It has been a while since an IPO has rocked the financial markets. The ARM IPO has been the highlight since its launch last week at the price of $51. At a PE of over 100, is it worth a look at or is it simply overhyped? Let’s take a closer look.
Giving some backdrop, Softbank took ARM private in 2016 at a valuation of 32 billion US dollars. Based on their listing IPO price of $51, it gives ARM a valuation of $54.5 billion dollars. Softbank still owns 90% of the company after this share offering.
The demand has been overwhelming with the IPO shares being ten times oversubscribed but it could be due to only 10% of the company being up for grabs. The first day gain was around 25% with the price touching $64.
ARM Business Model
ARM was established in 1990, Arm began as a joint venture between Acorn Computers, Apple Computer, and VLSI Technology. ARM was publicly listed on the London Stock Exchange and the Nasdaq Stock Market from 1998 until 2016 when ARM was taken private by SoftBank Group, our controlling shareholder.
Our open and flexible business model provides access to high-quality CPU products for a wide range of potential customer types and end markets. We license our products to semiconductor companies, OEMs, and other organizations to design their chips. Our customers license our products for a fee, which gives them access to our designs and enables them to create Arm-based chips. Once a chip has been designed and manufactured with our products, we receive a per-unit royalty on substantially all chips shipped. The royalty has typically been based on a percentage of the ASP of the chip or a fixed fee per unit, and it typically increases as more Arm products are included in the chip. Our business model enables the widest range of customers to access Arm products through an agreement best suited to their particular business needs
Source: ARM IPO Prospectus
Think of ARM as the architect or designer behind the brain of your smartphone or tablet. They create the blueprint for a type of computer chip called a “processor.” This processor is like the brain of your device, handling all the calculations and tasks it needs to perform.
ARM doesn’t actually make the physical chips; instead, they license their designs to other companies (like Apple, Samsung, or Qualcomm) who then manufacture the actual chips based on ARM’s designs. So they will earn licensing fees for each chip that was produced.
ARM is constantly compared to Nvidia as the two forefront stocks to benefit immensely from the development of the Artificial Intelligence Industry. From what we have read, ARM is more focused on the Central Processing Unit (CPU) whereas Nvidia is focused more on the Graphic Processing Units.
Here are the differences between the two products:
- CPU: CPUs are essential for general computing tasks, running operating systems, office applications, and tasks that require precise calculations and control. They are the primary computing component in most computers.
- GPU: GPUs are essential for graphics-intensive applications, including gaming, video editing, 3D modelling, and scientific simulations. They are also increasingly used for AI and machine learning tasks due to their parallel processing capabilities.
In summary, while both the CPU and GPU are vital components of a computer, they serve different purposes and excel in specific types of tasks. CPUs are versatile and handle general computing tasks, while GPUs are specialized for graphics processing and parallel computing tasks. Many modern computers and devices use both CPUs and GPUs to optimize performance and efficiency for a wide range of applications.
A Publication By The Big Fat Whale
ARM Growth Prospects
Looking through the IPO prospectus for ARM, their business will be split into these divisions:
- Mobile Application Processor (Mobile Phone Main Processor | Growth: 6.4% | Mkt Share: 99% | Mkt Size: $29.9 billion)
- Other Mobile Chips (Mobile Phone Other Processors | Growth: (0.2)% | Mkt Size: $17.6 billion)
- Consumer Electronics (Digital TVs, Wearables, Laptops etc. | Growth: 4.3% |Â Mkt Size: $53.2 billion )
- Industrial IoT and Embedded (Drones, Sensors, Robotics etc. | Growth: 6.7% |Â Mkt Share: 64.5% |Mkt Size: $41.5 billion )
- Networking Equipment (Wireless and Wired networking equipment | Growth: 1.8% | Mkt Share: 25.5% | Mkt Size: $17.2 billion)
- Cloud Compute (Data processing units and smart network interface cards | Growth: 16.6% | Mkt Share: 10.1% | Mkt Size: $17.9 billion)
- Other infrastructure (Not covered above | Growth: 2.7% | Mkt Share: 16.2% | Mkt Size: $12.7 billion)
- Automotive (Chips with processors within vehicles: Driverless Cars | Growth: 15.7% | Mkt Share: 40.8% | Mkt Size: $18.8 billion)
The total addressable market that covered all these segments would be $202.5 billion with an expected compounded annual growth of 6.8% to $246.6 billion by the end of 2025. This is not the headline-grabbing growth that the company is anticipating.
