In a recent turn of events, chip design company Arm Holdings (NASDAQ:ARM), owned by Softbank (OTC:SFTBY), saw its shares soar by 25% on the first day of trading last week. Despite this initial success, concerns have been raised about the company's inflated valuation and lack of top-line growth.
Arm, a key player in the chip industry, priced its initial public offering of 95,500,000 American depositary shares at $51 on September 13. The company's market capitalization reached $62 billion after the IPO, despite showing virtually no top-line growth in the last fiscal year, which ended on March 31, 2023.
Although Arm is fundamentally profitable with reasonable net profit margins of 20% in FY 2023, its revenues declined by 1% year over year to $2,679 million. This lack of top-line growth has raised concerns among investors who are comparing Arm's prospects with those of rivals like Nvidia (NASDAQ:NASDAQ:NVDA) and AMD (NASDAQ:AMD). These companies are expected to deliver stronger revenue growth potential while trading at lower valuation factors.
Furthermore, Arm's high price-to-sales ratio compared to its rivals suggests limited growth potential. Assuming no material top-line growth for FY 2024 and revenues of $2.7 billion, Arm is valued at a forward P/S ratio of 23X. In contrast, Nvidia trades at a forward P/S ratio of 14X and AMD at 6X.
The high ownership stake of Softbank, which owns nearly 90% of Arm's outstanding shares, also poses a potential issue for future buyers. If Softbank decides to sell more shares to the public in the future, this could lead to significant selling pressure and a potentially lower valuation factor.
Despite these concerns, Arm continues to hold a significant position in the chip industry, providing crucial CPU architecture used around the world. The company's chip designs are prolific in the consumer electronics and embedded markets, with more than 250 billion Arm-based chips shipped since the company was founded in 1990, and over 30 billion shipped in fiscal 2023 alone.
However, given the current valuation concerns and lack of top-line growth, investors are advised to tread carefully when considering buying into Arm's IPO. The company's current market valuation of $62 billion is seen by some analysts as unsustainable and there are concerns that shares of Arm could experience significant selling pressure in the near term.
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