Who’s the Biggest Winner From Apple Intelligence? It’s This AI Stock, Not Apple. | The Motley Fool

Apple (AAPL 0.05%) unveiled the latest steps in its artificial intelligence (AI) strategy on Monday with its “Glowtime” event focused on its iPhone 16 lineup, its first new phone launch since it introduced Apple Intelligence back in June.

The latest line of phones will all be compatible with the new generative AI features, scheduled to launch on iOS 18. Apple’s rollout of the new phones and Apple Intelligence will be perhaps the biggest test of demand for generative AI technology yet.

Cloud infrastructure companies and start-ups have poured billions of dollars into AI infrastructure, buying Nvidia components and filling up data centers in order to create and run generative AI applications like ChatGPT, but so far, there hasn’t been a significant business beyond increased demand for hardware components.

There isn’t really a “killer app” based on generative AI, and generative AI-based software hasn’t taken over the way some might have expected when ChatGPT was launched nearly two years ago. However, Apple has a better chance to change that than any company that has come before it as Apple Intelligence will come with generative AI writing tools like text rewrite, image generation, and Visual Intelligence, which allows users to get information just from a photo.

In other words, demand for the new crop of iPhones will be the biggest test yet for broader demand for generative AI and its marketability.

However, Apple stock didn’t get the boost from the news that some might have expected, finishing Monday essentially flat.

One AI stock that emerged as a winner

While Apple shares were flat on the news, a key supplier jumped. Arm Holdings (ARM -0.81%), which designs Apple’s CPU architecture, surged on the presentation, finishing Monday’s session up 7%.

Importantly, Apple’s new A18, which is powering the iPhone 16, will run on Arm’s latest CPU architecture, the v9, which commands twice the royalties as the prior version, the v8.

Apple is also Arm’s most valuable customer as the iPhone makes up roughly half of the company’s revenue.

Of course, Apple will benefit from strong sales of the iPhone 16, but, according to those numbers, Arm stands to be an even greater beneficiary if the new iPhones are a hit.

If iPhone 16 units increase 10% from the iPhone 15, Arm’s royalties from the iPhone would jump 120% as royalty rates will have doubled from the year before. If iPhone sales make up half the company’s royalty revenue, then that alone would drive royalty revenue up 60% even if the rest of the business is flat.

Another way Arm wins

Arm dominates the market for smartphone CPU architecture with greater than 99% market share. That’s largely due to its power-efficient architecture, which helps preserve battery life, but the company also sees an increasing opportunity in the data center from the AI boom as its Grace CPUs are also used by Nvidia in the Grace Hopper and upcoming Grace Blackwell Superchips.

The same advantage Arm has over x86-based competitors like Intel and AMD also applies to the data center as AI applications demand huge amounts of energy, and running them as efficiently as possible will help companies save money. In fact, Applied Materials CEO Gary Dickerson recently said, “In our discussions with leading AI companies, they are telling us that reducing power-per-operation is now more important than increasing operations-per-second.”

If Apple Intelligence does catch on, proving a larger market for AI devices, it could set off a supercycle of demand for Arm components in smartphones, the data center, PCs, and beyond.

Arm’s momentum is already building with licensing revenue, a forerunner of royalties, up 72% in its most recent quarter. If the iPhone 16 takes off, Arm looks likely to cash in, and the stock has a ton of upside potential in AI beyond that.