- UK-based silicon chip architecture specialist listed on NASDAQ on 14 September
- Shares were priced at $51 and soared to $63.59 on their first day of trading
- ARM has subsequently lost strength and the shares have gone below $50 amid wider weakness in semiconductor stocks
“A pet is for life, not just for Christmas, and a slide in ARM’s shares below the offer price means it is still too early to tell whether this deal is going to be a roaring success or not,” says AJ Bell investment director Russ Mould. “ARM’s lofty valuation is proving more difficult to sustain amid mixed commentary from leading silicon chip firms, lukewarm market responses to earnings from the Magnificent Seven and higher bond yields, which, historically, tend to be unhelpful for highly rated stocks such as ARM.
“ARM’s shares were priced at $51 on 14 September and, boosted by apparently strong demand and a very limited free float of barely 9%, they soared by a quarter to close at $63.59 on the first day of trading.
“That was enough to prompt further negative commentary on London’s suitability as a venue for major stock market listings and victory laps from those who championed New York, but the picture has changed a lot in just six weeks. ARM’s share price has sagged and quietly slipped below its offer price, despite all of the hoopla that accompanied the deal (and the inherent difficulty in shorting it posed by the limited number of shares that have been made available to buy or sell).
“The deal still looks like a triumph from the perspective of the seller, Japan’s Softbank and its advisers.
“Softbank sold stock at $51 a share to get an implied valuation for ARM of around $54 billion, a big premium relative to the $32 billion it paid to acquire ARM back in 2016 (although even that perspective must sweep under the carpet the $64 billion valuation implied when Softbank bought in the 25% of ARM it did not own from its Saudi-backed Vision Fund just prior to the NASDAQ listing).
“The 28 banks in the offering syndicate got their fees.
“The losers, for now at least, were those who bought stock at $51 or – worse – piled in once trading began. Someone somewhere must have paid that top-tick price of $63.59 for it to be registered, after all, and they must now decide what to do about their 25% paper loss.
Source: Refinitiv data
“This decision is particularly tricky as ARM’s $49 billion market cap still means that it trades at a huge premium to its industry peers, as benchmarked by the 30-stock Philadelphia Semiconductor Index, or SOX.
“ARM’s status as the leading fabless and chipless company in the world means it deserves a premium rating. The Cambridge firm neither makes chips nor even designs them but licenses out its architectures and then banks royalties every time a product using chips based on those architectures is sold. It has greater visibility than most chip makers, lower volatility of earnings owing to the absence of big production plants and offers strong cashflow.
“But the degree of premium is substantial all the same and one that may price in a lot of good news (and more) already, even as analysts predict strong growth going forwards.
Source: Company accounts, Marketscreener, analysts’ consensus forecasts.
*Based on the 21 silicon chip firms in the SOX and excludes the nine semiconductor production equipment (SPE) companies that are in the index.
**ARM fiscal year to March
“Doubts also seem to be creeping in across the benchmark SOX index. Despite a huge rally in 2023, it failed to recapture its early 2022 all-time high and has since shed 19% of its value, to leave it nearing ‘bear market’ territory.
Source: Refinitiv data
“A slower-than-anticipated rebound in second-half earnings in 2023 seems to be the prime reason for this slide, with TSMC, Micron and Texas Instruments among those to already acknowledge this, while Samsung Electronics is now talking effusively about an upturn in end-demand in 2024, as if to suggest 2023 is rather being written off as a bad job.
“Again, that would not be a problem if the valuation offered some downside protection, but the $49 billion market cap may offer little of that.
“At the height of the technology bubble, ARM’s market cap peaked at £9 billion in 2000, when sales reached £100 million – or 90 times sales – a figure which swiftly proved unsustainable, as the tech bubble burst and ARM itself ultimately coughed up its first ever profit warning in 2002 as the smartphone market went through one of its periodic slowdowns.
“Thankfully, investors are now being asked to pay ‘only’ 17 times sales but even that number could be problematic in light of the wider lessons of the 2000-03 tech bubble which were discussed by Scott McNealy, then the CEO of Sun Microsystems, a couple of years later, when he said:
“At ten times revenues, to give you a ten-year payback, I have to pay you 100% of revenues for ten straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next ten years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You do not need any transparency. You do not need any footnotes. What were you thinking?”
“Investors in ARM are being asked to take an even longer-term view to get their payback, even if its business model looks capable of much greater longevity than that of Sun Microsystems, which was taken over by Larry Ellison’s Oracle for around $7 billion in 2010, way below its peak bubble market cap of $200 billion in 2000.”
