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The fortunes of chip designer Arm have taken a turn. Previously faced with an oversupply of chips and decreased demand for electronics, the outlook was bleak. However, the boom in artificial intelligence has now brought a surge of interest in the chip sector. To maximize its valuation, it is essential for the SoftBank-owned company to list as soon as possible.
The demand for computing power and chips continues to grow, driven by the increasing reliance on generative AI applications. This has resulted in chipmaker Nvidia attaining an enterprise value surpassing $1tn. From Arm’s perspective, having an enterprise value to sales ratio similar to Nvidia’s could potentially lead to a $67bn valuation.
Unlike Nvidia, which holds a crucial position in powering AI development, there are alternative options to Arm in the chip market. Considering an average industry earnings ratio, Arm’s enterprise value would be around $32bn. However, Nvidia’s attempted acquisition and potential role as an anchor investor in an initial public offering are expected to raise Arm’s valuation.
Arm’s primary business model involves charging chipmakers small fees, approximately 2%, for utilizing its designs. As a result of its dominance in premium smartphones, Arm is vulnerable to weakness in that sector. Despite global chip sales reaching a record $550bn in 2021, Arm’s revenues accounted for only a small fraction at $2.7bn.
Increasing prices poses challenges for Arm. China, one of its major markets, has been developing RISC-V as an open-source chip design architecture, potentially serving as an alternative to Arm’s designs. Imposing higher fees could encourage clients to invest more in developing substitutes.
Furthermore, the prospect of Arm developing its own chips is complicated. It would place the company in direct competition with its customers who are involved in chip manufacturing and designing.
The demand for chip stocks driven by AI represents a rare opportunity for Arm’s IPO. However, it does not warrant the same valuation as the industry leader.
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