ARM Holdings (ARM) faces downside risks from litigation exposure, uncertain China demand, and a slump in AI design activity and production, which could be offset by "robust" licensing and a potential shift to its own chipmaking, Morgan Stanley analysts said in a Friday note.

The company has structural growth opportunities in cloud AI as client designs transition to Arm's v9 architecture and its compute subsystem, according to the analysts.

The brokerage said it thinks drop-through on additional sales could increase EBITDA to 60% by fiscal 2027, and it models a compound annual growth rate of 35% for earnings between fiscal 2024 and 2027.

Analysts said that Softbank acquiring Ampere, which uses Arm-based Altra processors, "augurs well should Arm opt to shift to making their own chips."

Morgan Stanley maintained an overweight rating on the stock but lowered its price target to $150 from $175.

ARM shares were down 2.6% in recent trading.

Price: 109.53, Change: -2.94, Percent Change: -2.62