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This ain’t a scene, it’s an Arms race
Bankers have stuck a hefty price tag on Arm Limited. But it doesn't matter. The market will pay up.


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“The Arms race” by DALL•E

Fall Out Boy, an American punk-pop band, said it best when they sang:

"And don't really care which side wins
Long as the room keeps singing
That's just the business I'm in"
— This Ain't a Scene, It's an Arms Race, Fall Out Boy, 2007

Bankers should re-listen to some '00s pop-punk—there are lessons in there. Taking a company public is lucrative. It doesn't matter which side wins as long as you ensure the markets keep dancing.

Masayoshi Son, a tech investor from Japan who runs Softbank, has been listening too. Arm Limited, a semiconductor company Softbank owns, filed to go public the other week. But bankers have attached a hefty $64bn price tag to the company. The price is overcooked, but that doesn't matter. The market will accept it as chip-maker valuations are sky-high.

At $64bn, the company is expensive. Using generous assumptions, I value Arm's equity at $33bn-38bn. I assumed the firm's top line would grow three times faster than the semiconductor market. Analysts expect industry revenues to grow at 12% per year until 2027, but I assume Arm's will grow at 37%. That will give them a growth rate in the industry's top fifth. Further, I model that the company will maintain its enormous 52% margins. That's less far-fetched than the growth story, as Arm charges other chip-makers a royalty to use their designs. Still, margins this wide put them in the industry's top percentile. Finally, I assume that Arm's business model is safer than the industry average. I give them a cost of capital in the industry's bottom quartile.

Even with this upbeat base case, buyers will unlikely get good value. My Monte Carlo simulation suggests the shares are too expensive in 92% of scenarios. Those are not good odds for value-seekers. Mr Son, however, will be happy about this valuation. If the market buys what he's offering, he'll offload an 8% cost of equity asset with a meagre 6% implied return.

But it would be a much-needed win after a series of losses for Softbank. Over the past few years, they've booked significant losses on their WeWork and Lemonade investments. Softbank's stock itself has also fallen on tough times—it's down by a third in the past two years. This listing would let Softbank carry the remaining 90% of Arm they'll keep at double the $32bn price they paid in 2016.

This listing would also help prove NVIDIA's valuation—another of Mr Son's holdings. There's much hype around artificial intelligence (AI) and the computer chips that power it. Shares in NVIDIA, one of the leading chip makers, have surged 220% this year. Some, like this journal, argue that the share price has risen too high. Others think the opposite. If the market accepts Arm at $64bn, that gives weight to the latter.

Either way, Arm's shares will likely jump after the initial public offering (IPO). Investors are high on AI and will continue to chase anything in that realm. Invesco's index of big American semiconductor companies is up 41% so far this year. Punters want in on anything and everything tech. With Arm in that lineup, those same traders will shoot their shot.

Shares in freshly minted public companies still tend to leap on their first day. So far in America this year, there have been 64 IPOs. On average, those stocks rose 8% on their first trading day. But since their IPO date, those same public companies have fallen by 25% on average. So, while public stocks still in their packaging tend to be expensive, that won't matter this time. Mr Son is selling into an Arms race.
Growth at an unreasonable price

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