performance.
Arm’s architecture is the best choice for mobile and Intel’s x86-64 is the best choice for the data center and PCs. However, we are on the precipice of going through a major shift to where Arm architecture will compete with x86 architecture for PCs. This has been promised many times in the past, yet starting with Qualcomm’s Snapdragon Elite X, there is a chance that a viable Arm-based Windows PC finally happens. To improve the chances an Arm-based PC finally sticks, both AMD and Nvidia are preparing to release Arm-based PC systems in 2025.
Arm’s different licensing models are the following:
Arm Total Access Agreements: It is a type of licensing model wherein the company provides a package of CPU designs and related technologies for an annual fee. The agreement has a fixed term and Arm reserves the right to modify the package by adding or removing specific products.
Arm Flexible Access Agreements: This model provides a selection of CPU designs and related technologies for an annual fee. However, the latest products are not included. In comparison, the total access agreement is a comprehensive package. Another key difference is that the customers need to pay a single-use license fee for specific products if they are included in the final chip design. Like total access agreements, the company reserves the right to modify the package.
Technology Licensing Agreements: It involves licensing a specific CPU design or technology to the customer for a fixed fee. The license can be used for a fixed term or the number of uses.
Architecture License Agreements: Under this agreement the customers design their own customized CPU designs using the Arm’s Instruction Set Architecture (ISA).
RISC-V
For the fiscal year ending March 2023, more than 260 companies have reported shipping Arm-based chips, including Amazon, Alphabet, AMD, Nvidia, Qualcomm, and Samsung.
Arm is based on lower power instruction sets and hardware, which is also known as a RISC architecture or Reduced Instruction Set Computing. As stated, this contributes to Arm’s approach to power efficiency by reducing the number of instruction sets required. Intel and AMD’s x86 CISC, or Complex Instruction Set Computing, offers more complex instructions that execute multiple operations. This leads to better performance but more power consumption due to the need to decode the complex instructions.
There is a third competitor to Arm and x86 which belongs in the RISC architecture category, called RISC-V. The instruction sets for RISC-V are similar to Arm’s yet RISC-V is open source and is also very new with an official launch in 2019. Compare this to Arm, which was founded forty years ago. RISC-V emphasizes register access over direct memory access, which may be more suitable for parallel processing.
It’s unlikely that RISC-V overtakes Arm in the near-term but it could become a serious contender in future years. Companies like SiFive and Imagination Technologies are designing RISC-V processors. Think Silicon released a RISC-V GPU in 2022. As of last year, AMD’s Radeon RX 6700 works with the RISC-V platform from SiFive.
According to Ars Technica, Qualcomm is also starting a joint venture with NXP, Nordic, Bosch and Infineon “aimed at advancing the adoption of RISC-V” with a focus on automotive use cases. With that said, there are not many games that support RISC-V and it has a long way to go to become a true competitor to Arm.
Arm Holdings Financials:
Arm Holdings is positioned to capitalize on the growing adoption of artificial intelligence (AI) technologies, leveraging its established licensing model and extensive ecosystem to drive future growth. Arm's established licensing model offers a recurring and relatively stable income source.
However, despite Arm dominating the smartphone market at 99%, the company has made very little on licensing compared to its partners. For example, mobile handsets created a $200+ billion segment for Apple, which relies on Arm technology for the iPhone, yet only resulted in (roughly) $3 billion for Arm. In this case, it was far better to own Apple.
The market is excited about the fact that AI will drive double the licensing fees for Arm. My contention is that, similar to mobile, it’s better to own the AI leaders who license Arm’s technology rather than Arm. Analyst estimates have Arm growing to $6.5 billion by 2028. For our purposes, this isn’t high enough growth to ensure insiders won’t take their exit following the IPO lock-up expiration – and frankly, the valuation on Arm is absurd at 41.9 Forward PS and 108 Forward PE Ratio. There is no riskier proposition than an IPO that is richly valued.
In the event the valuation comes down drastically (which it likely will, given IPOs tend to selloff sharply in the year following lockup expiration), we’ve done a thorough analysis on Arm as it’s a central player to Edge AI and is key to the next phase for AI.
Armv9 Architecture
The latest Armv9 architecture offers significant improvements in performance and efficiency, particularly for artificial intelligence (AI) applications. This has led to increased adoption by its partners, particularly in the premium smartphone segment.
