Arm's valuation is likely to be lowered on the eve of its IPO. Can Masayoshi Son's bold gamble succeed?

Arm, a chip design company that has always been highly regarded by SoftBank and even considered a matter of life and death by Masayoshi Son, began its roadshow this week.

Although Arm's position in the chip industry is unshakable, the current reality has prompted the market to reassess the company's value and prospects, lowering expectations for valuation and IPO amount.

On Monday, September 4th, some media reported that Arm is currently seeking to raise $5 billion to $7 billion through an IPO, lower than the previously sought $10 billion. The company's valuation may ultimately be between $50 billion and $60 billion, rather than the previous target range of $60 billion to $70 billion.

Other media believe that Arm's target valuation is between $50 billion and $55 billion, and some analysts believe that Arm's valuation is between $45 billion and $50 billion.

Why has Arm's valuation decreased?

However, the success of Arm's IPO to a large extent depends on broader and more complex factors, including the slowdown in the growth of the smartphone market and the potential profit growth brought about by the increasing popularity of artificial intelligence.

Analysts believe that one reason for the decrease in valuation is that Arm has already dominated its main smartphone business and has little room for further growth. They believe that SoftBank has invested more funds in research and development, and it may take several years to recover these expenses.

Even the artificial intelligence boom that began at the end of last year is unlikely to translate into revenue and profit for Arm. The market believes that the prosperity of artificial intelligence may increase the demand for server chips, rather than the demand for smartphone and PC chips, which are Arm's main products. Nevertheless, Arm positions itself as a potential beneficiary of artificial intelligence, stating that the growth of artificial intelligence systems such as autonomous driving cars may mean an increase in demand for chips designed by Arm. The IPO prospectus states, "Arm will be the core company driving the transformation brought about by artificial intelligence."

In addition, a British investment firm stated that the valuation level circulating in the market is "slightly more acceptable compared to the initially stated $80 billion valuation level." The institution believes that although Arm "has achieved diversified risk management and still has a very high-quality business model," there are still risks in its global layout.

Furthermore, some analysts believe that the data disclosed in Arm's prospectus is not supportive of the valuation because the prospectus shows that its revenue is declining.

For the fiscal years 2021, 2022, and 2023, Arm's annual revenue is $2.027 billion, $2.703 billion, and $2.679 billion, respectively. Net profit is $388 million, $549 million, and $524 million, respectively. R&D expenses account for 40%, 37%, and 42% of the annual revenue for the corresponding periods. Gross margin as a percentage of total revenue is 93%, 95%, and 96%, respectively. In addition, in the latest fiscal quarter ending on June 30th, Arm's quarterly revenue decreased by 2.5% YoY to $675 million, and net profit decreased from $225 million in the previous fiscal year to $105 million, a decrease of more than half YoY.

Last Friday, SoftBank arranged for Apple, Nvidia, and Intel to be strategic investors in Arm's US IPO, and the shareholders also include Samsung, AMD, and Google. Many investors may subscribe to up to $100 million worth of Arm stocks. It is worth mentioning that both Apple and Nvidia are major clients of Arm.

Will Masayoshi Son's bold gamble succeed?

When Masayoshi Son's SoftBank Group completed the acquisition of chip company Arm in 2016, he was very excited. He stated that after decades of technology investment, this $32 billion acquisition was "largely a deal that was destined for me. I can almost confidently say that its revenue will increase fivefold within five years."

However, the reality is different.

Arm is still the leading designer of smartphone, computer, and automotive chip components, but this largest-ever deal in SoftBank's history has fallen far short of its goals.

Since 2016, Arm's revenue has grown by 65%, slightly higher than the overall chip industry but far behind the industry leaders. Arm's research and development expenses have increased significantly, but they have not translated into the higher profits envisioned by Masayoshi Son. Arm's bet on the Internet of Things has also failed.

Unlike many startups invested by SoftBank's Vision Fund, Arm is a mature company with substantial profits, exceeding $500 million annually, and it holds over 90% of the market share in the field of mobile chip processor design.

After Masayoshi Son invested in Arm, he ordered a significant increase in recruitment and invested more resources in research and development. Masayoshi Son's bet was that global chip demand would grow rapidly, and Arm would seize this opportunity. However, it now appears that there is no evidence to suggest that Arm has seized the opportunity due to the rapid market changes in recent years.

Some analysts believe that if Arm's IPO performs weaker than expected, it may even affect SoftBank's credit prospects.

Analysts say that raising $5 billion to $7 billion through the IPO may not be enough to offset the impact of SoftBank's Vision Fund's acquisition of a 25% stake in Arm in August, when SoftBank valued Arm slightly higher than $64 billion. Arm's IPO may weaken SoftBank's adjusted loan-to-value ratio from 21% in June to about 24%, and its leverage ratio may remain weak. Arm's listing at a lower valuation may also raise doubts in the market about SoftBank and the Vision Fund's valuation of Arm at $64 billion.

The "backers" of the Vision Fund are mainly Middle Eastern investors, including the Saudi Arabian Public Investment Fund and Abu Dhabi's investment arm, Mubadala Investment Company. SoftBank has only invested about $28 billion out of the $100 billion Vision Fund. Therefore, SoftBank's purchase of Arm shares from the Vision Fund is actually buying back shares from Middle Eastern investors.