Arm, setting the record for this year's largest IPO, boasts a valuation even higher than NVIDIA's.
On Thursday, Arm made its successful debut on the U.S. stock market, surging 25% on its first day. At one point, it even spiked to a 30% increase, closing with a fully diluted valuation nearing $68 billion, marking the largest IPO this year.
Notably, Arm's profit over the past year was only around $400 million. This means the chip company's price-to-earnings ratio is approaching a staggering 170 times, surpassing NVIDIA's 110 times.
IPO documents reveal that Arm's sales up to March 31 were just under $3 billion, a decline of about 1%. Sales for the quarter ending June 30 dropped 2.5% to $675 million-merely a twentieth of NVIDIA's second-quarter revenue. Moreover, net profit decreased by over 50% year-over-year, settling at $105 million.
Yet, NVIDIA has been the undeniable star on the U.S. stock market this year. Bolstered by cloud computing companies heavily investing in AI chips, NVIDIA's recent quarterly revenue more than doubled. The company's stock price has surged 218% this year.
There have always been skeptics about Arm. Jay Ritter, a finance professor at the University of Florida who has long studied IPOs, mentioned that for a non-growth company, a P/E ratio over 100 is irrational. The narrative should be about the company developing new designs to reignite growth and generate profits.
Most of Arm's revenue comes from royalties, and they don't provide hardware. This model grants Arm an impressive gross margin of 96%. In comparison, NVIDIA's recent quarterly gross margin was 70%, and a year ago, it was less than 44%. Intel and AMD's gross margins stand at 36% and 46%, respectively.
However, even though royalties provide a steady income stream for Arm, most of Arm's architecture products are MCUs (microcontrollers), which are relatively cheap. Arm earns its royalties from the chip price, not the end product, resulting in modest revenue.
R. Scott Raynovich, founder of independent cloud tech analysis firm Futuriom, commented on the high valuation given to Arm, which is about four times the industry average. According to data from New York University, the average price-to-sales ratio for semiconductor stocks is five times.
Limited Tradable Shares
So, why does Arm's valuation surpass NVIDIA's?
A significant reason is the scarcity of Arm's tradable shares. Out of Arm's 1.03 billion circulating shares, SoftBank holds 90%. This IPO, raising $4.9 billion, also attracted a group of strategic investors, including Apple, Google, NVIDIA, Samsung, and Intel.
With SoftBank and tech giants holding a significant portion, there's even less volume available for institutional investors, retail investors, and traders. When the number of shares available for trading decreases, the stock price can experience significant fluctuations.
Goldman Sachs, the main underwriter for Arm's IPO, placed great importance on this offering. If successful, it could rejuvenate the sluggish IPO market, bringing more business to Goldman Sachs and its peers.
However, if there were missteps, it would further dampen the IPO climate and potentially tarnish the reputation of Goldman Sachs CEO David Solomon.
Goldman Sachs, one of the U.S. banks most reliant on investment banking, saw the most significant revenue decline among the six major U.S. banks during last year's IPO slump. Solomon also had to deal with internal disagreements at Goldman Sachs.
While these setbacks haven't affected Goldman Sachs' position on the IPO leaderboard, the bank desperately needs a win to quell external doubts.
Mike Mayo, an analyst at Wells Fargo, in a media interview, stated that this is the core of Goldman Sachs' business. The expectations are high, and they're likely to meet them. If they don't, there will be even more issues than we've seen so far.
Solomon, discussing Arm and other ongoing IPOs at a Barclays conference this week, expressed optimism about the significant IPOs in the market. He believes that if these IPOs progress smoothly, it will create a positive cycle, pushing more backlogged IPOs to the market.
