Arm Goes Public for $54.5 Billion: Should You Buy Into the Largest IPO Since 2021?

In the biggest IPO since 2021, Arm Holdings (NASDAQ:ARM), the renowned chip design firm, will start trading on the Nasdaq today for $51 per share — which prices the company at a hefty $54.5 billion market cap.

Arm, an acronym for Advanced RISC Machines, is a British semiconductor and software design enterprise headquartered in Cambridge, England. The company primarily focuses on designing the ARM architecture family of central processing units (CPUs).

Additionally, Arm designs various other semiconductor chips, offers software development tools through brands like DS-5, RealView, and Keil, and delivers comprehensive systems, platforms, system-on-a-chip (SoC) infrastructure, and software solutions.

Arm is a vital player in the technology industry, supplying core technology to major companies such as Apple (NASDAQ:AAPL) and Nvidia (NASDAQ:NVDA).

Majorly owned by Japan-based Softbank (OTC:SFTBY), the company has garnished the trust of industry giants like Apple, Google (NASDAQ:GOOGL), Nvidia, Samsung (KS:005930), Intel (NASDAQ:INTC), and Taiwan Semiconductor Manufacturing (NYSE:TSM), which all have already manifested interest in buying into the offering.

ARM’s current valuation comes seven years after SoftBank took it private for $32 billion, and it represents a decrease from the previous evaluation of $64 billion, which SoftBank (TYO:9984) used to purchase the remaining 25% stake in the company from Vision Fund just last month.

However, the offering price of $51 per share was set at the top end of the expected range between $47 and $51 per share and is expected to generate $4.87 billion for SoftBank through the sale of 95.5 million shares, which represents 9.4% of the company’s stock. After the IPO, the Japanese group will still control roughly 90% of ARM shares, underscoring the Japanese bank’s long-term trust in the company.

Macro Risks

Arm’s IPO comes at a time when the tech IPO market has faced uncertainty, with valuations declining from their pandemic-era highs due to economic fluctuations and rising interest rates.

The IPO is expected to raise about $4.9bn for SoftBank, which marks the largest initial offering in the US since the electric truck maker Rivian (NASDAQ:RIVN) generated about $12bn in early 2021.

As the company sets out to trade under the symbol ARM on the Nasdaq, it seeks to capitalize on the surging interest in Artificial Intelligence and position itself as a key player in the evolving tech ecosystem.

During a presentation to investors last Thursday, Arm emphasized its growth prospects in various markets. In the cloud computing sector, where it currently holds a 10% market share, the company said it anticipates a robust 17% annual growth rate through 2025, partly driven by advancements in artificial intelligence.

In contrast, Arm’s dominance in the automotive market, with a commanding 41% share, positions it favorably for the anticipated 16% market expansion. This contrasts with the mobile market, which is expected to grow at a more modest rate of just 6%.

But despite the seemingly overall interest from other companies in the chipmaker’s public debut, buying into the IPO doesn’t look like the best idea for retail investors at the moment.

First of all, Arm still needs to persuade investors that it possesses significant growth potential beyond its current dominance in the mobile phone market, where it commands an overwhelming 99% share.

However, dwindling mobile device demand amidst the global economic downturn has been threatening even the company’s core market of late. Last quarter, the company reported total sales of $2.68 billion in the 12 months ending in March, a decrease from the $2.7 billion recorded in the preceding period between 2021 and 2022.

Moreover, Arm’s large exposure to China — which currently comprises roughly 25% of its revenue — is yet another headwind, as the Asian country’s economy faces increased risks of a broader economic slowdown and lowering demand amid the economic war with the US escalating to new levels, especially in the chip industry.

On the bright side, Arm’s royalty fees — a revenue stream that has been steadily building since its inception in the early 1990s — reached $1.68 billion, marking a significant increase from the previous year’s $1.56 billion.

Stretched Valuation, Tough Competition

At $54.5 billion, Arm’s debut valuation seems too high, even for the expensive chip industry.

Arm is expected to go public already with a price-to-earnings ratio of approximately 104, based on its most recent fiscal year report. For better context, the Invesco PHLX Semiconductor ETF (NASDAQ:SOXQ), which tracks the performance of the 30 largest US chip companies, maintains a price-to-earnings ratio of around 25.

Arm’s valuation will be very close to Nvidia’s 108 times earnings valuation — and that’s a company that has been almost solely fueling the AI madness this year, and after an impressive revenue growth forecast of 170% for the current quarter, driven primarily by AI chips.

The company will also begin trading at very expensive price-to-sales figures.

Arm’s stock is expected to be priced at roughly 20 times its revenue, which positions it as a relatively high-priced option within its industry.

Comparatively, several competitors are achieving growth rates that surpass three times that of Arm, yet they are trading at more conservative multiples, typically ranging from 12 to 15 times their sales.

For instance, Nvidia shares a similar 20-times multiple with Arm, but industry experts anticipate Nvidia’s growth rate to reach approximately 100% this year. Furthermore, Nvidia boasts a more diverse range of business operations compared to Arm, further differentiating the two companies.

Moreover, as Ivana Delevska, the chief investment officer of asset management company Spear Invest recently stated, the company remains not competitive in the area that matters the most in the AI space.

“The real opportunity in AI and a lot of the value is in the GPUs (graphics processing units), which is not what Arm does. It won’t really be comparable to Nvidia because they just don’t have the same exposure to GPU.”

Javier Correonero, an equity analyst at Morningstar, agrees the stock is too expensive at these levels:

“From a valuation point of view the stock looks very, very expensive. Everything would have to go beyond perfect for them to be able to justify that $50 billion valuation,” Correonero concludes.

Bottom Line

There's no doubt that Arm will go public with a very high valuation, and, being so, investors are highly advised to stay away from the company's stock for now.

In the long term, however, I believe that investors should keep an eye on the company's developments as it aims to challenge big industry leaders with the support of companies that actually matter and above-industry resources.

As for the IPO market in general, I believe it remains too early to call a rebirth. However, there is a possibility that we might be looking at the first spark of a better 2024.

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Disclosure: The author is long on Apple and Google for the long term.