Introduction

Arm, a UK-based chip design company, made its Nasdaq debut on Thursday after being spun out by SoftBank, who acquired the company in 2016. While SoftBank stands to benefit from the successful IPO, Wall Street is puzzled by the company’s valuation.

Stock Performance

Arm’s stock surged 25% to $63.59 per share following its IPO, pushing the company’s fully diluted market cap to nearly $68 billion. This valuation appears disproportionately high for a semiconductor company that generated $400 million in profit over the past four quarters, resulting in a price-to-earnings ratio of close to 170. This ratio is significantly higher than even Nvidia’s P/E ratio.

Comparison with Nvidia

Nvidia, a company specializing in graphics processing units (GPUs) used for artificial intelligence workloads, has a P/E ratio of 109 based on trailing earnings. Despite experiencing a significant increase in stock price this year, outperforming other S&P 500 members, Nvidia’s valuation remains lower than that of Arm. In fact, no other chip company in the sector comes close to Arm’s valuation. The Invesco PHLX Semiconductor ETF, which measures the performance of the top 30 US chip companies, has a P/E ratio of about 21.

Growth Rate and Investor Perspective

The main difference between Nvidia and Arm lies in their growth rates. Nvidia reported a doubling of revenue in the latest quarter and projects a 170% expansion in the next period due to increased spending on AI chips by major cloud companies. In contrast, Arm experienced a slight decline in the last quarter. Some investors find it challenging to justify a P/E ratio of over 100 for a company with no growth. However, they believe that Arm will develop new designs that will reignite growth and generate profits.

Ownership and Trading Activity

SoftBank currently owns 90% of Arm’s outstanding shares, leaving only a small portion available for institutional and retail investors. On the day of the IPO, Arm was the fifth-most actively traded stock on the Nasdaq, with 126.58 million shares changing hands.

Arm’s Market Potential

Arm’s technology plays a central role in the transition to AI-based computing. Its chip designs are already present in smartphones, electric cars, and data centers. The company anticipates that the addressable market for products incorporating its designs will reach $246.6 billion by 2025, up from $202.5 billion in the previous year. Arm’s path to greater prosperity lies in gaining market share and improving economics.

Profit Margins and Unique Position

Despite a slight decline in revenue, Arm has maintained strong profit margins. Its gross margin for fiscal 2023 was 96%, significantly higher than Nvidia’s 70%, Intel’s 36%, and AMD’s 46%. Arm’s operating margin was 25% in the latest quarter, demonstrating its ability to stay profitable even during a challenging period for the chip industry.

Conclusion

Arm’s Nasdaq debut has been beneficial for SoftBank, but it has raised questions among Wall Street analysts. The company’s high valuation compared to its earnings and growth rate is a cause for concern. However, those who believe in Arm’s potential see its unique position in the chip industry and its role in the growth of AI-based computing as reasons to invest in the company.