Arm’s Nasdaq debut on Thursday looks good for SoftBank, which just divested the company after acquiring it in 2016. But it’s a headache for Wall Street.
The British chip design company saw its shares rise 25% to $63.59 after its IPO, boosting the company’s fully diluted market capitalization to almost $68 billion.
That’s a huge number for a semiconductor company that generated $400 million in profit over the past four quarters. It results in a price-earnings ratio over that period of almost 170, a number that even exceeds 170. Nvidias P/E ratio.
Nvidia, which develops graphics processing units (GPUs) used to run artificial intelligence workloads, is trading for 109 times trailing earnings – and that’s after its stock price more than tripled this year, far better than any other member of the S&P 500.
In the rest of the chip sector, nothing even comes close. The Invesco PHLX Semiconductor ETF, which is designed to measure the performance of the 30 largest U.S. chip companies, has a price-to-earnings ratio of about 21.
For investors, the crucial difference between Nvidia and Arm is the growth rate. Nvidia just reported a doubling of revenue in the last quarter and forecast 170% growth for the period, as all major cloud companies ramp up their spending on AI chips. Arm’s sales, on the other hand, fell slightly in the last quarter.
“There’s no way you can justify a price-to-earnings ratio over 100 for a company that’s not growing,” said Jay Ritter, a professor of finance at the University of Florida and a longtime expert on IPOs. The story should be that “the company is going to develop some new designs that will reignite growth and generate profits,” he said.
For now, there isn’t a big open market for Arm’s stock. Of the approximately 1.03 billion shares outstanding immediately after the offering, SoftBank owns 90%. The Japanese tech conglomerate took Arm private in 2016 in a deal worth $32 billion, and SoftBank CEO Masayoshi Son is aiming to raise some liquidity after a very difficult period of investment in his company.
Of the $4.9 billion in shares SoftBank sold, $735 million was purchased by a group of strategic investors, including Apple, GooglingNvidia, Samsung And Intel. That leaves a small sliver of stock to be exchanged between institutional and retail investors and traders, although volume was high enough Thursday that Arm was the fifth most actively traded stock on the Nasdaq, with 126.58 million shares traded.
To buy at these levels as a long-term investor, the focus must be on growth. In its prospectus, Arm stated that its technology will be “central to this transition” to AI-based computing. Arm’s designs are currently in virtually every smartphone on the market, as well as in electric cars and data centers.
“We’ve had significant growth in the cloud data center and automotive space,” Arm CEO Rene Haas told CNBC’s David Faber on Thursday. “And with AI, AI runs on Arm. It’s hard to find an AI device today that isn’t Arm-based.”
Arm said in its IPO filing that it expects the addressable market for products featuring its designs to reach $246.6 billion by 2025, up from $202.5 billion last year. That’s just 6.8% annual growth, so Arm’s path to greater prosperity must be through market share gains and improved economies.
“We expect that the cost and complexity of chip design will continue to increase, and that we will be able to contribute a greater share of the technology in each chip, which will result in our royalties accounting for a greater share of the total value of each chip .” says the prospectus.
Matt Oguz, founder of Venture Science, said his investment firm had expressed interest in the IPO but had not received an allocation. He said the positive case for Arm is that it has been able to maintain strong profit margins even with a slight decline in sales, and that it is a “unique company” given the ubiquity of its technology in so many key products.
For fiscal 2023, Arm’s gross margin — the percentage of profit left after accounting for cost of goods sold — was 96%, because the company makes much of its money from royalties and doesn’t provide hardware. Nvidia’s gross margin was 70% in the latest quarter, after rising from less than 44% a year earlier. Intel and AMD recorded gross margins of 36% and 46% respectively.
Arm’s operating margin was 25% in the last quarter, as the company was able to remain profitable even as much of the chip industry lost money, partly due to a post-Covid inventory glut.
“This is not a commodity company,” Oguz said. “When you put all those things together, it’s not that easy to calculate a multiple of future earnings,” he said.
— CNBC’s Kif Leswing contributed to this report.
Correction: Arm’s sales shrank in the last quarter. In an earlier version the company name was stated incorrectly.
WATCH: CNBC’s full interview with SoftBank’s Masayoshi Son and Arm’s Rene Haas