Is Arm’s IPO a Guaranteed Success? Perhaps Not

Arm’s relisting seven years after leaving the London Stock Exchange (LSE) will be a big deal for the bourse, as well as for the semiconductor theme. However, the British chip designer is facing its share of challenges.

• Arm set to issue an IPO valued at $64m, which would make it the biggest tech offering since Alibaba in 2014.
• Arm China, a separate entity, is the British chip designer’s biggest customer, accounting for 24% of total revenue in fiscal year ending 31 March.
• The VanEck Semiconductor UCITS ETF is up 45.2% year to date. 

British chip designer Arm has filed for a listing on the Nasdaq, some five months after it submitted the preliminary IPO paperwork. 

Arm is without doubt the most high-profile listing of the year. The chip designer’s $64bn valuation makes its public offering the biggest on the Nasdaq since electric truck maker Rivian’s [RIVN] $13.7bn IPO in October 2021. It might also turn out to be the biggest tech IPO since Alibaba’s [BABA] $25bn listing back in 2014, according to Bloomberg. 

Although Arm’s IPO has long been anticipated, investor interest in the listing has been heightened by the generative artificial intelligence (AI) frenzy. Indeed, Nvidia [NVDA], whose share price has been fuelled by rising demand for the powerful chips required for AI applications, was in talks to acquire Arm for a reported $66bn last year, while in July the Financial Times reported that Arm was working to attract Nvidia as an anchor investor. 

This did not come as a surprise to Ben Barringer, Equity Research Analyst at Quilter Cheviot. “[H]aving [Arm] controlled by one industry player was never going to work and thus having anchor investors helps to alleviate that problem. It is unlikely one company will be a dominant anchor investor,” commented Barringer in July.

Whether or not Nvidia comes on board, Softbank [9984.T], Arm’s controlling shareholder, “is playing the tech field and trying to get all the big players on board to drive up the price and achieve the greatest value possible”, added Barringer. 

But even if big players do invest, there are no guarantees that Arm’s IPO will be a runaway success. 

China Links Present Risks 

Arm licences chip designs, meaning that any company making electronics can buy its technology. “Arm is the ‘Switzerland’ of processing IP [intellectual property],” as Barringer put it.

The company’s ubiquity means that it is a vital player in the semiconductor space. According to Bernstein research shared by independent tech investor Eric Jhonsa on X, approximately 10% of servers around the world contain Arm processors, 40% of which are located in China.

Although China’s share of the Arm server shipment market has fallen since mid-2022, it remains elevated. This is understandable, as most servers contain x86 chips, which are dominated by two major US players: AMD [AMD] and Intel [INTC]. As the trade war between Beijing and Washington intensifies, Chinese companies are finding it increasingly difficult to procure US-made chips. 

The business in China is “an entity that operates independently of us and is our single largest customer”, according to the IPO prospectus. “We depend on our commercial relationship with Arm China to access the [People’s Republic of China, PRC] market. If that commercial relationship no longer existed or deteriorates, our ability to compete in the PRC market could be materially and adversely affected,” Arm stated. 

The China business may not be controlled directly by the wider company, but such “shaky ties” could present a risk to the bottom line in the future, according to Bloomberg Intelligence analysts Marvin Lo and Chris Muckensturm.  

Focusing on AI to Overcome the China Challenge

If Arm is to have a successful IPO, it will likely need to concentrate on AI, Mike Orme, Consultant Analyst of Thematic Intelligence at GlobalData, argued following the news of the offering. This will require Softbank to convince investors that Arm is an AI company. 

“[F]ocusing solely on AI will override the problems of the marked slowdown in the smartphone market, mounting problems with Arm’s Chinese operation, and the growing mid-term threat from the RISC-V open-source, licence-free ecosystem,” wrote Orme. 

In the long term, the company may have to lower its exposure to China and reduce its dependency on the country for business. As a customer, Arm China accounted for a staggering 24% of Arm’s total revenue in the fiscal year (FY) that ended 31 March 2023, up from 18% the previous year. The company’s top-five clients were responsible for 57% of revenue in FY 2022/23, compared with 56% the previous FY. 

Arm also warned in its IPO prospectus that if it were to lose one or more of its key customers “there are no assurances that we would be successful in identifying and contracting with one or more customers to replace any lost revenue”. 

Diversifying Revenue Could Be Tricky 

The chip designer is returning to the public market, having delisted from the LSE in 2016, but is doing so at a time when the smartphone market is on a downward trend. Qualcomm [QCOM], one of Arm’s customers, estimated that sales of chips for smartphone handsets in 2023 will be “down at least a high single-digit percentage” against 2022.

Retaining existing customers — let alone adding new ones — could prove to be tricky. If companies such as Apple [AAPL], another major Arm customer, switch to the new open source, licence-free RISC-V architecture later this decade, the chip designer could lose market share. 

“That is because chip designers say that apart from being free, the RISC-V instruction set offers more design flexibility than Arm,” concluded Orme. 

How to Invest in Semiconductors 

ETFs, or exchange-traded funds, offer an economical and diversified way to
invest in a variety of stocks within a particular theme.

Funds in Focus: the Invesco PHLX Semiconductor ETF

A few key thematic funds could hold Arm in the future. 

The Columbia Seligman Semiconductor & Technology ETF [SEMI] is weighted heavily in favour of the information technology (IT) sector (96.2%), as of 31 July, with industrials (2%) and communication services (1.8%) making up the rest. The fund is up 13% in the past year through 24 August and up 11.7% in the past six months. 

The Invesco PHLX Semiconductor ETF [SOXQ] had allocated 79.7% to the semiconductor sector and 20.3% to production technology equipment, as of 30 June. The fund is up 22.6% in the past year and up 19.5% in the past six months. 

The VanEck Semiconductor UCITS ETF [SMH] is a pure play on the IT sector. The fund is up 45.2% in the past year and up 25.6% in the past six months.