Dear Reader,

ARM Holdings is preparing for an initial public offering (IPO).

ARM is a semiconductor company whose products are known for their low power consumption. For years, it was one of the most highly anticipated IPOs in the tech sector.

But after a failed acquisition by Nvidia and the market downturn in 2022, those plans were put on hold… Now, ARM is officially making plans to go public. And if you listen to much of the media, it’s expected to be the hottest IPO of the year.

But what’s odd is that Wall Street is billing the deal as an AI-themed IPO.

It’s not.

The chipmaker primarily makes hardware for smartphones. Many believe ARM will eventually be the go-to supplier for on-device AI in smartphones. However, the company is not involved in the buildout of existing generative AI that took the world by storm.

Wall Street is hoping that people look over this fact and buy into the hype. That would be a mistake.

Let me explain.

Already Pricey

The landscape of IPOs has shifted. Once, the dream ticket for retail investors was to buy into fresh tech disruptors. That was the case in past years.

On its IPO day in 1997, Amazon (AMZN) carried a $438 million market capitalization. Today, the company is valued north of $1.3 trillion. Those are life-changing returns. And any investor – big or small – could have gone along for the ride.

But today’s IPOs often serve a different purpose. At times, Wall Street uses IPOs to off-load companies that have exhausted their private funding runway.

That’s the case with ARM and SoftBank.

SoftBank is a Japanese investment holding company that scooped up ARM in 2016 for $32 billion.

SoftBank tried selling ARM to Nvidia in 2020, but the deal fell through last year due to antitrust concerns from the FTC.

So SoftBank was left holding a company it couldn’t sell. It had just one option left – IPO.

To make matters worse for SoftBank, it recently announced a $32 billion loss in the fund that holds ARM. A blockbuster IPO would be a lifeline for the company.

No one’s questioning ARM’s stronghold in the tech ecosystem. Its low-power chip designs are embedded in 99% of all smartphones sold worldwide.

But here’s the catch – smartphone innovation is stalling out. Global smartphone sales are slated to hit a 10-year low this year.

That’s not what you want for an IPO.

Usually, IPOs are done when the business is growing. Ideally, analysts want to see strong growth over the past two years… with a good outlook for the next year or two. That’s not what’s happening with ARM.

When ARM’s financials were unveiled earlier this month, they didn’t paint a rosy picture. Revenue shrunk by 1%, and profits fell by 5%.

SoftBank is hoping that it can cover up slumping sales by billing ARM as an AI company and riding the hype that’s helped push Nvidia’s share price up over 200% this year.

We don’t know ARM’s exact IPO valuation. But I’m estimating it to exceed $64 billion. At that valuation, the stock would be trading at 122 times earnings. For perspective, that makes Nvidia, trading at 42 times earnings, look like a bargain. The difference here is that Nvidia doubled its revenue while ARM’s is about flat. 

Don’t expect Wall Street to highlight these facts. Instead, the focus will be on the dominant share of the smartphone market ARM enjoys and vague language about its AI opportunity.

But even its smartphone dominance is going to come under attack.

Risk Five

RISC-V (pronounced “risk-five”) is an open standard instruction aiming to take market share away from ARM.

Unlike other commercial chip architectures, RISC-V is open source, meaning it’s freely available to the public and can be used without licensing fees. This gives chip manufacturers and developers more flexibility and cuts costs.

In a recent filing, ARM mentioned RISC-V 16 times as a risk factor that could impact the company.

That’s because major tech companies are starting to embrace RISC-V.

Google announced earlier this year that RISC-V would be supported on Android. That means, in the near future, Android smartphones could operate using RISC-V rather than ARM designs. This is significant because Android is the most-used mobile operating system globally with a market share of around 71%.

Competition from open-source alternatives isn’t the only risk ARM faces. More alarming could be ARM’s reliance on China for sales. The country accounted for over 24% of the company’s revenue.

And China is the company’s subsidiary. It has become a complex issue for SoftBank. It initially granted the license to distribute ARM’s core technology to the Chinese market, but the subsidiary ventured into crafting its own intellectual property.

Adding to the challenges in China are the United States sanctions on certain chip technology being sold. In 2022, ARM recognized a $63 million reduction in revenue due to sanctions that restrict high-end semiconductors from being sold to China.

These tensions are shifting some Chinese firms to invest in RISC-V given the open-source design doesn’t fall under any political sanctions. Notably, Alibaba has unveiled several chips based on the open-source platform.

This all boils down to one thing – more competition for ARM in the future.

That’s why SoftBank is so anxious to take ARM public and start to sell its stake.

But don’t make the mistake of buying shares and bailing out SoftBank. At its current valuation, ARM offers much more downside than upside.


Colin Tedards
Editor, The Bleeding Edge