Investors Warily Await the $ARM Holdings Ltd(ARM)$ I.P.O.
Arm sign on side of building, the IPO for the UK-based chip designer Arm, which is more than five times oversubscribed, will close on Tuesday, instead of Wednesday as previously intended
British chip designer $ARM Holdings Ltd(ARM)$ is considering increasing the price range for its initial public offering (IPO) after experiencing strong demand.
People familiar with the matter said the IPO is more than 10 times oversubscribed, will close on Tuesday, instead of Wednesday as previously intended.
The IPO, backed by Softbank Group Corp, initially set a price range of $47 to $51 per share, resulting in a valuation of $54.5 billion.
Arm Holdings expects to raise $4.87 billion through the IPO. The final pricing is expected to be determined on Wednesday, with trading of the stock commencing on Thursday.
$ARM Holdings Ltd(ARM)$ declined to comment.
Arm is no stranger to making waves in the investing world: in 2020, $NVIDIA Corp(NVDA)$ attempted a takeover deal for the company but this ultimately fell through last year due to intense regulatory scrutiny. While the name may be familiar to tech investors, particularly those involved in the semiconductor space, many may not recognize Arm.
Who are they, what do they do in the semiconductor space, and why is their IPO such a big deal? You'll find those answers here; let's dive right in.
1. What Is Arm Holdings?
Arm is a semiconductor company that designs ARM-based processors. “ARM” is an acronym for advanced RISC machines. RISC stands for “reduced instruction set computer,” a special kind of computer architecture created to simplify how computers receive the code that makes them run. The company mainly focuses on CPUs (central processing units), although it has also expanded into GPUs (graphics processing units). ARM-based processors are unique in that they function as an integrated component of the computer’s build itself, rather than being discrete relative to the other hardware. This is called “system on a chip” and is one of the many novel aspects of ARM processors.
Now, if all this information is somewhat difficult to process (pun intended), don’t worry because for the purposes of investing, you can learn what you need to know about this company without requiring a degree in computer science. Suffice it to say that Arm’s products are popular among chip manufacturers because they’re innovative, efficient and cost-effective. The average person may not have heard of Arm, but if they’ve ever used a modern mobile device, then they’ve benefited directly from an Arm processor. They can be found in devices from big names like $Qualcomm(QCOM)$ , $Samsung Electronics Co., Ltd.(SSNLF)$ and $Apple(AAPL)$ , but Arm also creates units that are for specialized functions outside of a typical consumer product.
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2.Arm Holdings Key Stats
3-year Earnings CAGR: 16.2%
Average gross margin: 95%
Current ratio: 2.59 (current assets/current liabilities)
According to the recently filed F-1, Arm’s financials seem to be in a generally healthy place. On a CAGR basis, earnings have grown at a 16.2% clip since 2021; this isn’t particularly breathtaking, but considering how saturated many of the company’s active markets are, this is a respectable figure. COGS (cost of goods sold) and operating expenses all look reasonable and as expected relative to the company’s income lines.
We’ll explain why in the next section, but Arm’s average gross margin in the last three years has hovered near 95%, which is exceptionally high even for a tech company. Of course, that margin gets eaten into at the operational level thanks to R&D and headcount spending; again, this is expected for a tech company, especially one in the semiconductor design space. Arm’s balance sheet is also nothing out of the ordinary. The current ratio is a beefy 2.59, and the company shows no truly pressing line item among its total liabilities. Goodwill is high, sitting at 23% of total assets, but once more, this isn’t unreasonable given the value of the company’s designs.
When considering projections for the future, Arm’s 2023 annual figures look like its most stable and replicable. The market environment these originally materialized in continues to persist, and there are less special/extraordinary items that investors have to account for in their projections (i.e. the income from equity investments that heavily impact the earnings figure in both 2021 and 2022).
Overall, Arm’s numbers reflect what most investors likely already understand: this is a “story” stock, so you’re playing the narrative around this company rather than basing your investment on a stringent quantitative argument. The company has a healthy balance sheet, dominant market share, innovative technology and a host of other positives that mean the story around this name is clearly strong.
3. How Does Arm Holdings Make Money?
An important distinction between Arm and other semiconductor companies is that Arm does not manufacture its products. Instead, Arm makes money by licensing its designs to other firms, which then take it upon themselves to build and implement these processors into their own products.
This is critical to analyzing Arm for two reasons. First, this business model means that the margins and drivers will be quite different relative to peers in the semiconductor space. Second, a licensing approach like this also partially explains why the 2020 $NVIDIA Corp(NVDA)$ deal fell through. Given how many major consumer products are driven by Arm processors, a combination of its CPUs with Nvidia GPUs would have given the combined company tremendous oligopic power (or so the argument goes).
For investors looking to develop a comparable analysis, you could consider adding the typical semiconductor producers that most investors know: l$Intel(INTC)$, $Advanced Micro Devices(AMD)$, $NVIDIA Corp(NVDA)$ and $Taiwan Semiconductor Manufacturing(TSM)$ among many others. However, anyone who has studied this space understands that while all four of these names exist in the semiconductor industry, each has increasingly divergent business models.