If the management’s forecast is accurate, the hype of AI might have been overstated. Hence, the growth of the sector could be steady rather than phenomenal.
From the different segments, what stands out in terms of growth will be Cloud Compute and Automotive with growth expected to be at 16% over the next few years. Their market share in mobile phone processors, IoT and Automotive is huge and hence they have to defend their turf as the market leader in these segments.
Source: www.grandviewresearch.com
For us to have a balanced perspective apart from management’s guidance, we had a look at the growth guidance from research houses such as Grand View Research which is forecasting a growth of 37.3% CAGR from 2023- 2030.
Statista’s forecasted numbers are also in line with Grand View Research. Precedence Research is the most conservative with a forecast CAGR of 20% till 2032.
ARM Financial Ratios
| Stock | ARM | Nvidia |
| Price | 56 | 435.8 |
| Price to Earnings | 112 | 106 |
| Price to Book | 25 | 39.47 |
| Price to Sales | 22 | 33.23 |
| Price to Free Cash Flow | 92 | 109 |
| Debt to Equity | – | 35.29% |
| Current Ratio | 2.6 | 3.52 |
| Return on Investment | 9.87% (Latest Annual) | 27.49% (Trailing 12 months) |
Source: Reuters
Based on valuation metrics of PE, PB and PS respectively, ARM and Nvidia are sure not looking like a bargain. With the price to sales of 22 and 33, it reminds us of the valuation of tech companies during the dot com bubble. Moreover, PE is in the triple digits and the economy is not as buoyant as before due to the tightening monetary policies.
Therefore, the good old days when the market is flush with liquidity are a thing of the past, so we should exercise caution.
In terms of their financial strength, they are both generating free cash flow and have healthy ratios. Nvidia’s interest coverage is at 113.
Looking at return on investment, it seems Nvidia have an edge with an attractive 27.49% as compared to 9.87% of ARM. However, we want to highlight that the Nvidia ratio is based on the trailing 12 months and ARM is on an annual basis. On an annual basis, Nvidia’s ROI is just at 11% which is nonetheless still higher than the ARM figure.
Things to Take Note Of:
There are several factors we would like to bring to your attention that are insights we gathered from analysing the figures.
- Valuation is not cheap at triple-digit PE so unless we envisage phenomenal growth ahead, it would not be a good risk-reward investment.
- Growth for the total addressable market for ARM is just at 6% which is not mind-blowing to deserve rich valuations. When Google and Facebook first launched their IPO, they were priced at a PE of 80 too. However, their revenue growth for the next 3 years was at above 80 per cent and above 50 per cent respectively.Â
- The Return on Investment for ARM at close to 10% does not show it is a top-quality company. Nvidia’s trailing 12 months was impressive at 27% but is it sustainable as on an annual basis, it was just 11%.
- We do not deny that ARM has a strong moat (99% of Mobile Phone main processors) but to maintain this moat, they have to commit 42% of revenue to research and development. The tech sector is ever-changing and so are they able to maintain their lead, it is anyone’s guess. We do like the fact that they are not in a capital-intensive business, as they do not manufacture the chips themselves.
- China which forms 24% of their revenue is under their subsidiary ARM China which they do not have full control of. Given the geopolitical environment, their business in China could be adversely affected if there are any changes in policies.
Summing Up
Is ARM IPO Overhyped?Â
That was the question we were trying to tackle when we embarked on this research article. We opined that, at the current valuation of triple-digit PE, it might not be the right price point.Â
The market seems to agree with us as after peaking at $69, it has come back closer to its IPO price of $51 and is currently trading at $55.
Frankly, we were surprised that the forecasted growth rate for their total addressable market is at around 6%. Hence, given their gravity-defying valuation, we are not comfortable giving an endorsement with such lacklustre growth ahead.
We also highlighted 5 things to take note of that are bothering us to take up a position.Â
Nonetheless, we will never say never if we see further positive developments ahead.
If their revenue growth numbers (above 30%) are much better than expected, the return on investment is able to be consistent at above 20% and their valuation is halved from current levels, we will revisit this investment idea.
In the meantime, we are happy to be on the sidelines.
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Disclaimer:
The content here is for informational purposes only and should NOT be taken as legal, business, tax, or investment advice. It does NOT constitute an offer or solicitation to purchase any investment or a recommendation to buy or sell a security. The content is not directed to any investor or potential investor and may not be used to evaluate or make any investment. Do note that this is not financial advice. If you are in doubt as to the action you should take, please consult your stockbroker or financial advisor.