Compared to the previous Armv8 architecture, Armv9 chips command double the royalty rate. This means Arm receives a higher percentage of the chip's selling price when a manufacturer uses Armv9 designs.
The rapid growth in Armv9 adoption and its higher royalty rates have already contributed to a significant increase in Arm's royalty revenue. Armv9 constituted 10% of royalty revenue in the September quarter and accelerated to 15% in the recent quarter. By doing the math, Armv9 revenue grew 69% QoQ to $70.5 million. As adoption continues to rise, the Armv9 architecture is expected to be a major driver of future royalty income growth for Arm.
Addressable Market
The company’s total addressable market was $203 billion in 2022 and is expected to grow at a compound annual growth rate (CAGR) of 6.8% to $247 billion in CY2025. The company has maintained a market share of over 99% in the mobile applications processor market. It expects this market to grow at a CAGR of 6.4%, from $29.9 billion in 2022 to about $36 billion in 2025. The company estimates that the aggregate value of chips that contain Arm technology was $98.9 billion (48.9% market share) for the CY ending December 2022, up from 38.7% in 2014. Notably, the 6.8% CAGR is a low CAGR for an AI trend with AI chips expected to grow at a 38.2% CAGR.
Arm also has strong market share of 40.8% in the automotive chip market. Management expects the automotive chip market to grow from $18.8 billion in 2022 to $29.1 billion in 2025, growing at a CAGR of 15.7%.
The cloud compute chip market is expected to grow at a CAGR of 16.6% from $17.9 billion in CY2022 to $28.4 billion in CY2025. Arm’s market share in the cloud computing chip market has increased from 7.2% in CY2020 to 10.1% in CY2022. Since Arm-based chips are increasingly used in data centers, its market share is expected to increase significantly in the future. Per the prospectus, “Arm-based chips have been gaining market share as CSPs, such as Amazon AWS and Alibaba, have started to deploy Arm products in their own in-house designed chips used in their data centers, and as other CSPs, such as Microsoft and Oracle, start to deploy chips designed by Arm licensees, such as Ampere. As a result, we expect our market share of cloud compute to grow significantly faster than the overall cloud compute market.”
Financials
Arm’s recent Q3 FY2024 revenue ending December grew by 13.8% YoY to $824 million, helped by the recovery in the smartphone market and demand for AI technology. This marks the second consecutive quarter of positive revenue growth, following declines of (2.5%) in the June quarter and (3.7%) in the March quarter, due to the cyclical downturn from smartphones.
License and other revenue grew 18% YoY to $354 million. The company has seen strong growth in license revenue as they are signing long-term and high value agreements with its customers due to demand for Arm’s advanced CPUs to run AI workloads. The trend was strongest in the Sept quarter as license revenue grew by 106%.
The company’s CEO, Rene Haas, said in the earnings call, “And that has seen growth in not only the smartphone sector but also in infrastructure and other markets, which drives growth. We are also seeing strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”strong momentum and tailwinds from all things AI. From the most complex devices on the planet for training and inference, the NVIDIA Grace Hopper 200 to edge devices such as the Gemini Nano Pixel 6 from Google or the Samsung Galaxy S24, more and more AI is running on more end devices, and that's all running on Arm.”
They expect another record quarter for the licensing revenue. The company’s CFO, Jason Child said in the earnings call. “We are expecting another strong quarter for licensing with revenue up sequentially to near record levels. As with recent quarters, we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”we expect to sign multiple new ATA deals in Q4, and demand for our latest technology remains high as customers need access to AI-capable CPUs and related technology such as our Compute Subsystems.”
The company also reported record royalty revenue due to its higher value Armv9 technology and also market share gains in cloud server and automotive markets. Royalty revenue rebounded to 11% YoY growth to $470 million from a decline of (5%) and (8%) in the previous two quarters. Management’s guide for the next quarter is to grow over 30% YoY and mid-single digits sequentially.
