Arm / SoftBank – No winners

Delay is increasingly the best option.

• The discussion over which exchange Arm is going to re-list on is increasingly irrelevant as the far more pressing issue is how SoftBank is going to achieve $50bn anywhere under these market conditions.
• Throughout the entire attempt by Nvidia to acquire Arm, I was of the opinion that the simplest solution for Arm’s ownership was to return it to the public market from whence it came (see here).
• This is because public ownership resolves all of the conflict of interest issues (real or imagined) that exist by having Arm owned by a semiconductor company that competes with all of Arm’s other customers.
• Now that SoftBank has decided to return Arm to the public market the debate has arisen as to where it will have its primary listing.
• Softbank is looking to monetise its investment and so it has a fiduciary duty to its shareholders to achieve the best valuation for its shareholders.
• This is where the problem arises because Arm’s ancestral home is the London Stock Exchange (LSE) but there is very little doubt that SoftBank will achieve a much better price for its shares if it sells them for listing in New York.
• Arm is a British company although it is owned by a Japanese parent and as such the UK government is very keen to see it relist in London rather than in the USA.
• The LSE is also very keen to have Arm back as it is one of the best-known technology companies to have originated from Britain and would help the LSE to attract other technology companies to list at home rather than go overseas.
• The problem is that the difference in valuations that are afforded to companies that are listed in the USA compared to London.
• For many years, companies listed in the USA have been able to demand significantly higher multiples for their earnings than those that choose London and so it makes complete sense for SoftBank to choose the USA over London.
• The problem is that this is not the preference of the UK government and discussions are ongoing as to whether it would be appropriate to force SoftBank to list in London.
• However, with current market conditions, these arguments and discussions are rapidly becoming moot as the prospects of SoftBank getting anything like the valuation it would have gotten from Nvidia are quickly evaporating.
• High multiple narrative-driven companies are no longer the flavour of the month and as a result, many of them have fallen by 80% or more.
• To achieve a $50bn valuation, investors would need to swallow a valuation of 2021 18.5x EV / sales which with 30% YoY growth in 2022 would still be demanding 14.3x EV / sales.
• This is going to be extremely challenging as some of the highest-flying, highest-growth businesses (like Roblox, Unity etc) are now trading on around 10x 2022 EV/sales.
• Arm does not have the narrative or the growth that would convince investors to use these sorts of companies as comparables and so it will have to look elsewhere.
• In the last 18 months, Arm has restored its profitability to report Adjusted-EBITDA of $1bn or 37% but what has been adjusted is not clear.
• Typically, this would include one-off items (such as restructuring) and share-based compensation and so I am reasonably confident that unadjusted margins are above 30%.
• Furthermore, there is unlikely to be very much depreciation or amortisation meaning that EBITDA will be a reasonable approximation of net profit.
• Critics of course would argue that if this was the case then why does the company not just report operating profit which is a more accurate reflection of reality.
• The fact that Arm has profits is going to play greatly in its favour in this market and will help support a higher multiple of revenues as its profit multiples will be that much lower.
• However, I have real doubts whether the market still supports a 50x profit multiple which is close to what SoftBank would have to extract if it is going to achieve an exit at $50bn.
• This is where I think the IPO is going to have difficulty in either jurisdiction and why SoftBank’s shareholders might be better served by delaying the IPO until Arm has grown its profits to a higher level or market conditions have improved.
• I always understood that SoftBank acquired Arm to transform it into a much bigger company and then to return it to the market at a much higher valuation.
• This job is only half done, and I suspect the best outcome for all will be to wait until the transformation is complete and the market can see what it is being asked to pay for.