The news of Arm's public listing has been a significant event in the chip industry and a highlight in this year's otherwise stagnant IPO market.
On Tuesday, September 5, documents submitted by Arm to regulatory authorities revealed that the company priced its ADS (American Depositary Shares) between $47 and $51 per share. With a total issuance of 95.5 million ADS, the company aims to raise $48.7 billion in its U.S. IPO, valuing Arm at a staggering $523 billion.
The documents also highlighted that ten of Arm's clients, including Apple, Nvidia, AMD, Google, Intel, MediaTek, TSMC, Synopsys, and Cadence Design, have agreed to be cornerstone investors in this issuance, expressing interest in purchasing up to $735 million worth of ADS.
Previously, Arm had plans to raise between $80 billion and $100 billion, a figure higher than the current fundraising target. One reason for the adjustment might be SoftBank's recent decision to acquire 25% of Arm's shares that it didn't directly own from its Vision Fund. The IPO is expected to be finalized next week, with SoftBank retaining 90.6% of the company's shares.
A consortium of 28 investment banks, including Barclays, Goldman Sachs, J.P. Morgan, and Mizuho Financial Group, will serve as joint underwriters for Arm's IPO.
Sources informed media outlets that the joint underwriters stand to earn up to $1 billion in fees from the listing. Arm plans to pay the underwriters 2% of the fundraising amount, which ranges between $50 billion and $54 billion. This includes a basic fee of approximately 1.75% and a bonus of 0.25%.
SoftBank acquired Arm in 2016 for an estimated $32 billion. Although Arm's valuation now exceeds the purchase price, it still falls short of SoftBank CEO Masayoshi Son's target. When SoftBank recently acquired shares of Arm from its Vision Fund, it valued Arm at $64 billion.
Moreover, based on investor demand during the roadshow, Arm might adjust its fundraising scale. The company is considering pricing its shares on September 13 and commencing trading the following day.
Despite not meeting Son's expectations, Arm remains a coveted entity in this year's chip industry. It's set to be the largest global IPO of the year, and the target valuation indicates a very optimistic market outlook for Arm.
James Anderson, one of the UK's most prominent tech investors, commented that since SoftBank's acquisition, Arm "missed many opportunities," such as faster growth in the cloud computing sector. He believes that while Arm is strong in the smartphone market, its valuation is "more challenging than they imagine."
It remains uncertain whether Arm will play a pivotal role in the rapidly expanding era of artificial intelligence, but Anderson doesn't see any unique advantage for the company in AI development.
Arm's Unique Position in the Industry Chain
Arm, an unavoidable giant in the chip industry, has designed chip architectures used in 99% of smartphones worldwide. However, its brand recognition among consumers isn't high, and its profits aren't as optimistic as one might assume.
Arm operates at the upstream end of the chip industry. Its primary business model revolves around designing IPs, which include instruction set architectures, microprocessors, graphic cores, and interconnection architectures. These are then licensed to chip manufacturers, aiding them in faster chip design.
From the fiscal year 2021 to 2023, Arm's annual revenues were $2.027 billion, $2.703 billion, and $2.679 billion, respectively. Net profits for the same years were $388 million, $549 million, and $524 million.
In terms of revenue composition, Arm has two primary earning models: licensing (accounting for 40% of total revenue) and patent usage fees (accounting for 60% of total revenue).
Analysts explain that the licensing model means that other companies need to pay a fee to Arm every time they use its architecture to design a chip. The patent usage fee model involves Arm taking a percentage cut when chip manufacturers, using Arm's architecture, sell their chips.
The patent usage fee, Arm's most profitable business, isn't priced high. This is a significant reason why, despite a market share of 99%, its revenue and profit scales aren't exceptionally large.
In 2022, the total value of chips using Arm's technology reached $98.9 billion, accounting for nearly half of the market share. However, Arm's profit was only $1.68 billion, representing 1.7% of the chip value.
Some analysts point out that Arm's charging model is based on chips, not end-user devices like smartphones. In contrast, other high-tech companies typically charge for end-user products, and their fees are generally much higher than Arm's.
For instance, Qualcomm's patent fee rate is 3.25% of the original price of a 3G, 4G, or 5G multi-mode phone using Qualcomm's essential patents. This means for a phone priced at $300, Qualcomm would charge a patent fee of $9.75.
Can Arm Become the Next Nvidia?
According to Arm's prospectus, as of 2022, the company had 5,963 full-time employees across North America, Europe, and Asia. About 80% of these employees focus on research, design, and technological innovation. R&D expenses account for 42% of the total revenue. Arm's R&D intensity has been increasing, with R&D expenses accounting for 37% and 40% of total revenue in 2021 and 2020, respectively.
After Masayoshi Son's investment in Arm, he ordered a significant increase in hiring and channeled more resources into R&D. Son's bet was on the global surge in chip demand, with Arm poised to seize the opportunity. However, current indicators suggest that due to market shifts in recent years, there's no evidence that Arm has capitalized on this opportunity.
For the quarter ending June 30, Arm's quarterly revenue decreased by 2.5% year-on-year to $675 million. Net profit dropped from $225 million in the previous fiscal year to $105 million, a decline of over 50%.
Since 2016, Arm's revenue has grown by 65%, slightly above the overall chip industry but lagging far behind industry leaders. The significant increase in research expenditure hasn't translated into the profit rise that Son anticipated. Bets on the Internet of Things (IoT) also fell short, with the vision of interconnected fridges, doorbells, and other gadgets not materializing as expected.
Arm still positions itself as a potential beneficiary of the AI boom, suggesting that the growth of AI systems like autonomous vehicles might lead to increased demand for chips designed by Arm. Arm's prospectus states, "Arm will be at the heart of the transformation brought about by AI."
Rene Haas, who took over as Arm's CEO last year, is focusing on advanced computing, especially chips for data centers and AI applications. He believes that by pushing investments into specific instructions, such as SME and SVE, they can make significant strides in the hyperscale server market.
In a podcast, Haas mentioned that by shipment volume, Arm has the highest market share in GPUs. However, they will continue to emphasize "performance per watt" and won't venture into creating GPUs with power reaching hundreds of watts, like Nvidia's products.
Arm's revenue for the recent fiscal year was $2.68 billion, with a net profit of $524 million. Its historical price-to-earnings ratio ranged between 95 and 105 times, lower than Nvidia's 117 times. However, compared to other chip manufacturers, Arm's target valuation is still at a significant premium, especially considering these manufacturers also have a large exposure to the smartphone business. For instance, Qualcomm's historical P/E ratio is only 15 times.