The company’s CFO, Jason Child said in the earnings call, “Within Q4 total revenue, we expect royalty revenues to grow mid-single digits sequentially and to be up over 30% year-over-year as we compare against the bottom of the industry wide inventory correction that occurred in prior year Q4. Royalty revenue sequential growth is mainly coming from increasing penetration of Armv9, where royalty rates are on average, at least double the rates on equivalent Armv8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”increasing penetration of Armv9, where royalty rates are on average, at least double the rates on equivalent Armv8 products. Additionally, we are seeing an increasing amount of Arm technology in chips being deployed and as the amount of Arm technology in chips increases, so does the royalty rate.”
The management has increased its revenue guidance for the next quarter by $95 million to a range of $850 million to $900 million, representing YoY growth of 38.2% at the midpoint. The strong upward revision was due to the points discussed earlier, like the rebound in royalty revenue and the higher revenue opportunity from AI.
Analysts expect revenue to grow 37.4% YoY to $869.88 million in the next quarter and 27.9% in the June quarter.
FY2023 revenue ending March declined by (0.9%) YoY to $2.679 billion. Analysts expect FY2024 revenue to grow 18.7% YoY to $3.18 billion and 23.9% YoY to $3.94 billion for FY2025.
Annualized Contract Value
Annualized Contract Value (ACV) grew by 15% YoY and by 5% QoQ to $1.16 billion. The sequential increase was due to an increase in high-value license agreements and also the increase of total access agreements.
RPO
Remaining performance obligations (RPO) grew by 38% YoY to $2.43 billion, helped primarily by high-value license agreements and renewal of long-term customer agreement. As per the shareholder letter, “We expect to recognize approximately 28% of RPO as revenue over the next 12 months, 26% over the subsequent 13-to-24-month period, and the remainder thereafter.”
Margins
Gross margin was 95.6% in the recent quarter compared to 96% in the same quarter last year. Adjusted gross margin improved 50 basis points YoY to 96.8%.
Operating margin was 16.3% compared to 33.7% in the same period last year. The operating margin was lower due to the increase of R&D expenses from an increase in engineering headcount and SG&A expenses from increase of non-engineering headcount.
In the Sept quarter, the operating margin was low at (19.4%) due to increased R&D expenses, stock-based compensation, and IPO-related expenses. Stock-based compensation was higher than it’s expected to be in future quarters as the IPO triggered a one-time expense for previously granted shares. As per the September quarter shareholder letter, “Total share-based compensation cost (equity-settled) was $509 million with $19 million in cost of sales, $343 million in R&D and $147 million in SG&A. Share-based compensation costs were higher in Q2 than is expected in future quarters as the IPO triggered a one-time expense for previously granted shares. The future run-rate of share based compensation cost will depend on a number of factors, including the share price, but is currently expected to be between $150 million to $200 million per quarter.” At the midpoint, this will be about 20% of revenue.
Adjusted operating margin was 43.8% compared to 39.9% in the same period last year and 47.6% in the Sept quarter.
Net margin was 10.6% compared to 25.1% in the same period last year and (13.7%) in the Sept quarter. The adjusted net margin was 39.3% compared to 31.1% in the same period last year and 46.9% in the Sept quarter.
Cash Flow and Balance Sheet
The operating cash flow margin was 37.6% compared to 56.8% in the same period last year and 28.2% in the Sept quarter. The free cash flow margin was 30.5% compared to 53.5% in the same period last year and 21% in the Sept quarter.
The company has cash and short-term investments of $2.4 billion compared to $2.2 billion in the Sept quarter, and no debt.
Key Metrics
The company reports the actual chips shipped in the subsequent quarter. For the quarter that ended September, Arm’s customers shipped 7.7 billion chips, down (3%) YoY and up 8% QoQ, showing a sequential improvement for the second consecutive quarter on account of smartphone market recovery and demand for AI chips.
Total Access Licenses
Total Access Licenses grew by 80% YoY to 27, with the company signing five new licenses in the quarter. Notably, this included three companies upgrading from Flexible Access Licenses, marking the first time such a transition had occurred. This also caught the attention of the analyst, who asked “Did that take you by surprise or were these customers that were getting to be particularly large for an AFA and so it was natural for them to upgrade?”
