ARM Holdings Q4 FY3/25 Earnings Review
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Show Us The Money
by Alex King, CEO, Cestrian Capital Research, Inc
There’s a lot to like about ARM Holdings and its stock but one thing that I do not like is its cashflow performance. Generally speaking what good looks in business is that most or all of your GAAP earnings translates into actual cash inflow. To the extent it does not, it means that (i) you are not collecting cash from customers fast enough and/or (ii) you are paying suppliers too quickly and/or (iii) your GAAP earnings number isn’t a real number but instead one you wished you had but don’t in fact have.
Let’s discount possibility (iii) with ARM for now. Any company at any time may be inventing its earnings, but generally speaking with big liquid well-covered stocks it is relatively rare, so we should treat it that way here.
This should lead our attention to change in working capital. And when you go looking you will find that ARM simply does not get paid fast enough. Here’s the change in receivables vs. the change in TTM revenue vs. the change in payables, YTD. The company is paying its suppliers quickly; it is growing revenue; but its receivables are growing much more quickly than revenue.
That's not a good look. It cannot continue forever because at that point it will rather suggest that the revenue recognition would be aggressive. (We aren’t there yet).
There is actually some commentary on working capital in the ARM Shareholder Letter this quarter, as follows:
"Full-year results were negatively impacted by unfavorable working capital movements in receivables and the timing of payroll tax liabilities related to the IPO share vesting event, which created a $573 million benefit in Q4 FYE24 that was subsequently reversed in Q1 FYE25.” - ARM Q1 Earnings Release.
Working capital analysis may seem like the most boring thing in the world, which it probably is. But tracking why profits and cashflows don’t match is an excellent first step in actual due diligence when you think something may be amiss at a company.
ARM, in my view, has to see a significant swing in change in working capital back towards the positive, ie. it needs to start seeing some quarters where cash is generated from working capital, not sapped by it. If it doesn’t, then investors will start to ask about revenue recognition policies and whatnot (especially in the light of the 97% gross margins which themselves indicate a degree of aggression in how the company chooses to account within GAAP).
Let’s leave the boring behind for a moment and get into the numbers, the valuation, our stock chart and ratings.