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Arm Holdings IPO: A Value Trap

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The recent Initial Public Offering (IPO) of chip design company Arm Holdings (NASDAQ:ARM) generated a lot of excitement, with a significant 25% valuation gain on the first day of trading. However, despite this impressive start, there are concerns about the company’s inflated valuation and lack of top-line growth. Arm’s market cap is currently at $62B, even though it didn’t show any significant revenue growth in its last fiscal year. In comparison to other chip companies, Arm is trading at a significant premium, making it a risky investment. As an expert in the field, I strongly recommend selling Arm shares, as they are likely to face significant selling pressure in the near future.

Successful IPO, but Lack of Growth

Arm announced its IPO pricing on September 13, 2023, with shares priced at $51 at the upper end of the proposed range. The stock surged 25% on the first day of trading but dropped 4% the following day. While Arm is a key player in the chip industry, providing crucial CPU architecture to customers worldwide, its lack of top-line growth is concerning. Although the company remains profitable, generating $2,679M in revenues in its last fiscal year, it showed a 1% decline year-over-year. This lack of growth raises questions about the company’s future prospects.

Arm’s profit margins look reasonable, with net profit margins between 19% and 20% in the past three fiscal years. However, the lack of meaningful revenue growth is a red flag for investors. Compared to competitors like AMD and Nvidia, which offer better growth prospects, Arm’s value proposition may need reevaluation.

Potential Share Overhang and Valuation

Softbank, the majority shareholder of Arm, still owns nearly 90% of the outstanding shares. This significant share overhang could potentially depress Arm’s valuation if Softbank decides to sell more shares to the public. This is an issue investors need to consider when evaluating the potential risk and return of investing in Arm.

In terms of valuation, Arm is currently trading at a higher market cap than Nvidia. With a market cap of $62B, Arm’s forward price-to-sales (P/S) ratio stands at an inflated 23X, assuming no material top-line growth in the future. In comparison, Nvidia and AMD have lower valuation factors, with Nvidia trading at a forward P/S ratio of 14X and AMD at 6X. Moreover, Nvidia is expected to grow its top line by 43% next year, while AMD is projected to deliver 20% revenue growth. These factors make Nvidia and AMD more attractive options for investors seeking better revenue growth potential.

Risks and Final Considerations

There are some obvious risks associated with investing in Arm. The IPO hype could fizzle out, leading to a compression of the company’s trading valuation. Additionally, Softbank’s potential future sale of shares could create further downside pressure on Arm’s valuation.

In conclusion, while Arm’s IPO may have initially seemed promising, its lack of meaningful top-line growth and high valuation raise concerns about its future performance. With better options available in the chip industry, such as Nvidia and AMD, investors may want to reconsider investing in Arm. As an expert, I rate Arm shares as a strong sell.

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