Arm, the chip design company highly regarded by SoftBank and even viewed by Masayoshi Son as pivotal to SoftBank's survival, has kicked off its roadshow this week.
Despite Arm's unshakable position in the chip industry, current realities have led the market to reassess the company's value and prospects, lowering expectations for its valuation and IPO amount.
On Monday, September 4th, media reports suggested that Arm is now seeking to raise between $50 billion to $70 billion through its IPO, down from the previously sought $100 billion. The company's valuation might also end up between $50 billion to $60 billion, rather than the initial target range of $60 billion to $70 billion.
Other media outlets believe Arm's target valuation is between $50 billion to $55 billion, while some analysts estimate it to be between $45 billion to $50 billion.
Why the Drop in Arm's Valuation?
The extent of Arm's IPO success hinges on broader, complex factors, including the slowing growth of the smartphone market and potential profit growth from the increasing prevalence of artificial intelligence.
Analysts suggest that part of the reason for the valuation drop is that Arm already dominates its primary smartphone business, leaving little room for growth. They believe SoftBank has invested more in R&D, and these expenditures might take years to recoup.
Even the AI boom that began late last year might not easily translate into revenue and profit for Arm. The market believes that AI's prosperity might boost demand for server chips, not smartphone and home computer chips - Arm's primary products. Nonetheless, Arm still positions itself as a potential beneficiary of AI, stating that the growth of AI systems like autonomous vehicles might mean increased demand for chips designed by Arm. The IPO prospectus claims, "Arm will be at the heart of the transformation brought about by AI."
Additionally, a UK investment firm commented that the current valuation levels circulating in the market are "slightly more palatable compared to the initially stated $80 billion." The firm believes that while Arm has "achieved risk diversification and remains a very high-quality business model," the company still faces risks in its global layout.
Some analysts also believe that the data disclosed in Arm's prospectus doesn't strongly support its valuation, given that the prospectus shows a decline in its operating income.
For the fiscal years 2021, 2022, and 2023, Arm's annual revenues were $20.27 billion, $27.03 billion, and $26.79 billion respectively. Net profits were $3.88 billion, $5.49 billion, and $5.24 billion respectively. R&D expenses accounted for 40%, 37%, and 42% of the respective annual revenues, while gross profit percentages were 93%, 95%, and 96%.
Moreover, for the quarter ending June 30th, Arm's quarterly revenue decreased by 2.5% year-on-year to $6.75 billion, and net profit dropped from $2.25 billion the previous fiscal year to $1.05 billion, a more than 50% decline.
Last Friday, SoftBank arranged for Apple, NVIDIA, and Intel to be strategic investors for Arm's U.S. IPO. Other stakeholders include Samsung, AMD, and Google, with each potentially subscribing to up to $1 billion in Arm shares. Notably, both Apple and NVIDIA are major clients of Arm.
Will Masayoshi Son's Bold Gamble Succeed?
When Masayoshi Son's SoftBank Group acquired chip company Arm in 2016 for $32 billion, he was ecstatic. He believed that after decades of tech investments, this acquisition was "largely a deal destined for me. I can confidently say that its revenue will increase fivefold within five years."
That hasn't been the case.
While Arm remains a leading designer of components for smartphones, computers, and automotive chips, this largest-ever deal by SoftBank hasn't met its objectives.
Since 2016, Arm's revenue has grown by 65%, slightly above the entire chip industry, but far behind industry leaders. Arm's increased R&D spending hasn't translated into the higher profits Son envisioned. Arm's bet on the Internet of Things (IoT) also fell short.
Unlike many startups invested in by SoftBank's Vision Fund, Arm is a mature company with substantial profits, earning over $5 billion annually and holding over 90% market share in mobile chip processor design.
After acquiring a stake in Arm, Son ordered a significant increase in hiring and channeled more resources into R&D. Son's gamble was that global chip demand would skyrocket, and Arm would seize this opportunity. However, given the market's rapid changes over the past few years, there seems to be no evidence that Arm has capitalized on this.
Analysts believe that if Arm's IPO underperforms expectations, it might even impact SoftBank's credit outlook.
Analysts say that raising $50 billion to $70 billion through the IPO might not offset the impact of SoftBank's Vision Fund acquiring a 25% stake in Arm in August, valuing Arm slightly above $64 billion at the time. Arm's IPO might weaken SoftBank's adjusted loan-to-value ratio from 21% in June to about 24%, and its leverage might remain weak. A lower IPO valuation for Arm might also spark market skepticism about SoftBank and the Vision Fund's $64 billion valuation for Arm.
The Vision Fund's primary backers are Middle Eastern investors, including the Saudi Arabia Public Investment Fund and Abu Dhabi's Mubadala Investment Company. Of the $100 billion Vision Fund, SoftBank only invested around $28 billion. Thus, SoftBank's purchase of Arm shares from the Vision Fund essentially means buying back shares from Middle Eastern investors.
