arm IPO’s (another computer chip company)… does it make sense? Is this an AI company?

The company filed to go public, and is a huge part of the semi conductor industry. I think there are some pitfalls to watch out for with this company, for example their IPO’s timing with the recent NVIDIA hype. I also recommend 2 articles about

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arm F1

arm filed to go public. What is ARM, why are they important ,and what makes them worth over $50 billion?

What is ARM

Arm architects computer chips, and open sources their designs / architecture. Chips need an operating language an arm designs this language.

At the end of the day they sell a CPU architecture for chips. Most of the time this is for small ones. Really small ones. Like the ones that go into your phone, or your bluetooth speaker. Over 250 billion chips with an ARM architecture have been shipped since its founding… that’s a lot.

Arm Financials

arm made $2.7 billion in the 2022 fiscal year, with a gross margin of 96% (Woah… but makes sense because of their category). The company had a respectable operating margin of 25%. The are also valued at a $60 billion valuation… what? Over 20x revenue multiple and 110x price to earnings … this is going to be interesting.

Based on my limited understanding, arm decided to IPO because of their owning companies financial troubles & the current love for the semiconductor market.

Market Opportunity

arms Total addressable market is… everything with a computer in it. That’s big. Jensen Huang, CEO of NVIDIA sees this as about a $1 trillion market. arm, however estimates “only” about $250 billion (still enormous). The company also believes that as chips continue to advance, they can charge more for their designs and royalties. Plus as we buy more refrigerators that talk to you, their customers market will expand… meaning theirs will too.

One of the big innovations in smart phones is the use of low energy chips, that still perform. arm owns over 99% of the mobile phones market. One of their next innovations will be to make Machine Learning on your phone more accessible. However, this is not to say that this is an AI company. Their chips enable AI, but only work on the consumer end which is the “easier” part of the problem.

The phone is becoming the center of our lives. Over 60% of the whole gaming market is on mobile. Gaming is also the largest media segment out there. Phones will also begin to have more AI capabilites and arm has already begun designing the chips to enable that.

IoT & Consumer electronics are two versions of the same product. A machine, which used to be dumb… is now smart. This happens through additional sensors & processing units. Almost every device in your home has a processing unit, and arm designs the foundation for all of these.

Business Model

arm licenses its products to semi conductor companies and receive a per unit royalty on each unit sold. Instead of an x for y transaction, it is an $ for IP transaction. This license can work across all of their products, or be down to a very specific component.

Growth

arm dominates a segment of high powered, low evergy computing. There are 3 markets they see as opportunities to continue to expand with this model; cloud computing, networking equipment, automotive and consumer electronics. They own between 10 and 40% of each one of these markets, and these are all expanding markets. So if arm just defends its marketshare it will continue to grow over 5% per year in these segments.

Almost all embedded systems and smart phones have arm products in them. With the auto market moving towards self-driving, arm believes that this will become one of its most important segments. The company estimate that there are 13 arm based chips in each new vehicle produced, and eve.

They also have the opportunity to increase the value of each processor. As we continue to demand more complex chips, arm believes that it will require capacity to deliver better designs faster. By adding more value into the products, arm believes that it can continue to build market leadership and charge higher royalties.

Because of arm’s position in the market they have an interesting sales and marketing apparatus. Namely, very minimal. Their partner network basically sells their solutions for them, which means that they could be leaving margin on the table.

Things to watch out for

1. Massive risk within semi-conductors, and some reporting challenges

2. arm only own the instruction set. arm’s customers design, manufacture and sell the chips.

3. Low end chips are leaning towards becoming a commodity. arm needs to keep innovating to avoid margin compression