Arm is more expensive than NVIDIA! What's the reason?

Arm, which set a record for the largest IPO this year, has a valuation higher than that of Nvidia.

On Thursday, Arm successfully went public in the US, surging 25% on its first day, with intraday gains reaching 30%. After closing, its diluted valuation approached $68 billion, making it the largest IPO project this year.

It is worth noting that Arm's profit in the past year was only around $400 million, which means that the chip company's price-to-earnings ratio is close to 170 times, surpassing Nvidia's P/E ratio of 110 times.

According to IPO documents, Arm's fiscal year sales as of March 31 were less than $3 billion, a decrease of about 1%. Quarterly sales as of June 30 decreased by 2.5% to $675 million, which is only one-twentieth of Nvidia's second-quarter revenue. Net profit also decreased by over 50% compared to the same period last year, dropping to $105 million.

Meanwhile, Nvidia has been the undisputed star company in the US stock market this year.

Backed by cloud computing companies' heavy bets on AI chips, Nvidia's revenue has more than doubled in the latest quarter, and its guidance for the next quarter shows a YoY growth of 170%. Its stock price has risen by 218% this year.

Doubts about Arm have always existed. Jay Ritter, a finance professor at the University of Florida and an expert in IPO research, said:

A P/E ratio over 100 is unreasonable for a company without growth.

The story must be "the company will develop new designs, restart growth, and generate profits."

So far, most of Arm's revenue comes from royalties, and it does not provide hardware. This has also brought Arm a gross margin as high as 96%. In comparison, Nvidia's gross margin in the latest quarter was 70%, while a year ago, it was less than 44%. Intel and AMD have gross margins of 36% and 46%, respectively.

However, although royalties can provide a continuous stream of income for Arm, most of its architecture products are microcontrollers (MCUs), which are relatively cheap. On the other hand, Arm takes a cut from chip prices rather than charging fees for end products, so the revenue it generates is not high, and Arm cannot make "big money."

R. Scott Raynovich, the founder of independent cloud technology analysis company Futuriom, said:

Considering Arm's financial data shows it is a mature company with weak growth, giving Arm a valuation four times the industry average seems strange. According to data from New York University, the average price-to-sales ratio of the semiconductor industry stocks is 5 times.

Limited Circulating Shares

So why can Arm's valuation still exceed that of Nvidia?

One important reason is that Arm has a limited number of tradable circulating shares.

Arm has a total of 1.03 billion circulating shares, of which SoftBank holds 90%. The $4.9 billion public offering also attracted a group of strategic investors including Apple, Google, Nvidia, Samsung, and Intel.

Under the pressure from SoftBank and the tech giants, the trading volume available to other institutional investors, retail investors, and traders is even less.

When the number of tradable shares decreases, the possibility of significant fluctuations in the company's stock price increases. Previously, VinFast, known as the "Vietnamese Tesla," experienced roller-coaster-like fluctuations in its stock price because its controlling shareholder, Pham Nhat Vuong, held 99% of the shares, with only 1% being circulating shares.

However, Arm has not reached the extreme level of VinFast. On Thursday, the trading volume reached 127 million shares, making it the fifth most active stock on Nasdaq that day.

Goldman Sachs' "Battle for Prestige"

In addition to Arm itself, the IPO is also backed by the assistance of Wall Street investment banks.

Earlier, Wall Street Journal reported that Goldman Sachs, the lead underwriter for Arm, attaches great importance to this IPO. If this year's largest global IPO is successful, it may revive the sluggish IPO market and bring more business to Goldman Sachs and its peers.

On the contrary, any mishap will continue to cast a chill on the IPO market and may become another stain on the reputation of Goldman Sachs CEO David Solomon, who is already facing challenges.

As one of the six largest banks in the United States heavily reliant on investment banking, Goldman Sachs suffered the most severe decline in revenue among the six banks during the downturn of the U.S. IPO market last year. In addition, Solomon also needs to deal with internal divisions within Goldman Sachs, facing challenges both internally and externally.

Although these setbacks have not affected Goldman Sachs' position in the IPO rankings, it urgently needs a victory to quell external doubts.

Mike Mayo, an analyst at Wells Fargo, said in an interview with the media:

This is the core of the core of Goldman Sachs' business. Expectations are high, and they are likely to meet those expectations. If they don't, there will be more problems than we have seen so far.

Speaking at a Barclays conference this week about Arm and other ongoing IPOs, Solomon said:

"It's been a while since I've said to you that we have some very important IPOs in our market. This is progress, and I'm confident that if these IPOs go well (and they are going well at the moment), it will create a virtuous cycle that will push more backlogged IPOs into the market.