Hi Everyone 👋,

Semiconductors are one of the most critical resources in the world.

They power everything, from advanced supercomputers to toasters.

They have also become a hot topic for protecting the national interest of a nation’s technological advantages.

By now, we’re all familiar with the AI-focused behemoth Nvidia, but there is much more to the space.

We recently got a new exciting IPO to dive into: Arm.

For a full dive, check out the Company’s F1 Filing here

• What Do They Do? 👉 Revenue Model, Customers

• By The Numbers 👉 Financial Snapshot

• Public History 👉 Previously Public, Softbank Takeover, Recent Financing Round + IPO, Valuation

• Key Risks 👉 China Exposure, Customers = Competitors, Alternatives

Let’s get started!

1. What Do They Do? 👉 History, Products, Customers, Value Proposition

What Do They Do?

Arm is the creator of the most widely used computing architecture of all time. Arm helped define how all mobile phones operate, with it’s core architecture spreading to cars, sensors, and supercomputers.

However - what Arm doesn’t do is make or sell chips. Instead, the company designs and licenses blueprints for processor cores, which run software programs and perform calculations. Think of them as the set of instructions that electronic brains use to carry out basic operations.

Arm’s website boasts more than 250 billion chips in which its technology is embedded into since its inception in 1990. These chips are in everything from sensors to smartphones, with an estimated 99%+ of the entire world’s smartphones using the architecture. The marketshare chart is quite impressive:

To call this company a patent troll is a mistake. There is extensive technological know-how that has to be combined with many moving pieces across the semiconductor supply chain industry.

Revenue Model

Arm earns fixed upfront license fees when they deliver IP to partners and then variable royalties for each chip that contains Arm’s IP. The license fees vary between $1M- $10M, while the royalty is usually 1 to 2% of the selling price.

However, around the IPO, business model developments are in place. Instead of selling licenses for specific chip designs and hoping the royalty revenue eventually flows, it is offering so-called total access agreements. In these arrangements, major customers pay an annual recurring fee for the right to use a much broader suite of Arm’s intellectual property. Time will tell if this succeeds.

Customers

By building and licensing out the architecture, Arm aims to be the “Switzerland” in the semiconductor supply chain, remaining neutral and open for all businesses.

A major customer was Apple, who was part of a consortium that founded Arm back in 1990 and has been using its tech for chips that power iPhones and Macs. This relationship helped curb Apple’s over-reliance on Intel as a supplier. Intel has even turned to Arm to make networking chips, but also to back it up in its fight against TSMC on the contract manufacturing side.

Samsung, Microsoft and Alphabet also heavily use Arm to lower costs in their smart phone and other devices.

Amazon has used Arms to develop their own in-house chip called Graviton to power the cloud servers business, again - reducing reliance on Intel and AMD.

Additionally, Apple, Amazon, Intel, Nvidia, Alphabet, Microsfot, Samsung, and TSMC reported all wanted a piece of the IPO. It’s a great vote of confidence when your customers also want to become owners.

2. By The Numbers 👉 Financial Snapshot

Financials

As we discussed earlier, one component of revenue is licensing revenue. This tends to be one-time and lumpy in nature. We also have royalty revenue that is more recurring, and stacks based on new end product releases.

However, royalty revenue is also subject to macro downturns. Arm's sales fell to $2.68 billion in the 12 months ended March 31, hurt by a slump in global smartphone shipments.

So we have a business here where revenue growth is more or less linked with smartphone volume shipments, with moderate growth, and around 25% operating margins.

3. Public History 👉 Previously Public, Softbank Takeover, Recent Financing Round + IPO, Valuation

Arm has been a publicly traded company on the London Stock Exchange before. Back In 2016, SoftBank bought Arm for $32 billion. Masa Son’s plan here was to sell services to help coordinate and deliver software to billions of devices equipped with Arm chips. Although this was ultimately unsuccessful, there were licensing schemes with annual subscriptions, reducing the need for repeated negotiation for individual products. We all know how overdue Softbank is for a win after the whole WeWork debacle.

In September 2020, Nvidia reached a deal to buy Arm from SoftBank for $40 billion. That plan collapsed 18 months later after opposition from regulators and customers.

As recently as August 2023, Softbank acquired the 25% stake in Arm that it does not directly own from its Vision Fund unit in a deal that valued the company at $64B.

