This Artificial Intelligence (AI) Semiconductor Stock Could Lose Access to Valuable Intellectual Property. Here's Why It's a Buy Anyway.

Written By Michael Gary Scott

There’s a single company behind some of the biggest chip designers in the world, and it wields a lot of power in the industry.

Arm Holdings(NASDAQ: ARM) intellectual property is essential for producing chips for a wide range of products from the smartphone in your pocket to the data centers training next-generation artificial intelligence (AI). It licenses its CPU architecture and IP to clients and receives licensing fees and royalties in return.

It’s now threatening to revoke the license of one of its biggest customers, Qualcomm (NASDAQ: QCOM). It provided a 60-day notice earlier this month, notifying Qualcomm it was cancelling its architectural license agreement, according to a report from Bloomberg. The decision is related to a legal dispute started in 2022 over whether Qualcomm’s acquisition of Nuvia comes with its Arm licenses.

While Qualcomm could potentially lose access to the all-important Arm architectural licenses, investors should take the opportunity to be greedy while others are fearful and buy shares of the chipmaker.

A PC board with a chip in the middle labeled AI CPU.

Image source: Getty Images.

The importance of Arm’s IP to Qualcomm

It’s important to note Arm has two types of licenses. The company is planning to revoke Qualcomm’s architectural license, which allows a chip designer to take Arm’s architecture and add or remove components to create entirely new and unique designs. Arm also offers off-the-shelf licenses, which let clients incorporate Arm’s CPU designs into their own devices.

Qualcomm has an off-the-shelf license for many of its existing chip designs. But it’s using architectural licenses in many of its new products by incorporating Nuvia’s designs into new products.

Qualcomm acquired Nuvia in 2021 to accelerate its chip development. Nuvia’s designs, based on Arm architecture, are incorporated into Qualcomm’s “AI PC” CPUs, and a key part of Qualcomm’s product roadmap for more powerful smartphone CPUs. Qualcomm eventually sees similar chip designs in automobiles and Internet-of-Things (IoT) devices.

Revoking the architectural license would be a major blow to Qualcomm’s business. Qualcomm’s chip business accounts for about 85% of the company’s revenue and it’s growing faster than its licensing business. Without the Arm architectural license, Qualcomm would have to stop selling many of its new chip products and rework its product roadmap, halting its growth dead in its tracks.

Will Qualcomm lose its license?

Most companies generally aren’t in the business of mutual destruction. That appears to be what Arm would be heading toward if it severs its relationship with Qualcomm.

Qualcomm is very likely one of Arm’s top five customers. Arm’s top customer is Arm China, which accounted for 21% of its revenue last year. The other four top customers accounted for 33% of its revenue. In other words, cutting ties with Qualcomm would wipe out a good chunk of revenue for Arm.

Moreover, the revocation would also give other customers reasons to be weary of Arm. If Arm can’t be relied upon to maintain its relationships with top customers, that could push more semiconductor companies to look into building on the open-source RISC-V architecture, which would give them more control over their future.

It’s telling that Arm’s share price took a bigger hit than Qualcomm’s after the news came out. It shows how important Qualcomm is to Arm.

See also  Analysis of Netflix (NFLX) Investment Potential Analyzing the Viability of Investing in Netflix (NFLX) Amidst Wall Street's Optimism

Arm doesn’t want to cancel Qualcomm’s license. It just wants Qualcomm to pay more than the small start-up (Nuvia) did when it originally negotiated the licensing agreement. This is a negotiation tactic, and a risky one for both parties.

It’s unlikely the cancellation goes through, however, and more likely the two parties will find some way to continue their relationship.

Time to get greedy

With investors wringing their hands about the future of Qualcomm, it may be a good opportunity to buy shares of the chipmaker.

As mentioned, the company is developing new chip designs for PCs and smartphones along with plans for incorporating the same designs into chips for automobiles and IoT devices. The focus of these chips is the ability to run artificial intelligence applications on the device. This requires highly efficient processing capabilities, so that they don’t quickly deplete batteries or spike users’ power bills.

Many expect on-device AI to be the next step for artificial intelligence. Apple is ushering in such capabilities with the rollout of Apple Intelligence, which is designed to complete most AI-related tasks on the device, keeping your data private. Qualcomm could bring similar capabilities to Windows PCs, Android phones, and other devices.

At this writing, Qualcomm shares trade for a forward P/E ratio of just 15. That’s an incredibly attractive price for a chipmaker that could be at the center of the next phase of AI. While the Arm dispute presents an overhang to the future results, investors shouldn’t put too much weight on it. The odds that Qualcomm is unable to negotiate a license for its newest chips seem unlikely given the importance of the agreement for both parties. Meanwhile, the long-term potential for Qualcomm remains strong, even if it has to pay a bit more for its Arm license.

Don’t miss this second chance at a potentially lucrative opportunity

Ever feel like you missed the boat in buying the most successful stocks? Then you’ll want to hear this.

On rare occasions, our expert team of analysts issues a “Double Down” stock recommendation for companies that they think are about to pop. If you’re worried you’ve already missed your chance to invest, now is the best time to buy before it’s too late. And the numbers speak for themselves:

  • Amazon: if you invested $1,000 when we doubled down in 2010, you’d have $21,217!*
  • Apple: if you invested $1,000 when we doubled down in 2008, you’d have $44,153!*
  • Netflix: if you invested $1,000 when we doubled down in 2004, you’d have $403,994!*

Right now, we’re issuing “Double Down” alerts for three incredible companies, and there may not be another chance like this anytime soon.

See 3 “Double Down” stocks »

*Stock Advisor returns as of October 28, 2024

Adam Levy has positions in Apple and Qualcomm. The Motley Fool has positions in and recommends Apple and Qualcomm. The Motley Fool has a disclosure policy.