Arm’s highly anticipated debut on the Nasdaq exchange is a major win for SoftBank, which recently spun off the company it acquired in 2016. However, Wall Street is scratching its head over the valuation.
The UK-based chip design company saw its stock surge 25% to $63.59 after its initial public offering (IPO), pushing its fully diluted market cap to nearly $68 billion.
For a semiconductor company that made $400 million in profit over the past four quarters, this valuation seems incredibly high. With a price-to-earnings (P/E) ratio of close to 170, it even surpasses Nvidia’s P/E ratio.
Compared to Nvidia, which develops graphics processing units (GPUs) for artificial intelligence workloads and trades at a P/E ratio of 109, Arm’s valuation is off the charts. Other chip companies also pale in comparison, with the Invesco PHLX Semiconductor ETF boasting a P/E ratio of about 21.
The key difference between Nvidia and Arm lies in their growth rates. Nvidia reported a doubling of revenue in the latest quarter and expects 170% expansion this period, thanks to increased spending on AI chips by major cloud companies. Conversely, Arm’s revenue shrunk slightly in the last quarter.
“There’s no way you can justify a P/E ratio of over 100 for a no-growth company,” said Jay Ritter, a finance professor at the University of Florida. Ritter, an expert in initial public offerings, believes the story has to be that “the company will be developing some new designs that restart growth and generate profits.”
Currently, there isn’t a large market for Arm’s stock. SoftBank owns 90% of the roughly 1.03 billion shares outstanding after the IPO. This move allows SoftBank to generate some liquidity after a challenging period of investments. The remaining shares are available for institutional and retail investors, though trading volume was high enough on the Nasdaq to make Arm the fifth most actively traded stock on the exchange.
To invest in Arm at these levels, the bet must be on growth. Arm believes its technology will play a central role in the transition to AI-based computing. Its designs already dominate the smartphone market, as well as electric cars and data centers.
According to Arm’s IPO filing, the addressable market for products featuring its designs is expected to reach $246.6 billion by 2025, compared to $202.5 billion last year. Arm’s path to prosperity lies in gaining market share and improving economics, despite modest annual growth of around 6.8%.
Arm has managed to maintain strong profit margins despite a small drop in revenue, making it an appealing investment. The company’s gross margin for fiscal 2023 was an impressive 96%, mainly due to its royalty-based business model. In comparison, Nvidia’s gross margin in the latest quarter was 70%. Intel and AMD recorded gross margins of 36% and 46% respectively.
Arm’s operating margin was 25% in the latest quarter, highlighting its ability to remain profitable while other players in the chip industry struggled.
“This is not a commodity company,” said Matt Oguz, founding partner of Venture Science. Oguz believes that considering all these factors, it’s challenging to calculate a multiple for future earnings.
— CNBC’s Kif Leswing contributed to this report.
Correction: Arm’s revenue shrank in the latest quarter. An earlier version misstated the company name.
WATCH: CNBC’s full interview with SoftBank’s Masayoshi Son and Arm’s Rene Haas
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