The company’s CEO, Rene Haas replied, “Yeah. Thank you for the question. We didn’t bring it up in our comments. We had a lot of good stuff to talk about this quarter, and I was trying to keep it as concise. But the AFA transition to ATA, thank you for calling that out. That’s a great trend for us. When we designed the program a number of years ago, that was absolutely the intent is that customers that launched into an AFA would ultimately go on to a total access license.When we designed the program a number of years ago, that was absolutely the intent is that customers that launched into an AFA would ultimately go on to a total access license.
What largely drives that, quite frankly, is the company that AFA start to get commercial traction in their business. Some of the AFA customers are early-stage companies. They may have an early exit or get acquired. But as they get larger and mature, we expect them to embrace Arm technology in a broader way. So I wouldn’t call it a surprise. I would actually call it an expected outcome that we have, and we’re really happy to see it. It’s great.”
Flexible Access Licenses
The Flexible Access Licenses grew by 6% YoY to 218. These agreements are renewed annually and over 50 were renewed in the quarter and 14 new agreements were signed with 6 net additions in the quarter.
Risks
The company also highlighted the risk in its prospectus that some of its customers support open-source RISC-V. This may not be a potential immediate risk to the business. However, it might be difficult for Arm to raise prices.
Arm China accounted for about 24% of revenue for the FY ending March 2023. The company said in its prospectus, “Neither we nor SoftBank Group control the operations of Arm China, which operates independently of us.” So, this is a potential political risk to consider if the US-China tensions escalate.
The company’s IPO lock-up period expired on March 12th, so volatility is likely in the coming months. The risk that Arm cannot hold the exuberant valuation it currently trades at post-lockup is very high.
Arm was previously listed from 1998 to 2016 when it was taken private by SoftBank Group, and it holds about 90% of the outstanding shares. The high ownership of SoftBank is a significant risk to consider since SoftBank could slowly start to book profits on Arm Holdings once the IPO lock-up expiry is now over. Arm’s current valuation of $135 billion (90% is $122 billion) is significantly higher than SoftBank’s current market valuation of $85 billion.
Arm’s shares have doubled since its IPO in September 2023. Arm is currently trading at a forward P/S ratio of 41.9. As seen in the chart below, this is trading far higher than the other AI semiconductor companies. The 1-year forward for fiscal year ending in March 2025 is a PS ratio of 33.8, which still exceeds other AI-related semi companies – including Nvidia.
Qualcomm
As we look into Arm-based PCs, it’s worth noting that Qualcomm will be the first to release an Arm-based PC this summer with ETA of June. Qualcomm is a tough stock to own because it’s subject to licensing and IP lawsuits that the company most recently won, and anti-trust lawsuits that the company has lost. China adds complexity, as similar to Samsung and Apple, the OEMs use Qualcomm but ultimately seek to compete with Qualcomm where possible. This leads to IP battles and creates risk not present in other stocks. Interesting enough, Qualcomm is being sued by Arm following the acquisition of Nuvia as Arm alleges the IP deal it had with Nuvia should have been terminated at acquisition. What goes around, comes around.
For the most part, Qualcomm’s customers are frenemies. This is true for all of tech but especially Qualcomm. The tug-o-war between partners/competitors was noted in the most recent earnings call when an analyst asked the following:
“Tal Liani:
Thanks. I have two follow-ups on answers or questions you had before. The first one is Samsung. On one hand, there is a new contract. On the other hand, Samsung is going to use their own more in '24 versus '23. So net-net, are you expecting revenues of Samsung to go up or down in '24 versus '23? What are your expectations of share losses within — can you frame it for us?”
Management didn’t directly answer the question so I’m not going to quote their answer here other than to note the material concern to Qualcomm’s business model. Even as the company innovates on chips, chipsets and SoCs, the older products typically get replaced (where possible).
Qualcomm is not of interest for our portfolio right now as we would want to see more top line growth. Handsets have been in a decline, IoT is in a deep trough, yet automotive is surprisingly strong – which is all detailed below. However, Qualcomm is an important company to cover for AI edge devices and can be instrumental in helping us time our other investments.
From the most recent earnings call, the major takeaways for our purposes are timing for the Windows upgrade, Android’s roll-out for AI features, and China’s ramp in mobile that favors domestic OEMs like Huawei instead of Apple. Most importantly, as stated, the company is working with Microsoft on an Arm-based PC due out mid-2024. Details around this help to inform our thesis on AI-powered PCs, which was detailed here and here.
