Foreign on Thursday September 13th the British Semiconductor Company Arm ipo'd at 51 per share. At the time of recording this video, the prices increased to 65, giving the company a 65 billion valuation. This has also made it the biggest IPO this year by far. In the most recent fiscal year, they generated 2.7 billion dollars of Revenue representing a one percent decrease from the prior year.

They also generated 524 million dollars of net income, a 22 decrease from the prior year. Despite their revenue and profits decreasing, they have a trailing Revenue multiple of 24 times and a price to earnings ratio of 124 times. To put this in perspective, Nvidia's trailing pressure earnings multiple is 107 times, meaning that Arm is more expensive on this metric. While Nvidia might be overvalued, there's no doubt that it's one of the biggest beneficiaries of AI.

In the most recent quarter, its Revenue doubled in its net income increase nine-fold Arm was able to achieve its incredibly Rich valuation by convincing investors that it's an AI company. But how can this possibly be the case when their revenue declined in the last fiscal year? Despite the AI Computing boom in this video, we'll take a deep dive into Arm and see if it has any chance of living up to the hype before we get into the Arm. IPO A quick word from today's video sponsorship station: The holiday season is approaching, which can be the best time of the year, but also the most hectic time of the year for e-commerce businesses. but with the right tools you can sail through without breaking a sweat.

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Instead, they develop designs called architectures which are like blueprints to produce central processing units or CPUs chip makers like Qualcomm Pay Arm for the right to use their architecture and Arm receives a royalty on each chip sold. One of the key differentiators of Arms proprietary architecture is its power efficiency. This has made it popular for smartphones and laptops where battery life is an issue. It is currently estimated that over 90 percent of all smartphones sold today contain CPUs.

Based on Arms architecture, Arm is not a new company by any means. It was founded in 1990, enlisted its shares on the London Stock Exchange in 1998. AS Global Smartphone adoption increased throughout the 2000s and early 2010s. Arm was a major beneficiary and its stock was a multi-bagger In 2016, it caught the attention of the Japanese technology conglomerate SoftBank which acquired the company for 24 billion pounds, which at the time was equivalent to 31 billion USD dollars.

This represented a 43 premium over the share price at the time. In the interest of Simplicity, we'll convert all currencies to US dollars at contemporaneous exchange rates for the rest of this video. Prior to the SoftBank acquisition, arms Market cap was 22 billion dollars. That represented a revenue multiple of about 17 times and a price to earnings multiple of about 43 times.

This is by no means cheap, but given the strong growth in the smartphone market at the time, it was at least within the realm of rationality. SoftBank is not exactly known for being sensitive to valuation and they paid a massive premium to take the company private. The acquisition price represented much higher multiples at 25 times Revenue in 62 times earnings in 2023, Arm has a 65 billion dollar market cap which represents 24 times its Revenue in the most recent fiscal year, in 124 times its profits, while Revenue has more than doubled between then and now, profit margins have shrunk substantially and net income is about the same as it was in 2016. Now, not only that, but when SoftBank acquired Arm in 2016, its Revenue was growing and the most recent fiscal year Revenue declined by 0.9 percent as Global smartphone shipments have declined.

arms. Revenue Growth is very volatile because they receive royalties for every smartphone or laptop that has sold Global Smartphone and laptop shipments are cyclical depending on macroeconomic conditions as well as upgrade. Cycles There was a massive surge in Revenue in fiscal year 2022, which is the 12 months ended March 30th 2022. This was likely due to laptop shipments surging during the covet pandemic.

While the majority of arms Revenue comes from smartphones, they also have a sizable market share for laptop CPUs as they offer Superior battery life Revenue declines slightly in fiscal 2023 as PC sales decreased. The more important segment for Arm is smartphones. Global Smartphone shipments peaked in 2016 and have been gradually declining ever since. It's a saturated Market Because most people already own a smartphone and replacement Cycles can be multiple years.

There is still some growth because newer smartphone models can have more CPU cores than older models, and Arm makes a royalty on each core. But this growth is limited. In recent years, they've attempted to expand beyond the cyclical smartphone and laptop verticals by creating architecture for Data center. CPUs These have had some success as they allow data centers to operate with less electricity consumption, but Data Center only makes up a small percentage of arms total revenue.

In his meetings with prospective investors leading up to the IPO arms, CEO emphasized that Arm-based CPUs are essential for artificial intelligence and in fact Nvidia is one of their customers. Yeah, so one of one of the benefits of the Roadshow is spending a lot of time with investors talking about Ai and where we fit. and I Think one of the misconceptions is that a GPU can run without a CPU Which is just not the case. The CPU is Central to every electronics device and there are devices that ship with a CPU and a GPU.

So once investors kind of got that, then explaining where the puck was going relative to Gosh, Nvidia's next gen Advanced product Grace Hopper is using Arm CPUs instead of the competition, the light bulb went on that Oh my Gosh, you need the CPU and at the same time, Nvidia has made a big bet on Arm in their most sophisticated product. And once that message kind of sunk through people, the light bulb went on as Oh My Gosh, I Get it by positioning themselves as an AI enabler, Arm was able to secure a premium valuation far greater than they had back in 2016.. foreign cloud computing companies including Microsoft Alphabet and Google are spending billions of dollars to buy Nvidia Gpus to run AI workloads. This explains the meteoric revenue growth that Nvidia has seen in the recent quarters.

Gpus are good at applying the same computations and many data elements simultaneously, which makes them highly efficient at crunching the massive amount of data fed into large language AI models. but you also need a CPU to manage the process and give instructions to Gpus. Thus, CPUs are necessary for running AI workloads. In addition to selling Gpus, Nvidia also sells data processing units or Dpus.