During the September IPO, the initial range pointed to a valuation of $50B at the midpoint of $49/sh. A $14B haircut from the valuation a month ago? Wild. During the IPO process, we found out that the book was 10x oversubscribed. But as we know, everyone pads their orders so this means absolutely nothing.

Arm’s IPO price finally settled at $51/sh, it started trading at $56.10, and it finished the day at $63.59 (Marketcap of $65B).

Wherever the stock settles over the next little while, if its around the $60B valuation range, it looks incredibly expensive. At a $60 billion valuation, Arm’s price-to-earnings multiple would be over 110x based on the most recent fiscal year profit. That’s comparable to Nvidia’s valuation, which trades at 108x earnings, but without Nvidia’s 170% growth forecast for the current quarter.

Comparing Arm to Nvidia is like comparing an old Beatles catalog that continues to print royalties vs. Taylor Swift who has her Eras tour that puts up huge numbers ontop of also collecting royalties.

4. Key Risks 👉 China Exposure, Customers = Competitors, Alternatives

China Exposure: As discussed in my paid monthly piece, the US-China trade wars are causing tension everywhere, and this is no exception. Arm has about 25% of its revenue its China. However, this risk is slightly mitigated because Arm China operates as a separate entity. Sales data and payments from this entity have sometimes been late, per the IPO prospectus.

Customers = Competitors. While a customer may use a single central processing unit (CPU) design from Arm, it may choose to develop the other components on its own. While Arm captures the initial upfront license fee, there is a risk that the company develops complete capabilities in-house come license renewal time.

Alternatives: Like any innovation, you have to continually invest in R&D to keep your product competitive. However, Arm has an additional risk. Lower-cost alternatives have emerged, including RISC-V, a technology whose instruction set can be licensed for free. RISC-V already has a strong foothold in the laptop and data center categories. Arm will need to remain competitive.

Wrapping Up…

This will be an interesting one. Arm looks like a critical partner with all major technology players, as they allow megacorps the optionality to design their own chips, in order to limit the power of other key suppliers in the system.

From a business perspective, creating a platform instead of a lumpy license revenue business will be quite the achievement if they can pull it off.

Either way - we’re back in the IPO market, and it’ll be fun to watch how this one trades.

Until next time. Always Yours. Incessantly Chasing ROI.

THE INFORMATION CONTAINED ON THIS WEBSITE IS NOT AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE, AND DOES NOT PURPORT TO BE AND DOES NOT EXPRESS ANY OPINION AS TO THE PRICE AT WHICH THE SECURITIES OF ANY COMPANY MAY TRADE AT ANY TIME. THE INFORMATION AND OPINIONS PROVIDED HEREIN SHOULD NOT BE TAKEN AS SPECIFIC ADVICE ON THE MERITS OF ANY INVESTMENT DECISION. INVESTORS SHOULD MAKE THEIR OWN INVESTIGATION AND DECISIONS REGARDING THE PROSPECTS OF ANY COMPANY DISCUSSED HEREIN BASED ON SUCH INVESTORS’ OWN REVIEW OF PUBLICLY AVAILABLE INFORMATION AND SHOULD NOT RELY ON THE INFORMATION CONTAINED HEREIN. INVESTORS SHOULD OBTAIN INDIVIDUAL INVESTMENT ADVICE BASED ON THEIR OWN CIRCUMSTANCES BEFORE MAKING AN INVESTMENT DECISION

No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer or the solicitation of an offer to buy or sell the securities or financial instruments mentioned.

The author, publisher or insiders of the publisher may currently have long or short positions in the securities of the companies mentioned herein, or may have such a position in the future (and therefore may profit from fluctuations in the trading price of the securities). To the extent such persons do have such positions, there is no guarantee that such persons will maintain such positions.

Any projections, market outlooks or estimates herein are forward looking statements and are inherently unreliable. They are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur. Other events that were not taken into account may occur and may significantly affect the returns or performance of the securities discussed herein. The information provided herein is based on matters as they exist as of the date of preparation and not as of any future date, and Grit undertakes no obligation to correct, update or revise the information in this document or to otherwise provide any additional material.

Grit does not accept any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of the information contained herein.

By using the Site or any related social media account, you are indicating your consent and agreement to this disclaimer and our terms of use. Unauthorized reproduction of this newsletter or its contents by photocopy, facsimile or any other means is illegal and punishable by law.

Please read: Terms of Use, Privacy Policy, Disclosure Policy and Disclaimer Policy

If you have any questions please contact us at [email protected]