Brief Overview of the Financials:
In 2023, Qualcomm entered a trough similar to many other semiconductor companies. This was driven by mobile handsets and internet of things (IoT). Qualcomm’s IoT segment includes consumer virtual headsets and edge networking such as WiFi 7 broadband devices. In the most recent quarter, Qualcomm returned to positive growth of 5% after four quarters of negative growth, some as steep as (-24%) and (-23%).
The rebound will be strongest in the second half of CY2024 when Qualcomm returns to growth with an estimated 12.5% in the September quarter. Notably this estimate has come down since the last earnings report, when it was estimated to be 14.3%. The December quarter estimate is for 5.90%.
According to the earnings call, the September quarter will be seasonally stronger due to the anticipated Windows upgrade that is due to be released around the school season.
Here is what was said on the earnings call:
“We're tracking to the launch of products with this chipset tied with the next version of Microsoft Windows that has a lot of the Windows AI capabilities. We're still maintaining the same date, which is driven by Windows, which is mid-2024, getting ready for back-to-school, what we're excited about it is since we announced that Tech Summit showing the performance of the product and the AI capabilities, design traction continues to increase.”
On the bottom line, Qualcomm reported $2.75 non-GAAP EPS, beating estimates for $2.37. The company is returning to growth on the bottom line with the September quarter being the peak at 22% growth for EPS of $2.46. Last quarter, Qualcomm “returned $1.7 billion to stockholders during the quarter, including $784 million in stock repurchases and $895 million in dividends.”
Margins:
- Gross margin of 56.6% is in line with previous quarters
- Operating margin of 29.5% is higher than previous quarters. Discussion from Q&A is noted below.
- Net margin of 28% is higher than previous quarters.
More on Mid-2024 Timing
As mentioned above, the Windows upgrade is expected to hit mid-2024. There were some additional notes on timing:
Tom O'Malley:
Thanks for taking the question. Just passing on my congratulations to Akash as well. I just wanted to ask on the ASP side for Android. You're obviously kind of characterizing the market that's flattish into March, kind of the bottom in June and then improving from there. But you benefited from some good mix in the beginning of the fiscal year here. Could you talk about what you would expect from a mix perspective as you go to the back half? Would you see the same kind of strength on the ASP side that you've kind of seen over the past year? That would be really helpful to understand. Thank you.
Akash Palkhiwala:
Yeah. So if you think about premium flagship launches for our OEMs, a lot of the launches happen in the holiday time frame just before the holidays going into Chinese New Year as well. And so you've seen a lot of those happen. We do have some significant launches through the middle of the year, but obviously, the next big launch goes into the holiday season, starting with Apple and then going into the Android launches. So that's a typical cadence.”
China is a Problem for Apple
We outlined how BYD was becoming a problem for Tesla. According to commentary on Apple’s earnings call and Qualcomm’s earnings call this quarter, China’s preference for domestic OEMs is becoming a problem for the iPhone. In particular, Huawei is making a comeback. Below is mention that Huawei is performing well in the premium tier.
“Samik Chatterjee
[…] So just wondering if you can give us an update in terms of what you’re seeing from those customers? And if at all, Huawei and their reemerges in the market is starting to have an impact in terms of volume or market share for these customers as well in the context of your flat guide for them for quarter-over-quarter? Thank you.
Akash Palkhiwala
In terms of your comment on Huawei, really what we’ve seen since Huawei 5G launch is that the premium tier TAM in China has expanded. And so we’re continuing to see strong demand from our customers post that launch.”
There’s additional evidence that a Chinese OEM is gaining market share as a new customer emerged at 14% of revenue for Qualcomm compared to an estimated 20% from Apple.
“Ross Seymore
Great. And I guess for my follow-up, I noticed in the 10-Q, you had a new 10% customer, I think it was a 14% customer. I don't expect you to name who that is. But is that a reflection of the strong China demand that you talked about in the continuation of good future growth opportunities or was there any onetime aspect of that customer, whoever it may be popping up in the quarter?
Akash Palkhiwala
I think the you framed it in your first theory is a reasonable way of thinking about it.”
Per our write-up on Big Tech earnings, “Apple is facing competition from other smartphone companies in China due to foldable designs and advanced AI features. The company’s total revenue from China in the recent quarter was $20.8 billion, which missed estimates of $23.8 billion.”
