The Company Powering 99% of Smartphone Is Set To Be 2023 Biggest IPO

Arm has filed its IPO prospectus and is set to become the largest IPO in 2023.

Most people have probably not heard of Arm.

But almost everyone has used its invention.

An overwhelming 99% of the globe's smartphones rely on Arm for their operation. Whether it's an iPhone or a Samsung device, the odds are high that you're currently holding a device equipped with an Arm-designed chip.

Consider Arm as a fundamental blueprint for CPU chips. Historically, Intel has held a predominant position in chip design with its x86 series, which is based on the CISC (Complex Instruction Set Computers) architecture.

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However, the x86, while powerful, had issues of excessive heat generation and high energy consumption for mobile gadgets. In contrast, Arm introduced a more straightforward design using the RISC (Reduced Instruction Set Computer) architecture, resulting in lower power consumption, diminished heat emission, and higher speed. Arm-based chips became better suited for our mobile devices.

Subsequently, mobile devices gained unprecedented global traction, leading to the widespread embrace of Arm-based chips, marking a transformative chapter in the evolution of computing technology.

Arm gradually made its way into the realm of laptops. Previously, Apple had relied on Intel chips to power its Mac computers. However, in 2020, Apple introduced its own M1 chips, which are based on the Arm architecture. This move dealt a significant blow to Intel's position in the market.

Presently, Arm chips have reached a level of competence suitable for laptops. In fact, I am currently using one to compose this post. The remarkable aspect is that I can operate unplugged throughout the entire day and still have battery life remaining by day's end. The performance is impressive as well.

Nonetheless, I use it mainly for work, composing with office apps and searching the internet for information – a primary function for which most people employ laptops. Thus, an Arm-based chip proves more than adequate for such purposes. However, if your intentions include gaming or running specialized software, it's important to note that an Arm-based laptop may not deliver optimal performance in those scenarios.

It should be evident at this point that Arm's influence is widespread, and most of us interact with at least one device powered by its technology. However, you might wonder how Arm generates its revenue.

Arm doesn't do any manufacturing or chip design. Instead, it charges a royalty or licensing fee on every device that uses an Arm-design chip. For each device utilizing an Arm-designed chip, Arm charges a fee. This fee can either be a percentage of the device's selling price or a fixed fee per unit. While the exact figures remain undisclosed by Arm, certain sources suggest that the fee could range from approximately 1% to 2% for each chip. To put this in perspective, considering the average smartphone's selling price in 2022 at $335, this translates to potential earnings of around $3.35 to $6.70 per device.

While this might not seem substantial on an individual basis, when multiplied across the billions of devices sold annually, the cumulative revenue becomes significant, amounting to billions of dollars. In the fiscal year 2023, Arm reported a revenue of $2.7 billion, underscoring the immense financial success achieved through this royalty-based business model.

Given its absence of manufacturing costs, the company has achieved an impressive gross profit margin of 96% while its net profit margin stands at a respectable 20%. The majority of its expenditures are directed towards research and development (R&D), accounting for 42% of its revenue in FY2023. This commitment to R&D underscores that Arm is not resting on its laurel and has been developing the next generation of products.

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It's worth noting that a substantial portion of these R&D costs is attributed to share-based compensation. Arm remains a cash generating business. During the fiscal year 2023, the company generated an additional $500 million in cash. It now has $1.6 billion in cash, which constitutes 22% of its total assets. The company maintains a total debt-to-equity ratio of less than 50%. These indicators collectively point to Arm's healthy and stable financial position.

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In terms of growth, Arm is expected to benefit from the expanding landscape of interconnected technologies, particularly fueled by the emergence of smart cities, the Internet of Things (IoT), and wearable devices. This evolution enables previously unconnected objects, ranging from lamp posts and buildings to household appliances like refrigerators and washing machines, to be transformed into intelligent devices through embedded chips. This creates a demand tailwind that propels Arm's prospects forward. The company anticipates that its total addressable market will experience a compound annual growth rate (CAGR) of 6.8% up to the year 2025.

Additionally, Arm can grow by winning more market share. According to Arm's own estimates, it had achieved a 48.9% market share by the close of 2022, a notable increase from its 42.3% share in 2020. There is momentum driving the company's pursuit of even greater market share in the foreseeable future.

Arm is undeniably a fabulous business to own. The foundation of its success rests on its role in originating a design that is now ubiquitous across various devices, enabling it to continually reap the benefits. This is a moat that is hard to penetrate - not impossible but very difficult as Arm did unseat Intel's dominance.

Lastly, we do not know the IPO price of Arm but my guess is that it is likely to be overvalued. Sure, the price might even pop on the IPO day but I always believe it isn't worth to pay a premium for any investment. Wait for the dust to settle and we might be able to buy it at a fairer price. Regardless, Arm remains a key company to watch.