It turns out that the tech IPO market isn’t dead.
In an event that could mark a turning point for both Silicon Valley start-ups and Wall Street investment banks, Arm Holdings (ticker: ARM) this past week completed a highly anticipated initial public offering. The deal was a smash hit.
It’s the first tech IPO of any consequence since Intel (INTC) spun off Mobileye Global (MBLY) 11 months ago—and it went as well as could be hoped. At $51, Arm shares priced at the high end of the expected range and opened 10% higher. The stock closed the week up 19% from the offering price, at $60.75. The public market is valuing Arm at $65 billion, about $10 billion below memory chip leader Micron Technology (MU), which generates 10 times as much revenue as Arm.
Arm is now trading for about 25 times its most recent full year of revenue—and at more than 100 times profit. And that could be where things get tricky for the new stock. Needham analyst Charles Shi picked up coverage after the first day of trading with a Hold rating, writing that “valuation looks full.”
The list of medium- and large-size tech companies trading at more than 25 times sales is short: It includes Nvidia (NVDA). And no one else.
Heading into the IPO, some investors expressed concern about Arm’s soft recent financial performance. The company had revenue in the March 2023 fiscal year of $2.68 billion, down a hair from $2.70 billion the previous year. Net income was $524 million, down from $549 million.
In an interview on listing day, Arm Chief Financial Officer Jason Child said that the year of flat revenue followed a year of outsize growth, when some customers accelerated licensing activity in advance of Nvidia’s then-pending acquisition of the company. Child said investors should look at Arm’s three-year average revenue growth—around 15%—as a proxy for potential growth.
This was a stock market homecoming for Arm, which first came public in 1998, before being taken private by Japanese holding company SoftBank Group in 2016 for $32 billion. In early 2022, SoftBank’s deal to sell Arm to Nvidia fell through in the face of sharp regulatory objections.
Arm has an unusual business model, with no true peers. Founded in 1990 as Advanced RISC Machines, Arm focuses on semiconductor designs. Chip makers license Arm’s work and then pay a small royalty for every Arm-designed chip they sell.
The company generates about 45% of its revenue from the mobile phone market—99% of the world’s mobile phones include Arm-based processors. Arm’s second-largest end market is the Internet of Things, the buzzy name for network-connected gadgets. That business is about to be eclipsed in size by chip designs for cloud computing. The automotive sector is another fast-growing area for Arm.
This is a volume business, and investors will want to see Arm grow its royalties per unit, particularly in mobile phones. In its March 2023 fiscal year, more than 30 billion Arm-based chips were sold, up 70% since 2016.
Arm generates just six cents in revenue per device shipped, according to Child, but he notes that the figure should increase over time as more customers shift to products that use Arm’s more-advanced platforms.
Much of Arm’s pricey valuation is tied to its potential attachment to artificial-intelligence trends. Child calls AI a “huge opportunity” for the company. The market has focused on training large language models, which require the kind of computing power provided by Nvidia’s graphics processors. Over time, though, Child says that more of the opportunity will be in “inference,” software that leverages those models.
Child thinks a lot of that inference work will take place on the devices themselves, where Arm designs are prevalent. HP Inc. (HPQ) and Dell Technologies (DELL) have told Barron’s in recent months that they expect to launch AI-capable laptops in the months ahead.
“The killer app of AI will be that you’ll love your PC again,” Dell Chief Operating Officer Jeff Clarke said in a recent interview.
Child says that most laptop and phone AI workloads will be based on CPUs—central processing units—rather than Nvidia’s pricey graphical processing units. He says that Arm has been in talks with PC makers—including Dell and HP—about designing models with Arm-based processors to supplant the traditional x86-based chips from Intel and Advanced Micro Devices (AMD).
But for all the AI talk, Arm’s near-term revenue is still closely tied to the smartphone market, where growth is slow. Given its rich valuation, Arm will have to quickly prove its AI chops. If it sputters, the stock could as well.
Arm’s strong debut will raise hopes for two venture-backed tech IPOs due in the next few days: Maplebear, parent of the grocery delivery company Instacart, and Klaviyo, the e-commerce marketing automation software company. If those also go well, a flood of additional offerings could follow.