Some of Qualcomm’s commentary is useful for if/when we build a position in Apple in anticipation of AI mobile devices. As of now, Apple faces a serious headwind with Huawei and Chinese OEMs. We saw the technicals flashing a few months back in a free analysis here and again here.
Snapdragon AI Platform Roll-Out:
Qualcomm’s Snapdragon 8 Gen 3 mobile platform is helping to bring generative AI to the edge with an AI engine that can run LLMs up to 20 tokens per second. It offers on-device AI such as live translate, interpreter and chat assist. Per management: “This marks the beginning of how gen AI will evolve the overall smartphone experience and highlights the significant opportunity for Snapdragon platforms.”
The Samsung Galaxy S24 Ultra, GalaxS24 and S24 Plus is using the Snapdragon 8 Gen 3 mobile platform. Per management: “The Snapdragon 8 Gen 3 mobile platform is setting a new standard for on-device gen AI experiences for premium smartphones and powers all through flagship Android devices launched and launching this fiscal year.”
In addition, the Snapdragon X Elite will offer on-device gen AI and copilot for the upcoming Windows upgrade. There was a second mention of “mid-2024” for this release.
The Snapdragon X35 will also serve 5G-enabled industrial IoT devices equipped with generative AI, such as enterprise workflow, inventory management and warehouse applications (there are dozens or use cases). According to Qualcomm: “We continue to believe that industrial edge devices with connectivity, high-performance computing and on device AI will become one of our largest addressable opportunities fueled by the secular trends of digital transformation.”
Custom Oryon CPU Cores:
Qualcomm’s Snapdragon AI platform is powered by a new Arm-based CPU called Oryon. This effort began with the acquisition of Nuvia, a company that specializes in custom Arm silicon. This was important for Qualcomm to compete with Apple’s M1 chip, released in 2020 with more iterations since, such as M1 Pro, M1 Max, M2 and M3.
Prior to Nuvia, Qualcomm used Arm designs off-the-shelf with Cortex cores designed by Arm. The Oryon CPU will be the first 64-bit that Qualcomm has designed itself using an architectural license. Legally, only ARM themselves or companies Arm has sold a license to are allowed to design Arm CPUs. When Qualcomm bought Nuvia for its CPU design, Arm is asserting the license is no longer valid and is not transferrable since the company with the license no longer exits.
The importance of this is that Arm architecture on PCs is expected to help Windows PCs compete on performance and power efficiency with MacBooks. It could also spell trouble for Intel. Here are current benchmarks (benchmarks tend to be skewed in favor of one performance measurement rather than overall performance). This is also benchmarked against the M2 whereas the M3 on 3nm technology came out last Fall. According to Apple, the M3 is 15% faster than the M2 with efficiency cores that are 30% faster than what was benchmarked against the upcoming Qualcomm release.
With that said, Oryon is rumored to have power efficiency issues due to Qualcomm using cell phone PMICs. The power management integrated circuits (PMICs) are what manage and regulate the power in electronic components. By using cell phone PMICs, the CPU cores won’t run in the optimal efficiency range. In order to handle the needs of a laptop, Qualcomm is bundling together PMICs. In the very near-term, this means selling more Qualcomm PMICs, but in the medium-term, it means a competitor like AMD or Intel (or Nvidia) could crush Qualcomm on price and performance. The full write-up from SemiAccurate is worth a read. Here is what the independent analyst stated:
“Laptops have a large multiple of the board area of a cell phone, think more than 10x rather than a percentage. So a very expensive cell phone spec board just blew out costs for Oryon laptops. Whoops. Some OEMs SemiAccurate talked to were a tad peeved by this because it is entirely unnecessary, it is mandated solely by the force bundled PMICs. Allowing a suitable PMIC would also allow for a much cheaper PCB too but as you might guess, Qualcomm took a different path.”
Although we will have to wait until 2025 for AMD and Nvidia’s Arm-based laptops, the stage is being set for Qualcomm to stumble and this is something we track for portfolio purposes. To translate, Qualcomm could do well in 2024 given it will be the first to launch Arm-based Windows PCs for AI purposes but whatever lead Qualcomm gains in roughly 6 months time will be harder to maintain in 2025 and beyond as Qualcomm’s exclusive deal expires and more competition arrives.
