Is ARM Worth Investing in?

Arm has officially filed for an initial public offering (IPO), setting the price range for each American Depositary Share (ADS) between $47 and $51. The company aims to raise approximately $4.87 billion through this IPO. Following the issuance, SoftBank will maintain a 90.6% ownership stake in Arm. It is worth noting that the current valuation of the company stands at around $54 billion, which falls below the previously anticipated range of $60-70 billion.

ARM is a prominent company specializing in the design of Reduced Instruction Set Processors (RISC CPUs). In contrast to Intel's Complex Instruction Set Processors (CISC CPUs), Intel's CISC CPUs deliver superior performance, albeit at a higher price point, which has had a significant impact during the era of personal computers. Conversely, ARM's RISC CPUs offer distinct advantages in terms of lower power consumption and cost-effectiveness, rendering them highly suitable for deployment in small mobile devices. Unlike Intel, ARM follows a business model centered around IP licensing, which effectively mitigates risks and costs while expanding the scope of their product offerings.

With the decline of the PC era and the explosive growth of global consumer electronics, such as smartphones, ARM has rapidly expanded its market share, ultimately achieving a dominant position. As of December 31, 2022, ARM's processor technology were powering 99% of smartphones worldwide. According to ARM's estimates, approximately 70% of the world's population utilizes products based on ARM technology. In the fiscal year ending on March 31, 2023, the shipment volume of ARM architecture chips witnessed a remarkable increase of approximately 70% compared to the fiscal year ending on March 31, 2016, reaching a staggering total of over 30 billion units.

To maintain its technological dominance, ARM possesses a portfolio of approximately 6,800 published patents, primarily related to key technologies utilized in contemporary chip manufacturing. Furthermore, the company continues to augment its research and development (R&D) investments in order to broaden its range of products. In the fiscal year 2023, ARM's R&D expenses have exhibited a consistent increase, amounting to $1.133 billion, as compared to $995 million in fiscal year 2022 and $814 million in fiscal year 2021. Apart from advancements in RISC CPUs, ARM has also made significant strides in the GPU domain, exemplified by their flagship product, the Immortalis-G715.

In the industry chain, ARM holds an upstream position, whereas downstream chip design manufacturers such as Qualcomm, Broadcom, and NVIDIA occupy a downstream position. Despite ARM's advantageous position in the industry chain, downstream chip design manufacturers wield considerable bargaining power.

In September 2016, SoftBank Group, a Japanese conglomerate, acquired ARM for $32 billion and took it private. Masayoshi Son, the former wealthiest individual in Japan and an investor in the global internet technology sector, had actually intended to divest and exit for some time. In 2020, SoftBank attempted to sell ARM to NVIDIA for $40 billion, but the deal faced regulatory resistance. The acquisition ultimately failed in February 2022. Subsequently, SoftBank sought to promote ARM's listing, with the main purpose of obtaining investment returns to make up for investment losses.

SoftBank reported a net revenue of 6.57 trillion yen for the fiscal year 2022, representing a year-on-year growth of 5.6%. However, the company also experienced a significant net loss of 9,701.4 billion yen (approximately 50 billion Chinese yuan), which greatly exceeded the market's anticipated loss of 3,437.1 billion yen. Similarly, the SoftBank Vision Fund, like SoftBank, faced substantial losses, with a loss of 4.3 trillion yen (approximately 32 billion US dollars) throughout the fiscal year 2022, compared to a loss of 2.55 trillion yen in the previous year. The investment losses for theSoftBank Vision Fund amounted to 5.28 trillion yen, whereas it was 3.43 trillion yen in the previous year.

Based on the disclosed IPO information, ARM has experienced a slight decline in performance while maintaining a high valuation. In the fiscal year 2023, ARM reported revenues of $2.68 billion, which is slightly lower than the $2.7 billion achieved in the fiscal year 2022. The net profit for the same period was $524 million, down from $549 million in the previous year. Although ARM achieved a gross margin of 96% and an operating profit margin of 25% in the fiscal year 2023, the quarterly sales as of the latest date, June 30th, showed a 2.5% decline compared to the same period last year, indicating that the growth momentum has not yet been fully realized. Based on the net profit for the fiscal year 2023, the price-to-earnings (PE) valuation for this IPO exceeds 100 times.

Furthermore, there are potential risks in the Chinese market. As of the financial year ending on March 31, 2023, and the previous year, ARM China accounted for approximately 24% and 18% of the total revenue, respectively, making it the company's largest customer. ARM China primarily licenses ARM's processor technology to Chinese customers and collects licensing and chip sales fees. Although ARM's total revenue from China has grown year-over-year in the 2023 fiscal year, the growth in the 2022-2023 fiscal year is likely due to the impact of Huawei being removed from the Entity List. This factor is influenced by international politics and is of great concern to the company. The sales prospects for ARM in the Chinese market are uncertain, and it is expected that the royalty revenue from China will continue to decline.

Even though ARM holds a dominant market position, it still needs to demonstrate high profitability and low risk to justify such a high valuation. Ultimately, the final profit will determine ARM's ability to deliver investment returns.