Arm Holdings Readies High Valuation U.S. IPO (Pending:ARM)

A Quick Take On Arm Holdings

Arm Holdings (ARM) has filed proposed terms for a $4.7 billion IPO of its American Depositary Shares representing underlying ordinary shares, according to an amended SEC registration statement.

The firm creates and licenses CPU technologies for a wide range of devices and applications globally.

ARM has produced declining topline revenue, reduced operating profits, a swing to cash burn, and the IPO has an EV/EBITDA valuation multiple of 100x, which is excessive in my view.

My outlook on the IPO is Neutral [Hold] due to questions about its growth trajectory, profitability reduction, lowered margins and ultra-high valuation.

Arm Holdings Overview

Cambridge, UK-based Arm Holdings Limited was founded to enable advanced computing using power-efficient semiconductor design technologies.

Management is headed by Chief Executive Officer Rene Haas, who has been with the firm since 2013 when he joined the company as VP Strategic Alliances.

Mr. Haas was previously Vice President and General Manager of computing products business at NVIDIA and held executive roles at Scintera Networks and Tensilica.

Management estimates that ‘70% of the world’s population uses Arm-based products.’

As of June 30, 2023, Arm has booked fair market value investment of $1.275 billion from investors, including SoftBank Group Corp.

Arm’s Customer Acquisition

The company markets its intellectual property to original equipment manufacturers, operating system companies and third-party tool vendors.

The firm is also a leading developer of AI- and ML-enabled computing, creating technologies for generative AI and autonomous driving applications.

Selling, G&A expenses as a percentage of total revenue have trended lower as revenues have decreased slightly, as the figures below indicate:

Click to enlarge

(Source – SEC)

The Selling, G&A efficiency multiple, defined as how many dollars of additional new revenue are generated by each dollar of Selling, G&A expense, fell slightly to negative (0.1x) in the most recent reporting period, as shown in the table below:

Click to enlarge

(Source – SEC)

Arm’s Market & Competition

According to a 2023 market research report by Precedence Research, the worldwide market for semiconductors was approximately $592 billion in 2022 and is expected to reach $1.88 trillion by 2032.

This represents a forecast CAGR of 12.28% from 2023 to 2032.

The main drivers for this forecasted growth are ongoing demand for advanced semiconductor performance and improvements in offerings by various supply chain participants.

Also, the chart below shows the historical and projected future growth trajectory of the global semiconductor market from 2022 to 2032.

Major competitive or other industry participants include the following:

• Qualcomm Technologies

• Broadcom

• Intel Corporation

• Samsung Electronics

• NXP Semiconductors

• SK Hynix

• Texas Instruments

• Micron Technology

• Maxim Integrated Products

• Numerous Chinese Companies

• Others

The company’s recent financial results can be summarized as follows:

• A slight decline in topline revenue

• Reduced gross profit and gross margin

• Growing operating profit and net income

• A swing to cash used in operations

Below are relevant financial results derived from the firm’s registration statement:

Click to enlarge

(Source – SEC)

As of June 30, 2023, Arm had $2.0 billion in cash and $2.5 billion in total liabilities.

Free cash flow during the twelve months ending June 30, 2023, was $778 million.

Arm’s IPO Details

ARM intends to sell 95.5 million ADSs representing 95.5 million underlying ordinary shares at a proposed midpoint price of $49.00 per share for gross proceeds of approximately $4.68 billion, not including the sale of customary underwriter options.

Regarding existing or potential new shareholders, the company said,

Advanced Micro Devices, Inc., Apple Inc., Cadence Design Systems, Inc., Google International LLC, Intel Corporation, MediaTek Inc.’s affiliated entities, NVIDIA Corporation, Samsung Electronics Co., Ltd., Synopsys, Inc. and TSMC Partners, Ltd. (collectively, the “Cornerstone Investors”) have, severally and not jointly, indicated an interest in purchasing up to an aggregate of $735 million of the ADSs offered in this offering at the initial public offering price and on the same terms and conditions as the other purchasers in this offering.

