What you have to know before Arm's IPO?
$ARM Holdings Ltd(ARM)$ is set to be the largest IPO since 2021. According to its latest filings, price will be between $47 and $51 per share, with 95.5 million shares being offered. This puts ARM's IPO valuation between $50 billion and $54 billion, lower than the $64 billion valuation when $Softbank Group Corp(SFTBY)$ optained the remaining 25% stake last month.
It also confirms major tech companies, including $Apple(AAPL)$ , $Alphabet(GOOG)$ $Alphabet(GOOGL)$ $Advanced Micro Devices(AMD)$ $NVIDIA Corp(NVDA)$ $Intel(INTC)$ $Synopsys(SNPS)$ $Samsung Electronics Co., Ltd.(SSNLF)$ $Taiwan Semiconductor Manufacturing(TSM)$ as investors.
About ARM Holdings
ARM Holdings is a semiconductor company headquartered in the UK, operating on a fabless business model, meaning it doesn't manufacture chips but earns revenue by selling intellectual property.
As of December 31, 2022, ARM's highly efficient CPUs powered over 99% of global smartphones, totaling more than 250 billion chips, providing power from the smallest sensors to the most powerful supercomputers.
ARM is known for its architecture, widely used in various chips, and has expanded into emerging fields such as IoT, autonomous driving, and artificial intelligence (AI). Its flexible and customizable architecture allows it to deliver outstanding performance and efficiency in different application scenarios, making ARM a preferred partner for tech companies and device manufacturers.
Financial Performance
The company's fiscal year ends on March 31st. From fiscal years 2021 to 2023, ARM's revenues were $2.027 billion, $2.703 billion, and $2.679 billion, with gross profit margins of 93%, 95%, and 96%, respectively. Net profits were $388 million, $549 million, and $524 million for the same periods.
However, in the 2023 fiscal year, revenue declined, mainly due to a decrease in global smartphone shipments. In Q1 of the fiscal year ending June 30, 2023, ARM's quarterly revenue decreased by 2.5% year-on-year to $675 million, and net profit dropped from $225 million in the previous fiscal year to $105 million.
Geographically, in the fiscal years 2021-2023, the revenue from mainland China accounted for approximately 21%, 18%, and 25% of Arm's total revenue, respectively. Arm's subsidiary in China, Arm China (An Mou Technology), is directly controlled by SoftBank, and Arm does not have voting rights.
In terms of customer distribution, in the fiscal year 2023, the top five customers accounted for 57% of its total revenue, with the top three customers contributing 44% of the total revenue, indicating a relatively high revenue concentration. The largest customer accounted for 24% of the total revenue, while the second and third largest customers accounted for 11% and 9% of the total revenue, respectively.
Regarding the sources of revenue, the two business models of licensing and royalties have different proportions. Royalty income is the primary source, accounting for 50%, 40%, and 55% of the total revenue in fiscal years 2021-2023, respectively, showing a year-on-year increase.
In March of this year (end of fiscal year 2023), Arm informed several of its largest customers of its plans to completely change its business model. It intends to stop charging chip manufacturers based on the value of their chips using its designs and instead charge based on the value of the end products. The patent usage fees will be set based on the average selling price (ASP) of mobile devices rather than the average selling price of chips. Since the value of smart terminals is much higher than that of chips, Arm will earn more money for each design sold. Therefore, royalty income is expected to account for a higher proportion in the future.
Public Listing history
In April 1998, Arm went public for the first time and was listed on the $LONDON STOCK EXCHANGE GROUP PLC(LSE.UK)$ Early supporters included Apple's Steve Jobs.
In 2016, $Softbank Group Corp(SFTBY)$ acquired Arm for $32 billion and privatized it. However, since then, the semiconductor company has experienced a surge in the secondary market. Especially after the arrival of the AI era, companies led by NVIDIA doubled their market values, instilling great confidence in the entire semiconductor industry.
In 2021, SoftBank attempted to sell Arm to NVIDIA with an estimated valuation of about $40 billion, but the deal did not materialize due to regulatory reasons.
Starting in November 2022, Masayoshi Son announced a focus on pushing for Arm's IPO, hoping that Arm's listing would be the "largest in scale" in the history of the semiconductor industry. This Arm IPO has also attracted at least 28 top investment banks, making for an impressive lineup.
Valuation and Price
Based on the valuation of 50-54 billion US dollars for this IPO, SoftBank's return on investment since its acquisition in 2016 for 32 billion US dollars is only 9%, which is clearly below the average level of the semiconductor industry represented by the $Philadelphia Semiconductor Index(SOX)$
However, from a valuation perspective, with a median valuation of 52 billion US dollars, Arm's static price-to-earnings ratio is also close to 100 times, which is relatively high within the entire industry. Of course, as an industry leader, it is reasonable for Arm to enjoy a valuation similar to NVIDIA.
However, in terms of growth prospects, Arm may still lag behind NVIDIA due to its higher correlation with the shipment volume of smart devices. Its performance may also depend more on the shipment cycles of companies like Apple and Samsung, and the overall smart device market.
Considering that Arm has also started to shift its business model towards terminal billing, it is not ruled out that there may be an increase in revenue and profit in the future, which would better support its current valuation.
But an IPO is not just about valuation; it also depends on factors such as investor composition, buyer strength, and market liquidity.
Investors who dislike high valuations will naturally not participate in such offerings. Long-term investors with business relationships may not pay much attention to short-term stock price fluctuations, and investors involved in the initial IPO negotiations will naturally not miss this opportunity.
In my opinion, the third-largest chip company that went public earlier, $GLOBALFOUNDRIES Inc.(GFS)$ which is also a giant IPO in the semiconductor industry, could provide a very good reference for the pre-listing trading situation.
And the current market environment, especially the sentiment towards the semiconductor and technology sectors, may be more optimistic than when GFS went public. This is also an important factor that allows Arm to go public at a high valuation and attract a sufficient number of large investors.
The most likely scenario is that it won't experience significant drops (because it can easily attract long-term investors to build positions) or significant gains (liquidity constraints will be an important factor limiting price increases), but it may remain active for a period of time after listing, leading to periodic short-term fluctuations.
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