These dpus include a CPU a GPU and a network that allows them to communicate with each other quickly and efficiently. The CPUs inside of Nvidia's Dpus are based on arms architecture, and thus Nvidia pays royalty fees to Arm. According to Nvidia's website, the CPUs are industry standard. They aren't really anything special.

Nvidia is making so much money from the AI boom due to the high performance of their Gpus. The CPUs are key enabler, but they're not the key differentiator. Thus, Nvidia takes most of the profits and Arm gets relatively little. Arm does not disclose its Revenue by vertical, but their work with Nvidia likely makes up only a tiny percentage.

In the second calendar quarter of 2023, arms Revenue declined by 2.5 percent compared to the prior year. In the same quarter, Nvidia's Revenue more than doubled. Thus, any benefit that Arm is receiving from the AI boom is minuscule. The vast majority of arms Revenue likely still comes from smartphones and other consumer electronics, not data centers Besides AI.

Arm also says that they plan to grow the business by increasing the value of their architecture, which will allow them to charge higher royalty rates. but this is easier said than done. Arm has historically not disclosed how many Arm-based ships have been sold each year, but in 2018, they disclose that their customers ship 22.9 billion chips in aggregate. This does not mean that 22.9 billion devices have been shipped because one device can have many CPU cores they did not provide for prior years, but we were able to estimate the number of chips each year by counting the number of pixels on each bar.

With this, we can estimate the number of Arm-based chips shipped per year. The only Year we're missing is fiscal 2020. By comparing this with their reported Revenue, we can calculate their revenue per chip. This metric has stayed roughly flat at 9 cents per chip since 2015..

the narrative that they're increasing the value of their architecture is difficult to believe, seeing as they've historically been unable to raise prices. At first, it seems odd that RMS fail to increase its prices. With over 90 percent of smartphone Cpu's licensing arms architecture, the company is a near Monopoly. Shouldn't this give them significant pricing power? The situation is a bit more complicated according to Arm's own IPO perspectives.

They warn that they face intense competition and could lose market share. Specifically, many of their customers are also major supporters of the Risk 5 architecture. If Risk 5 related technology continues to be developed and Mark your support for Risk 5 increases, their customers may choose to utilize this free open source architecture instead of Arms products. In 2011, researchers at the University of California at Berkeley invented the Risk 5 architecture.

They published the technical documentation online and anyone is allowed to use it for free. Some Engineers believe that Risk 5 may be better than Arm in certain respects, but it has thus far seen limited adoption because most existing applications are designed to run on the ubiquitous Arm architecture. With that being said, large armed customers including new Google are actively developing Risk 5 compatible Technologies with the goal of reducing their Reliance on Arm. Thus, Arm has to be very careful with its pricing if it price gouges its customers.

This will motivate them to accelerate their adoption of Risk 5. Us-based companies like Google aren't the only ones trying to reduce their Reliance on Arm. Chinese Hyperscalers, including Alibaba and Tencent are also investing heavily in Risk 5. Chinese Investment in Risk 5 is driven just as much by Politics as economics, and this may be where the biggest risk lies.

Foreign 's most important markets, representing almost a quarter of their revenue. If you've been paying any attention to U.S China Relations Over the past year, things haven't been going particularly well, especially in the technology sector. Arm is headquartered in the Uk, but it also has significant operations in the U.S This means that they are subject to both the U.S and UK export restrictions. In 2022, both the U.S and UK announced export restrictions against China Banning certain high-end chips which could have military applications.

This only affected a small percentage of Arms chips, so the immediate Revenue impact has been limited. The bigger problem is China's reaction with the supply of western-made chips. Unreliable. China is investing tens of billions of dollars to develop their own semiconductor industry and they plan to reach 70 self-sufficiency by 2025.

One of the lowest hanging fruit is to replace Arm because risk 5 is freely available and cannot be subject to export controls. Chinese Companies including Huawei are already investing heavily in Risk 5 and will like we continue to do so. Arm also has another big China problem. A few years ago, the CEO of Arms Chinese subsidiary went rogue and effectively took control of the company.

We made a video about this previously Linked In The description below. Long story short, they came to an arrangement where the Chinese subsidiary will operate as an independent company and license Arm architecture to chip makers within. China. In return, they pay royalties to Arm.

Holdings These royalty fees from Armed China represented 24 percent of Arms total revenue in the most recent fiscal year. Armed China reports how many Arm-based ships were sold in China each quarter and pays Arm Holdings a royalty based on this. but Arm Holdings has little means of independently verifying these numbers. Arm Holdings admits that they have had issues obtaining timely and accurate information from Arm China.

They've also received late payments from Armchina and have had to expand company resources to obtain payments from Armchina. This doesn't exactly Inspire Confidence What's more concerning is that their non-china revenue is shrinking and the fiscal year ended March 30th, 20 23 Their total revenue decreased by one percent. Their China Revenue grew by 38. Their non-china revenue decreased by nine percent.

China is their main growth engine given the technological, political, and counterparty risks that Armed faces in. China. This is not exactly a company you would expect to have a high valuation. This makes their 120 times price to earnings ratio very difficult to understand.

The Arm IPO exemplifies how little most investors understand about AI by hyping up their AI credentials. Arm achieved an otherwise unjustifiable valuation. In the long run. their investors will pay the price.

Alright guys, that wraps it up for this video. What do you think about Arm? Let us know in the comments section below. As always, thank you so much for watching and we'll see in the next one. Wall Street Millennial Signing out.