The company’s enterprise value at IPO (excluding underwriter options) will approximate $49 billion.

The float to outstanding shares ratio (excluding underwriter options) will be approximately 9.31%.

As a foreign private issuer, the company can choose to take advantage of reduced, delayed or exempted financial and senior officer disclosure requirements versus those that domestic U.S. firms are required to follow.

All proceeds of the IPO will go to the selling shareholder and parent firm SoftBank Group Corp., and the company will receive no proceeds.

SoftBank will own approximately 89.9% of the outstanding shares of the company immediately post-IPO, so the company will be a ‘controlled company’ under Nasdaq’s rules.

The firm has a number of equity compensation incentive plans. ‘As of June 30, 2023, there were Executive Awards in the aggregate amount of $95 million outstanding under the 2022 RSU Plan.’

Management’s presentation of the company roadshow is available here until the IPO is completed.

Regarding outstanding legal proceedings, Arm has recorded a $40.0 million settlement liability for a non-top-five customer dispute.

Also, the firm has guaranteed up to $8.5 billion in a Facility Agreement related to Kronos. Parent SoftBank has also posted 75.01% of its interest in Arm as collateral.

The listed bookrunners of the IPO are Barclays, Goldman Sachs, J.P. Morgan, Mizuho and a number of other investment banking firms.

Valuation Metrics For Arm Holdings

Below is a table of the firm’s relevant capitalization and valuation metrics at IPO:

Click to enlarge

(Source – SEC)

Commentary About Arm Holdings’ IPO

Arm is going public at a time when semiconductor technologies are in ever-increasing demand worldwide.

The company’s financials have generated slightly lower topline revenue, reduced gross profit margin, and lowered operating profit and net income.

Free cash flow for the twelve months ending June 30, 2023, was $778 million.

Selling, G&A expenses as a percentage of total revenue have moved lower despite a drop in revenue and its Selling, G&A efficiency multiple dropped to negative (0.1x) in the most recent partial-year reporting period.

The firm currently plans to pay no dividends and to retain future earnings for reinvestment back into the company’s growth and working capital requirements.

The company is subject to dividend laws in England and Wales, so it is restricted as to the conditions under which it may pay dividends in the future.

Arm’s recent capital spending history indicates it has spent lightly on capital expenditures as a percentage of its operating cash flow.

The market opportunity for CPU design is large and expected to continue growing at a reasonably high rate of growth in the coming years, so the firm enjoys strong industry growth dynamics in its favor.

Business risks to the company’s outlook as a public company include the following management discussion about its Chinese entity and operations:

a ‘significant portion of our total revenue is generated from Arm China, a related party.[…] Despite our significant reliance on Arm China through our commercial relationship with them, both as a source of revenue and as a conduit to the important PRC market, Arm China operates independently of us. Under the IPLA, Arm China’s payments due to us are determined based on the financial information that Arm China provides to us. Accordingly, we are dependent on Arm China providing us with reliable and timely financial information. […] For the fiscal year ended March 31, 2023, although our total revenues derived from the PRC increased as compared to the prior year, the growth in our royalty revenues slowed for the same period primarily as a result of economic issues in the PRC and factors related to export control and national security matters. Furthermore, in light of these issues, we expect to continue to see declining royalty revenues derived from the PRC and we could see a decline in licensing revenues.[…] In the fiscal year ended March 31, 2023, royalty revenue represented 63% of our total revenue.’

Management is asking IPO investors to pay an Enterprise Value / Revenue multiple of just over 100x, an extremely high multiple.

Investors who can stomach a 100x EV/EBITDA multiple would need to believe Arm is really worth a far higher valuation than $49 billion.

While the firm is well positioned in the current demand growth environment for AI-related chip technologies, I question the proposed valuation given the company’s recent declining topline revenue growth, drop in operating profit and turn to operating cash loss.

Accordingly, my outlook on the ARM IPO is Neutral [Hold] due to excessive valuation.

Expected IPO Pricing Date: September 13, 2023.