On Sept. 14, Arm Holdings PLC (ticker: ARM) began trading on the Nasdaq under the ticker ARM. After pricing its initial public offering at $51 per share, the stock traded as high as $69 before dropping back below its IPO price less than a week after it began trading. Arm is a semiconductor design company that generates revenue from royalties from chip sales and licensing its intellectual property. The company is a market leader in smartphones, but it has struggled to break into the much higher-growth cloud computing market.
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With a valuation of about $55 billion, here are three pros and three cons to buying ARM stock following its IPO.
Arm Stock Pros
Profitability
One of the biggest drawbacks to investing in tech IPOs is that many of them are still years away from profitability. Not Arm. The company’s prospectus said its fiscal 2023 net income was $524 million. In its IPO roadshow, Arm management said it expected at least $1.5 billion of adjusted operating profit in the year ending in March 2025.
Doug Clinton, managing partner at Deepwater Asset Management, says Arm isn’t the typical cash-burning tech startup IPO with no long-term track record.
“ARM is a pretty mature company. It was previously a public company and taken private after SoftBank bought it in 2016 for $31 billion,” Clinton says.
High-Profile Backers
In addition to its solid fundamentals, Arm has a long list of heavy-hitting investors and customers. Arm’s technology is used in 99% of global mobile processors, and its customers include Apple Inc. (AAPL), Alphabet Inc. (GOOG, GOOGL), Nvidia Corp. (NVDA), Samsung Electronics Co. Ltd. (005930.KS), Intel Corp. (INTC) Advanced Micro Devices Inc. (AMD) and Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC). In September, Arm announced a new deal with Apple through 2040 and “beyond.”
Following its IPO, Arm is still about 90% owned by Japanese tech conglomerate SoftBank and its billionaire founder Masayoshi Son. Arm also counts some of its major customers as investors, including Apple, Google, Nvidia, Samsung, AMD, Intel, Samsung and TSMC.
This many high-profile relationships and investors are a vote of confidence for the value of Arm’s technology.
Growth Opportunities Outside of Smartphones
Outside of its core smartphone market, Arm also has growth opportunities in several large emerging markets in tech that could provide significant additional revenue growth opportunities for years to come. Arm’s chip designs are also used in the cloud computing market, but Arm has only about 10% market share in that high-growth market. The company has plenty of room to grow its share in server data centers. Arm also has about a 41% share of the automotive market and has chips used for smart devices and industrial applications as well. Arm is also attempting to tap into the artificial intelligence investment cycle, though analysts at Bernstein recently downplayed Arm’s AI opportunities.
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Arm Stock Cons
Valuation
One of the biggest criticisms of the Arm IPO has been the stock’s valuation. Arm’s IPO price put its price-to-earnings ratio in the triple digits, based on a $60 billion valuation — in Nvidia territory but without its growth prospects. That valuation has since dropped, but some analysts say the numbers don’t add up.
David Trainer, CEO of New Constructs, says investors can find plenty of other high-growth tech stocks at much more attractive valuations.
“The roughly $49 billion valuation implies that the company needs to grow its revenue by over 20% compounded annually every year for the next decade, which is a highly unlikely scenario, even for a company like Arm Holdings that is profitable and is in an industry with plenty of growth ahead,” Trainer says.
Clinton says the market’s ability to support Arm’s valuation will be a bellwether for the tech IPO market moving forward.
“ARM is getting a pretty rich valuation, which speaks to investor optimism around tech in general,” he says.
Competition
Another major challenge for Arm will be to meet growth expectations in an extremely competitive environment.
Trainer says each one of Arm’s end markets are highly competitive.
“Many of the competitors have more than enough capital and expertise to build their own custom solutions and box Arm out of many of the markets in which it needs to grow to justify its lofty IPO valuation,” he says.
Third Bridge analyst Albie Amankona says open-source RISC-V chip architecture is a real threat to Arm’s architecture.
“The growing adoption of RISC-V chip architecture is the biggest risk for Arm. Our experts say RISC-V is already making inroads in mid- and low-end applications, such as the embedded market, including automotive,” Amankona says.
Saturated Smartphone Market
More than half of Arm’s royalty revenue comes from the mobile device market, and that market is approaching a saturation point. In fact, Arm reported negative year-over-year revenue growth in the fiscal year ending in March 2023, thanks in large part to slumping smartphone sales. Counterpoint Research recently projected global smartphone shipments will drop 6% year over year in 2023.
To make matters worse, roughly 20% to 25% of Arm’s revenue comes from China. Counterpoint estimates smartphone sales in China declined 4% in the second quarter, and geopolitical tensions among China, the U.S. and the U.K. could further threaten Arm’s China business in coming years.
Bottom Line
In general, big tech IPOs have a spotty track record at best. Insiders typically only sell a company when they believe they are getting the highest possible market price.
In Arm’s case, the U.S. IPO is far from a fire sale given SoftBank still owns 90% of the company. And with the stock trading at about 20 times sales, some extremely high growth expectations appear to already be priced into the stock.
Arm doesn’t have a lot of Wall Street analyst coverage just yet, but the few analysts that have weighed in on the stock don’t seem particularly optimistic. Arm currently has one “buy” rating, three “hold” ratings and one “underperform” rating, with a median analyst price target of just $49.13.
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Should You Buy Arm (ARM) Stock? originally appeared on usnews.com
