SoftBank & Arm – All the stops pt. III

SoftBank is making things difficult.

• The final details of Arm’s IPO have now been made clear with SoftBank cutting back on the price in a sign that this deal has not been plain sailing.
• This should have been a perfectly ordinary IPO, but SoftBank’s need to book a big profit from its ownership of Arm has made the IPO much more difficult which highlights how crucial the first day of trading is going to be.
• SoftBank is offering 95.5m shares of Arm which will be issued as American Depositary Receipts (ADRs) on a one-for-one basis at a price of $47 to $51 per share.
• The greenshoe option is 7m ADRs should demand exceed the 95.5m already being offered for sale.
• AMD, Apple, Cadence, Google, Intel, MediaTek, Nvidia, Samsung, Synopsys and TSMC have indicated an intention to subscribe for a total of $735m of the ADRs (15m shares).
• Notably absent is Qualcomm where Qualcomm is embroiled in litigation with Arm making an investment impractical at this stage.
• All of the shares being offered are already held by SoftBank meaning that Arm is raising no capital in this IPO with all of the proceeds going to SoftBank.
• There are currently 1.029bn shares in issue meaning that at the mid-point of the range, the market capitalisation of Arm will be $50.4bn and the enterprise value will be $48.4bn.
• That puts Arm on a March 2023 historic PER of 96.2x and a March 2023 historic EV / Sales of 18.8x.
• This is a pretty bad time to do a highly-rated IPO of a company where the majority of its revenues are coming from the smartphone market.
• This is because at these multiples, investors are going to want to see rapid growth in earnings which is going to be very difficult to achieve through no fault of Arm’s.
• The problem is the smartphone market where inflation, high interest rates and the resulting pressure on the cost of living have led consumers to hang onto their existing phones for longer before making an upgrade.
• This combined with the inventory correction that is being seen by many of its customers, means that they will ship fewer chips leading to lower royalties for Arm.
• Arm has done a pretty good job of offsetting this weakness by signing licences for its latest processor designs, but it is unlikely to be enough to stop revenues this fiscal year from declining YoY.
• For example, in calendar Q2 2023, revenues declined by 2.5% YoY and net income declined by 53%.
• There are plenty of arguments as to why this will recover in the long term as there are plenty of adjacent device categories that Arm is well suited to address, but the market is fickle and especially when it comes to highly valued technology companies.
• This is why I suspect that the big story on the roadshow is going to be AI because at the moment if the market thinks that a company is enabling the generative AI revolution then valuation ceases to matter.
• As it stands today, it is difficult to make the case that Arm is an AI company in the same way that Nvidia is an AI company.
• There is certainly a long-term case to be made as Arm is in an excellent position to capitalise on the opportunity of running AI models on smartphones and other devices.
• The fact that Nvidia is using Arm IP in some of its AI training products for the cloud is also a plus, but these opportunities are not meaningfully impacting revenues now like they are at Nvidia.
• Arm does not scream AI-company and as such, everything will depend on the roadshow that Arm and SoftBank are conducting with investors to convince them that an “AI-like” valuation is warranted.
• If this strategy works, then I expect that this IPO will get away quite easily which will be helped by the fact that most of the street is included in the deal and will not be asking too many hard questions.
• Given the pre-marketing that has almost certainly been carried out, I suspect that SoftBank will be able to get this away at the current price of $49 per share, but everything will depend on what it does on the first few days of trading.
• This will be the first time that the market will be able to vote on whether Arm is an AI company or a semiconductor IP company.
• Failure will mean a more modest valuation which I think will be better for the long-term outlook for Arm regardless of what numbers SoftBank wants to record on its balance sheet.