ARM Holdings PLC (ARM, Financial) was founded in 1990 as a joint venture between Acorn, VLSI and Apple Computer. The company initially went public in 1998 and stayed on the stock exchange up until 2016, when SoftBank (TSE:9984, Financial) acquired the business. Recently, the company has gone public again after a takeover by Nvidia (NVDA, Financial) was blocked by antitrust regulators. This is the biggest initial public offering of 2023 so far as there is a huge amount of excitement behind its semiconductor chips, which are used by both Apple (AAPL, Financial) and Samsung (XKRX:005930, Financial).
As such, I am going to take a closer look at the company's business model, financials and valuation. Let’s dive in.
Understanding ARM's dominant business model
ARM Holdings is the world’s leading supplier of power-efficient CPUs, which are used in 99% of the world's smartphones, according to its S1 filing.
In the filing, ARM announced a long-term chip deal with Apple that extends up until 2040 and possibly beyond. Apple is known for creating its own chips, but they were built on ARM's architecture. Therefore, it is not just the iPhone that is using ARM, but also the iPad, Mac and likely any future products, such as virtual reality headsets, that are on the product roadmap.
The other major smartphone provider, Samsung, also uses ARM for its Exynos processors. However, the company is developing its own Galaxy chip for 2025, so it may not be using ARM's services.
Applications of ARM processors
Other applications of ARM processors is in internet of things devices, which require the power efficiency. In addition, wearable devices (like the Apple Watch), Smart Home devices and the automotive sector also use ARM's chips.
Even Amazon Web Services' custom Graviton chip and the Fugaku supercomputer in Japan, which was ranked the world’s fastest in 2020, are based upon an ARM processor.
Intel as an investor
Intel (INTC, Financial) may have been considered as competition for ARM, but the company invested into it as an “anchor investor” pre-IPO.
According to Stuart Pann, senior vice president of Intel Foundry, “investing in ARM Holdings PLC (ARM, Financial), doing partnerships with ARM, should give you a signpost that we're absolutely serious about playing in this business because if you're not working with ARM, you can't be a foundries provider.”
He also mentioned that 80% of Taiwan Semiconductor Manufacturing's (TSM, Financial) wafers produced have an ARM processor in them.
Other reported Anchor investors include Apple and Google parent Alphabet (GOOG, Financial), though full details have not been disclosed.
Financial performance
ARM reported mixed financial results for the fiscal year ending in March 2023. Its revenue was $2.67 billion, which is close to flat relative to the $2.7 billion reported in the prior year, according to its S1 Filing.
In the June quarter, the business reported $675 million, down from $692 million reported in the prior year. This was expected, however, given the semiconductor industry is currently going through a cyclical pullback.
Profitability and balance sheet
ARM Holdings has a super gross margin of 96%, with $2.5 billion reported in fiscal 2023.
Its operating margin is a solid 25%, with $671 million reported in 2023. This is up from $633 million in the prior year and massively higher than the $233 million reported in 2021. This is despite the business having 5,963 employees, 80% of whom are focused on research, design and innovation.
The company has a solid balance sheet with $2.2 billion in cash and short-term investments, up from $1.6 billion a year ago.
What's ARM worth?
Valuing ARM is challenging, but I do know the business has a price-sales ratio of 23.
In comparison, Advanced Micro Devices (AMD, Financial) trades at a substantially cheaper price-sales ratio of 7, while Intel has a sales multiple of 3. However, Nvidia trades at a higher price-sales ratio of 33 and a forward price-sales ratio of 20.
IPOs are usually priced slightly lower than fair value to drive initial excitement. In ARM Holdings' case, the company originally planned to go public at $52 billion, or between $47 to $51 per share. Its market capitalization has increased to close to $60 billion at the time of writing, or $60 per share, and thus may be slightly overvalued at the time of writing.
Final thoughts
ARM is a tremendous company that is truly dominant in the world of power-efficient CPUs. I believe its long-term deal with Apple is a competitive advantage and guarantees solid cash flow for nearly two decades. The strategic investments by partners such as Intel also give the business a major advantage and that should help to suppress any competition. Its valuation is a little spicy right now due to the IPO excitement, so prudent investors may wish to wait for a pullback.
