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## Using poppler version 22.04.0In the forthcoming IPO, ARM Holdings is eyeing a valuation north of $50 billion, predicated on a projected annual earnings growth rate of close to 20%. While the company holds a dominant position in the semiconductor industry, leveraging a unique business model of licensing its cutting-edge ARM-based processors to other firms, this valuation raises concerns of being overpriced.
New Constructs CEO, David Trainer, has highlighted that the proposed valuation of approximately 49 billion USD is based on an assumption that ARM would sustain an annual growth rate exceeding 20% for the next decade. This projection seems to be on the higher side, considering the realistic growth avenues available in the industry, despite ARM’s current profitability and potential for growth. Trainer suggests that such a high growth rate is more of an optimistic speculation rather than being grounded on firm fundamentals.
In this summary, a DCF valuation approach is used to validate these views with a simple valuation perspective.
ARM Holdings, a British semiconductor and software design company, stands as a behemoth in the industry, pioneering the “system on a chip” architecture through its ARM-based processors. Despite not being a household name, ARM’s technology is ubiquitous, finding applications in products of giants like Apple, Samsung, and Qualcomm.
The company’s business model is centered around licensing its designs, a strategy that affords impressive gross margins nearing 95%. Sentiments towards ARM have been overwhelmingly positive, reflecting a general consensus of optimism and approval from various stakeholders. This favorable perspective is grounded in the company’s innovative approach to technology and its sustained efforts in maintaining a leading position in the semiconductor industry.
The IPO comes at a time when the semiconductor industry is witnessing divergent business models and intense competition. ARM operates in a space shared with heavyweights such as Nvidia, Intel, and AMD, each carving out a niche in the semiconductor landscape.
The IPO is expected to rejuvenate a somewhat subdued IPO market, drawing interest from both retail and institutional investors, albeit with a cautionary note on the potential risks involved in blockbuster IPOs.
Leveraging the discounted cash flow (DCF) approach grounded in the Damodaran FCFF (Free Cash Flow to Firm) valuation methodology, this page is a personal attempt to apply tidy principles in R to perform valuation for ARM Holdings.
The valuation of ARM Holdings is grounded on a meticulous analysis leveraging a series of financial metrics and assumptions, which are derived from authoritative data sources. The methodology encompasses the following pivotal stages:
The data central to this analysis has been meticulously sourced from the renowned datasets curated by Professor Damodaran. The extraction process entailed the deployment of R functions to download and refine the data, thereby facilitating a seamless analysis.
The semiconductor industry’s fundamental EBIT growth rate, as delineated in the data source, is 12.7%. This metric is instrumental in shaping the valuation landscape.
The reinvestment rate, a cornerstone in the valuation process, is assumed to be 68.56%, mirroring the semiconductor industry average (source). This rate encapsulates the fraction of earnings reinvested to foster future growth. While historical data offers a starting point, it may not always encapsulate future trends accurately, a perspective supported by Damodaran.
The risk-free rate is predicated on the 10-year treasury yield as of September, a standard practice in financial analysis, offering a reliable benchmark for the valuation.
The valuation incorporates a detailed capitalization of R&D expenses, grounded on the premise that R&D investments, akin to capital expenditures, engender future economic benefits. The data spanning from 2016 to 2023 has been extracted from the IPO prospectus as well as extrapolated due to lack of data.
The process entailed:
The outcomes of this analytical process are encapsulated in the table below:
## Loading required package: tidyxl## Loading required package: readxlPost the adjustments from capitalizing R&D expenses, we proceed to the valuation using the FCFF approach with detailed breakdown of various metrics including the equity valuation, expected FCFF, and cost of capital among others. Below, we present the results and undertake a detailed analysis of each metric:
In the dynamic landscape of the semiconductor industry, the expected growth rate stands as a pivotal metric in the valuation of a firm. It is imperative to scrutinize this parameter through a lens of sensitivity analysis to fathom the potential fluctuations in ARM’s valuation under different growth scenarios. The sensitivity analysis involved varying the expected growth rate and observing its impact on the Free Cash Flow to the Firm (FCFF) and, consequently, the valuation of ARM Holdings. The analysis spanned a range of growth rates, providing a spectrum of valuation outcomes, thereby offering a comprehensive view of the potential valuation landscape under different growth assumptions.
A valuation north of 50 billion USD necessitates an expected growth rate exceeding 20%. This insight is echoed by New Constructs CEO David Trainer, who highlighted that the proposed valuation of approximately 49 billion USD is based on an assumption that ARM would sustain an annual growth rate exceeding 20% for the next decade. This projection seems to be on the higher side, considering the realistic growth avenues available in the industry, despite ARM’s current profitability and potential for growth. Trainer suggests that such a high growth rate is more of an optimistic speculation rather than being grounded on firm fundamentals. (source).
As ARM Holdings steers towards its IPO guided by SoftBank, the projected growth rates stand central to its valuation, painting a picture of a valuation exceeding 50 billion USD based on a growth rate of over 20%. This optimistic projection, echoed by industry analysts, has raised eyebrows and necessitates a critical appraisal by potential investors, who must navigate a landscape fraught with industry-specific challenges and competitive dynamics.
While the IPO is witnessing a substantial influx of interest, being oversubscribed, it brings with it a set of concerns rooted in the sustainability of the projected growth rates and the geopolitical intricacies that govern the semiconductor industry.
Investors are encouraged to delve deep, analyzing the potential risks and rewards grounded in the industry’s complex dynamics. It is imperative to approach this with a discerning eye, weighing the optimistic growth assumptions, strong market sentiments supporting ARM’s valuation, and the potential hurdles that lie in ARM’s path to achieving such a high-growth trajectory.
This analysis, is presented to aid individuals in forming a well-rounded perspective. It is important to note that this does not constitute investment advice and is a personal insight devoid of any liability, urging individuals to undertake comprehensive research and possibly consult with a financial advisor before making investment decisions.