We listened to Arm’s first earnings call since their IPO. We learned a lot during that hour. Not about Arm – their business is doing well – growing, diversifying. No, we learned a lot about how the Street is thinking about Arm.
As this was their first reported earnings since the IPO, the stakes were fairly high. As we discuss in our book about IPOs, the first two earnings calls are critical for establishing management’s credibility with the Street. The company is by definition new to public market investors (even though Arm was public years ago, much of the buy-side has turned over since then and does not know the company.), and these first calls demonstrate the company’s ability to deliver what they say they will deliver. Unfortunately, since the stock is so new, the mechanics of following the company are not yet in place. In particular, the data providers have not yet assembled data on the company, so there was literally no consensus on what the Street expected from the company.
The company is also fairly constrained in how it communicates forward earnings during the IPO process. There seems to have been a disconnect between what Arm thought expectations were and what the Street expected for the December quarter. As a result, the stock traded off after hours, and analysts on the call spent a lot of time on questions trying to puzzle through that. Much of Arm’s licensing business should be very predictable, but the timing of the start of those contracts is harder to predict. If a large deal is in the works, the conservative approach is to assume it takes a little bit longer to come on stream.
Bottom line, Arm’s core business looks to be doing better than management expected, and they raised their guidance for the full year. Everything else is just noise in the system.
Another thing we learned is that everyone is a bit confused about Arm’s business model. They have license payments – which are a fixed amount – and they have royalty payments which fluctuate depending on end demand. However, beyond that, they have a new subscription model, which we think many people tend to view as analogous to a software-as-a-service (SaaS) model. But this is not quite right. Arm implemented this plan to better enmesh itself with its customers, making it easier for those customers to share more information with Arm about future plans without having to pay for the privilege too soon. On top of that, Arm’s product nomenclature has always been very confusing, and sorting out what products are ramping now leads to a lot of confusion. Putting this together, we suspect that the Street is building overly-detailed models. Seen from above, Arm’s business is fairly simple, but with all the information they provide it is tempting to model out all the different ways in which they sell it. Speaking as long-time professional model builders, we can say that path leads to madness. Arm has too many customers and too many products to really be able to tease out all the intricacy that it seems should be possible. We suspect this will be a recurring theme as investors adjust for the right amount of detail to build into their models.
Along those lines, one thing that impressed us was Arm’s press release. Unlike most company’s with their three page press releases, Arm prepared a 25 page report, complete with management’s prepared remarks, leaving the full hour for questions. This is a commendable level of sharing, we wish more companies took that approach. However, it did have one drawback. The company shared a lot of new information which no one has had time to digest yet. For instance, the company broke out “Remaining performance obligations” (RPO). What is that? It turns out that is backlog, and the company added almost $1 billion to it in the quarter. That is a massive gain, but few people asked about it, largely because we believe no one was quite sure what it was.
One more area of confusion is the company’s relationship with Arm China. The one thing we gleaned from the call was the fact that Arm Global invoices Arm China’s customers directly, and Arm Global’s sales engineers are deeply involved in supporting the business brought in by Arm China’s sales team. This seems opaque and confusing. Largely because it is. Doing business in China is different. Welcome to our world.
We also found it noteworthy that there was not a single mention of RISC V on the call. We think RISC V a real long-term threat, but it is not challenging Arm’s core mobile franchise any time soon. So we can hold off asking the company about it for now.
On that note, we think many investors want to know more about Arm’s opportunity beyond mobile. This is probably our biggest concern for the stock. A few analysts touched on these questions and management gave credible answers. This is one area where we wish the company could provide more information. We have a good sense of how the IoT, data center and automotive semis markets are faring so we can tell that parsing out Arm’s opportunity is going to remain a challenge for investors to decode for some time.
As we said, Arm actually turned a pretty strong set of results, and the market will eventually figure that out. That being said, the company is still in early days of learning the Language of the Street.