For example, $Taiwan Semiconductor Manufacturing(TSM)$ and $Intel(INTC)$ own their foundries, meaning that they’re the companies that manufacture chips alongside designing them. $Advanced Micro Devices(AMD)$ and $NVIDIA Corp(NVDA)$ are popular battleground names, but neither one manufactures their designs (you may have heard the term “fabless” associated with these companies, which is what the term alludes to in this industry). Nvidia also mainly focuses on graphics processing units or GPUs, while others like $ARM Holdings Ltd(ARM)$ and $Intel(INTC)$ focus mostly on CPUs (although they’re both branching out into GPUs), so these companies’ customers and design focuses won’t be exactly comparable. Consider adding Cadence and SynopsysSNPS 0.0% to your list of semiconductor comps.
Again, these names aren’t going to be perfect apples-to-oranges, as they both focus on software for designing chips, but their inclusion should create a more evenly distributed comparable mix.
4.Who Are The Anchor Investors?
First, let’s define an anchor investor. An anchor investor is a strategic supporter of an IPO that buys a stake prior to the IPO’s initiation. The amount bought by the anchor investor is typically a large stake (anywhere from 10% to 50% of the issued shares) and these investors are often major players in the industry that the IPO is taking place in. So essentially, the anchor investor provides two types of support: financial and psychological. The valuation of an IPO is supported thanks to the purchased shares, and the IPO decision itself is validated by having the anchor investor’s involvement.
The anchor investors in the Arm deal are a who’s who of A-list tech companies. The list below is what has been reported so far of Arm IPO anchor investors:
Note that the majority of these investors are unconfirmed as of the time of writing, but this will change as we get closer to the IPO date. But what’s clear is that both Arm customers and Arm competitors want to be involved with this event.
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5. Arm’s IPO Looking ‘Quite Expensive’ Compared With Competitors
In the most recent fiscal year, Arm generated $2.7 billion in revenue and net income of $524 million, down about 4.5% from net income of $549 million in the previous fiscal year.
Correonero says the firm is growing in the “high single digits,” and while Arm is profitable, it is less so than before it was taken private by SoftBank in 2016. He attributes the decline to a significant uptick in spending on research and development.
With a target valuation of roughly $50 billion, Correonero expects Arm stock to trade at a multiple of about 20 times revenue.
That would make the stock “quite expensive” compared with its competitors, a number of whom are growing more than triple Arm’s rate but trading at multiples closer to 12 or 15 times sales. Nvidia is also trading at a 20-times multiple that’s comparable to Arm’s, but experts expect that company to grow at a rate of about 100% this year. Nvidia also has a much more expansive variety of business operations compared with Arm.
Arm is “not a fast-growth company anymore,” Renaissance Capital’s Einhorn says, and that may affect how excited investors are about the listing and how much they are willing to pay for shares.
That said, the likelihood that Arm will be a relevant company over the next decade-plus is “quite high,” Correonero says, thanks to its strong competitive position, cutting-edge technology, and long-term relationship with its clients.
6. Arm’s IPO Comes With China Exposure Risks
In its registration statement with the Securities and Exchange Commission, Arm highlighted several risks to its business. Chief among these, according to Morningstar’s Correonero, is its exposure to China.
Arm’s operations in China are handled by Arm China, which is now an entirely separate entity from the main company. Nearly a fourth of Arm’s revenue came from Arm China—which Arm does not control—in the 2023 fiscal year. Ongoing geopolitical tensions between the U.S. and China surrounding the distribution of semiconductors could also impact Arm’s operations.
“It’s a strong business, but there’s a decent degree of uncertainty,” Correonero says.
Correonero also points out that weaknesses in financial reporting disclosed in the company’s most recent filing could be an issue down the road.
7. How To Buy Into Arm’s IPO
Buying into Arm’s IPO will be as straightforward as buying shares in already listed companies. As long as you have a brokerage account with access to the market that the company is going to be listed on, you can typically buy shares once that market opens on the day of the IPO. In Arm’s case, the Cambridge, England-based company’s American depositary shares (or ADS) will be listed on the Nasdaq and the ticker will likely be ARM.
8.Final Thoughts
The final thought on buying into Arm’s IPO (or any popular IPO really) is a simple warning. In recent history, IPOs have shown positive returns on the first-day of the company trading. But the anchor investors, underwriters and other deeply involved institutions are typically beholden to a lock-up period, so they won’t be trading their shares until several weeks or months following the IPO.
This means that the average retail investor will likely be trading against anyone ranging from other retail investors to funds that specifically target events like this to try to secure this return in the immediate period after the IPO launch. So keep in mind that there are plenty of active market participants out there with enough capital and influence to impact the trading around Arm’s shares.
This event will be at the top of financial news cycles, but don’t let FOMO be the reason you’re left holding the bag after the first trading day. As with any security, do your own due diligence before you invest.
Sources:
https://www.sec.gov/Archives/edgar/data/1973239/000119312523216983/d393891df1.htm
https://www.morningstar.com/markets/arm-ipo-dominant-chip-designer-very-very-lofty-price
https://www.forbes.com/sites/investor-hub/article/arm-ipo-what-you-need-to-know/?sh=1b902d13389f
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