Tech Corner: How Does the ARM IPO Stack Up?

By Daniel Morgan, Synovus Trust Senior Portfolio Manager

Arm Holdings (ARM), the chip design company controlled by SoftBank, jumped nearly 25% during its first day of trading on September 14 after selling shares at $51 a piece in its initial public offering. At the open, ARM was valued at almost $60 billion. The company, trading under ticker symbol “ARM,” sold about 95.5 million shares. SoftBank, which took the company private in 2016, controls about 90% of shares outstanding. The day before the IPO, ARM priced shares at the upper end of its expected range. Upon the release, the shares hit the tape at $56.10 and rallied to close the day at $63.59. Softbank plans to raise as much as $4.87 billion, offering 95.5 million ADR shares at $47-$51 each. ARM had been valued at $60 -$70 billion after being purchased by Softbank in 2016 for $32 billion. The current IPO deal would place ARM’s value at $60 billion.

ARM licensing and royalty business model collects fees from different semiconductor companies for the design of their CPU chips. These fees are not inexpensive, as Qualcomm has raised concerns in the past that ARM has been charging too much royalty fees for its chip designs. Many of ARM’s royalties come from products released decades ago.

About half the company’s royalty revenue, which totaled $1.68 billion in 2022, comes from products released between 1990 and 2012. ARM’s open design help architect, develop and license high-performance, low-cost, and energy-efficient CPU products and related technology that allows advanced computing in greater than 99% of the world’s smartphones. In addition to smartphones, ARM CPUs run the vast majority of the world’s software, including the operating systems and applications for tablets and personal computers, data centers and networking equipment, vehicles, smartwatches, thermostats, drones and industrial robotics.

The company sold $735 million in shares to a group of strategic investors comprising Advanced Micro Devices, Apple, Cadence, Google, Intel, Nvidia, Samsung, Synopsis and Taiwan Semiconductor Manufacturing Company. It’s a testament to ARM’s influence among chip companies, which rely on ARM’s technology to design and build their own chips. More than 260 companies reported that they had shipped ARM-based chips in the fiscal year ended March 31, 2023, including the largest technology companies globally, such as Amazon.com, Inc. and Alphabet Inc., and major semiconductor chip vendors such as Advanced Micro Devices, Inc., Intel Corporation, NVIDIA Corporation, Qualcomm Inc. and Samsung Electronics Co., Ltd. In Feb. 2021, Nvidia’s attempted a $40 billion acquisition of British chip designer ARM from Softbank, but the deal never went through as the Federal Trade Commission sued to block the merger in December 2021.

As the world moves increasingly toward artificial intelligence-(AI) and machine learning (ML)-enabled computing, ARM will be central to this transition. ARM CPUs already run AI and ML workloads in billions of devices, including smartphones, cameras, digital TVs, cars and cloud data centers. The CPU is vital in all AI systems, whether it is handling the AI workload entirely or in combination with a co-processor, such as a GPU or an NPU. ARM is working with leading companies such as Alphabet, Cruise LLC, Mercedes-Benz, Meta and NVIDIA to deploy ARM technology to run AI workloads. At this point, a large part of the AI push has been in the use of GPUs in the data center, over CPUs. It will be interesting to see how ARM positions its CPU designs in the future AI-mania footprint!

The ARM IPO comes at a time when the overall semiconductor industry is in a slump. The near-term fundamentals of the global semiconductor market point to revenues projected to decline 11.2% in 2023, according to the latest forecast from Gartner, Inc. In 2022, the market totaled $599.6 billion, which was marginal growth of 0.2% from 2021. Economic headwinds persist, weak end-market electronics demand is spreading from consumers to businesses, creating an uncertain investment environment. In addition, an oversupply of chips that is elevating inventories and reducing chip prices is accelerating the decline of the semiconductor market this year. The PC, tablet and smartphone semiconductor markets are stagnating. The combined markets will represent 31% of semiconductor revenue in 2023 and total $167.6 billion. These high-volume markets have saturated and become replacement markets devoid of compelling technology innovation.

ARM’s IPO price is not for the faint hearted. ARM shares trade at a hefty premium compared to its peers. At the current $55 billion market valuation, ARM’s forward price-to-earnings (P/E) multiple based FY2024 earnings estimates places the shares at 67x earnings. That multiple appears frothy even when compared to the AI chip poster child Nvidia, which shares trade at 41 times FY2024 projected earnings. This high multiple even comes without Nvidia’s 218% annual profit growth forecast.

Overall revenues for ARM over the past year have been flat with FY2023 sales at $2.679 billion versus FY2022 at $2.703 billion, while Net Income fell 24% Year-over-Year (YoY) (2022 to 2023) to $524 million versus $692 million. Today, ARM’s value of $55 billion on FY2023 revenues of $2.679 billion would equate to a Total Market to Sales Value ratio by 20 times. That valuation is far greater than the average for the chip sector, as measured by the Philadelphia Stock Exchange Semiconductor Index’s (SOX), which trades at 5.5 times sales. ARM’s Total Market to Book Value stands at 12.5 times. This compares to the SOX’s current Market to Book Value of 4.5 times. So, based on ARM’s current valuation, the shares are not cheap.

With the deal six times over-subscribed, it looks investors viewed the ARM IPO as an AI play and forgot to look at the price tag!