Qualcomm will release its first smartphone processor with the Oryon CPU in late 2024. The Snapdragon 8 Gen 4 will feature custom CPU cores for the first time since 2016.
Note on Automotive:
The handset segment reported +16% growth and IoT reported (-32%) growth whereas the Automotive segment reported +31% growth.
It’s the smallest segment by revenue size at $598 million compared to handsets at $6.7 billion and IoT at $1.1 billion. However, what’s important to note is that Qualcomm’s automotive segment is growing when other pockets of Automotive are weak on an industry-wide basis.
According to the Auto Investor Day, Qualcomm expects to have “greater than $4 billion in revenue in fiscal '26 and greater than $9 billion in revenue in fiscal '31.”
Here is what was stated on the call:
“And we already have some revenue from ADAS processing. You see a lot of cars for example, in China with both ADAS and autonomy with our processor, you see some of our customers in the United States of our processor. And I think that continues to grow as we get towards our 2026 revenue target, you’re probably going to see very healthy components of all of those elements.”
Regarding the disconnect between Qualcomm’s growth in automotive versus the industry declining, the following was stated:
“Switching over to your second question on automotive. You should really think — the way to think about our automotive business is we're tied to the launch of new cars. Clearly, the industry is going through a transformation, digitization of cars, and we are right at the intersection of that transformation. We are we're benefiting our cars put in more infotainment content for experience within the car. More ADAS content comes into the car as well.
And really, we get to benefit from all those intersection points in the car, and we're increasing the content as new cars launch. So that's the maybe a disconnect between some of our peers what they're seeing and what we're seeing. Stepping back, I mean, clearly, this is an industry that's going through some shorter-term dynamics, so we'll be closely monitoring it. But when you step back, our technology, our position, our products look really good, and we're excited about where we're going.”
Nvidia and AMD could strong ARM Qualcomm
The efficiency shown by the M1 and M2 chips from Apple has resulted in a long battery life and high performance per watt. Apple’s laptops like the M2 Max Macbook Pro can compete with discrete graphics and is better suited for AI processing than laptops with x86 processors. This has led to Apple doubling its market share since the M1, and has caught the attention of Nvidia and AMD. Qualcomm has an exclusive through 2024, which leaves 2025 as the year the world’s top design companies can release an Arm-based PC. According to Reuters, this is exactly what they plan to do.
In addition to Qualcomm’s controversial use of mobile PMICs, which could alter the benefits of an Arm-based PC in terms of power requirements, Nvidia and AMD are more equipped to build advanced AI features into CPUs and devote on-chip resources for AI-enhanced software (need I go further into how Nvidia and AMD will potentially beat Qualcomm on advanced AI features? This one is a tad obvious)
Where the rubber meets the road is that x86 applications have a mature ecosystem and is ubiquitous whereas code for Arm-based Windows is far less supported. If Nvidia and AMD are getting involved, then they must be envisioning the power requirements for AI will be enough of a motivating factor to push forward efforts for Windows Arm-based code.
Conclusion:
We are not interested in Qualcomm or Arm as a portfolio position at this time, rather we are tracking these companies more closely as they will help to bring AI to the edge with Arm-based PCs. This will be timed to an AI-focused release for Windows in mid-2024. There is also quite a bit of excitement around Arm at the moment. For the most part, our firm does not participate in IPOs as the vast majority trade below their opening price after the lockup expires. Arm’s valuation is particularly shocking as it exceeds even Nvidia. We find it advantageous to take our time and buy post-lockup, especially given Arm CPUs dominate 99% of mobile and it’s procured very little revenue compared to mobile heavy hitters in hardware and software. What’s also of interest to our portfolio is that Qualcomm may stumble given the mobile PMICs being used, and in that case, our favorites AMD and Nvidia could have an opening to dominate come 2025.
The overarching theme is that Edge AI is approaching and we want our positions to be aligned as closely as possible given client revenue has been weak for semis across the board. It will be the perfect recipe when client revenue segments return to growth, combined with ongoing data center strength. We want to be positioned when this happens for otherwise strong semiconductor companies that are currently a “tale of two cities” – weak PC and mobile segments detracting from strong data center/AI segments.
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