Giant UK microchips designer ARM has filed its highly anticipated Wall Street IPO (initial public offering) prospectus, firing the gun on a long mooted and highly anticipated return to equity markets for the Cambridge-based company that has been owned by Japan’s Softbank (9984:TYO) since 2016.

ARM by numbers

Founded: 1990

Headquarters: Cambridge, UK

Number of employees: 6,000 approx.

Revenue March 2023 financial year: $2.68 billion

Stock market: Nasdaq

Potential valuation: $60 billion to $70 billion

Source: Reuters, Shares

Once described as ‘the jewel in the crown of British technology’, when ARM was last listed (in London) it built a massive and loyal fanbase among investors thanks to years of above-average returns.

As Shares wrote at the time of the company’s $32 billion takeover by Softbank in 2016, ‘investors who put money into this fantastic British technology success story at any time during its 26-year run on the UK stock market have made money, potentially lots of it’.

For example, £1,000 invested a year before the bid went through would have been worth £1,820, based on the £17.00 per share take-out price. The same sum put in three years before would have grown into a £1,905 nest egg, while investors that took Shares’ hint on the stock back in August 2011 at 490p would have seen their £1,000 turn into a £3,468 lump sum by the time of the takeover.

And even that pales by comparison to the 14-fold-plus returns over 10 years up until the takeover, which would have turned your £1,000 into a staggering £15,179 cash pile, clearly illustrating the enormous value creation potential of some technology investments if you’re willing to play the long game.

WHEN & WHERE WILL ARM LIST ITS SHARES THIS TIME?

The IPO will likely happen sometime in September although the exact date will depend on market conditions and how much time the company needs to complete its investor roadshow, where it sells its investment story to potential backers.

Despite an intense lobbying campaign by the UK Government, Softbank snubbed the London Stock Exchange in favour of Wall Street’s Nasdaq, where the Japanese firm clearly believes it will attract a higher valuation.

This was a slap in the face for the London market’s ambitions to attract more high quality, high growth technology listings, but it is hard to argue with Softbank’s logic. US tech valuations are among the highest in the world and the country has a vast investor base of tech specialists that the UK simply cannot match.

Nasdaq is also home to the largest tech firms in the world – Apple (AAPL:NASDAQ), Alphabet (GOOG:NASDAQ), Microsoft (MSFT:NASDAQ), and chips star Nvidia (NVDA:NASDAQ) are all listed on Nasdaq, so ARM will be in great company.

WHAT DOES ARM DO?

ARM does not make microchips but instead designs the architecture on which chipmakers create their semiconductor designs. Building a new house might be a decent analogy. While fabless (meaning they don’t directly manufacture) chip designers like Nvidia, for example, might decide where to put interior partition walls, doors and furniture, ARM designs where load-baring walls, windows, plumbing and gas/electricity supply go, so to speak.

The chip manufacturers – TSMC (2330:TPE), Samsung (005930:KRX), Intel (INTC:NASDAQ) – provide the bricklayers, carpenters, plumbers, etc to build the property.

ARM operates a licence and royalties model. It sells the right to use its chip designs to customers for a fixed term, then takes a small cut of every chip produced by the customer using that design.

HOW MUCH WILL ARM BE WORTH?

It’s too early to say and estimating pre-flotation valuations for any company ahead of an IPO is always tricky, but ARM is a unique business which should see the shares attract a rarity premium, especially given the frenzy for AI technology stocks this year, an area where ARM sees plenty of opportunity.

Bloomberg has previously reported that Softbank is aiming for a valuation in the $60 billion and $70 billion ballpark, which would imply a rough price to sales multiple between 22 and 26-times.

SoftBank recently bought the 24.99% stake in ARM that it didn’t own outright from its own Vision Fund, and this reportedly implied a valuation of more than $64 billion for the whole business. This would tally with the Bloomberg reports yet as an inter-Softbank deal, it’s difficult to say how good a marker that transaction will be.

WHAT ARE THE BIG OPPORTUNITIES FOR ARM?

ARM has become world leader in the design of low power chips, perfect for mobile devices that rely on battery power. It has virtually cornered the global mobile devices market but there’s plenty more growth from new vertical markets. It has been deepening its technological edge in both automotive and super-connectivity Internet-of-Things for years, while data centres represent another opportunity.

The company also sees a significant role for itself in the AI space and has been increasingly touting itself as an AI company. In May, ARM unveiled two new chipsets targeted at machine learning applications. One, a new CPU (central processing unit) called Cortex-4, is a chipset that delivers faster machine learning performance and consumes 40% less power than its predecessor, according to ARM.

The other, a GPU (graphics processing unit) called G720, offers better performance and uses up 22% less memory bandwidth than its predecessor, ARM claims.

WHAT ARE THE RISKS WITH INVESTING IN ARM?

Scattered throughout the hundreds of pages of ARM’s IPO prospectus are details of the company’s labyrinthine relationship with China, its second-largest market. Sales in China contributed 24.5% of its $2.68 billion revenue in fiscal 2023, and nearly all of that comes from ARM China, an independent entity that has the exclusive rights to distribute ARM’s technology in the country.

A group of Chinese investors and a private equity firm control a majority stake in ARM China (51%), with ARM a minority shareholder (4.8%). Tensions between Washington and Beijing mean sanctions are an obvious risk, while ARM China has been dogged by lawsuits in the past and has a history of overdue payments to ARM, so these are things to be aware of.

There are also questions about ARM’s opportunity in emerging tech like AI and machine learning. The vast data calculations require enormous processing power and this will mostly happen in data centres that are plunged directly into the mains, not an area where ARM has dominance. Lowering data centre energy needs seems to be where ARM’s immediate opportunity lies, but there can be no guarantee of success.

The global semiconductors industry is typically cyclical, so bouts of chip de-stocking tend to slow royalty income and put pressure on earnings. This is nothing new, ARM has been dealing with these challenges for years so investors should have reasonable confidence it will continue to manage these threats in the future, and keeping a strong pipeline of licence wins should help to offset this.

WHO IS LIKELY TO BACK THE IPO?

ARM has engaged in discussions with some of its major customers about supporting the IPO, and we would expect a good handful to participate as strategic investors. ARM will also join the Nasdaq Composite, so tracker funds and ETFs will buy stakes in ARM, although probably after the flotation.

ARM may also join the Nasdaq 100 index, based on even the lowest valuation estimates. Based on current data, about 10 of the index’s constituents would be smaller than ARM.

We would also expect many technology and growth company funds to back the IPO, perhaps Scottish Mortgage (SMT), the Polar Capital Global Technology Fund (B42W4J8) or even Fundsmith Equity (B41YBW7), given the company’s earnings and cash flow quality in the past. Only time will tell.

HOW CAN INVESTORS IN THE UK BUY ARM SHARES?

As is typically the case with IPOs in the US, there is no retail investor offer so ordinary investors will have to bide their time until after the listing has happened. But buying on the open stock market should be easy across most investment platforms.

The shares may not initially be available on some platforms, often there is a delay of several days before ordinary investors can trade new IPOs. But this could work to your advantage since we have seen many new IPOs soar in the first few days post-float, only to drift back to lower levels thereafter as initial excitement dissipates.

Shares will keep a close eye on ARM and will aim to provide a more thorough analysis of the investment case when more data is available.

DISCLAIMER: The author of this article owns shares in Scottish Mortgage and Fundsmith Equity.

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