High hopes over Arm’s relisting may clash with reality

A heap of hope is riding on the forthcoming stock market relisting of the British chip designer Arm in New York in what may be a defining deal of the decade. 

The company’s owner SoftBank, the Japanese investment firm run by the mercurial Masayoshi Son, is hoping to recoup part of the £24bn it paid for Arm in 2016 and validate its investment portfolio that has been shredded by the global tech market downturn.

A long line of private tech start-ups, living off financial vapours, is also hoping that a successful flotation will revive the moribund market for initial public offerings. Venture capital investors, starved of fresh funding in recent months, are hoping that a hot-again IPO market will enable them to cash out existing investments and recycle funds into new start-ups. Then, the industry’s lucrative financial merry-go-round can start spinning again.

But it may well be that second stock market flotations, like second marriages, represent a triumph of hope over experience. SoftBank’s troubles extend way beyond whether it can extract market value from Arm. Start-ups would be rash to count on a swift return to the go-go market conditions — and valuations — of 2021 (unless they slap generative artificial intelligence all over their pitch decks). And VC investors are facing the fact that the financial dynamics of their industry have radically changed in a higher interest rate world.

When Arm first floated in London in April 1998 (with a secondary listing on Nasdaq in New York), it was a very different company and a very different time. A heady amalgam of boffinish brilliance and entrepreneurial drive, the Cambridge-based chip designer emerged at the perfect moment to surf the mobile phone wave, as James Ashton records in The Everything Blueprint. The stock market was in the final stages of an extraordinary bull run, too. 

Arm’s shares popped 46 per cent on their first day of trading, earning the company a symbolic $1bn valuation and a 30-second congratulatory call from Steve Jobs of Apple, an early backer. By the end of 1999, Arm’s market valuation had surged to £6bn and it had entered the FTSE 100 index, before being sideswiped in the dotcom crash of 2000.

In several respects, Arm remains a remarkable company, one of Britain’s very few tech businesses of global relevance. Its chip designs, incorporated into almost every smartphone, are used by about 70 per cent of the world’s population, according to the prospectus. More than 30bn chips based on Arm’s designs were shipped in the last fiscal year alone. Looking beyond smartphones, the company is trying to exploit the latest tech trend that is wildly exciting investors: AI.

However, Arm looks an also-ran in that particular race compared with Nvidia, the giant US chip company that boasts a market value of more than $1.1tn and previously tried to buy Arm, before regulators got sniffy on competition grounds. Nvidia’s AI-friendly graphics processing units are massively in demand, or “considerably harder to get than drugs”, as Tesla boss Elon Musk puts it. But, as Arm admitted in its prospectus, its own central processing units are not best suited to running the latest AI algorithms.

Considering geopolitical tensions, investors may also be wary of a US-listed company that generates 24 per cent of its revenues in China but does not fully control its local business there. Investors are therefore likely to give Arm a far less euphoric reception than in 1998. SoftBank appears to be targeting a valuation of $64bn, which seems rich given that Arm’s revenues fell last year. “That valuation is nuts,” says Ben Thompson, author of the Stratechery newsletter.

Like Son, a gaggle of start-ups founders will be hoping that Arm’s IPO is a runaway success. But they know that in a higher interest rate world, investors demand profits and positive cash flow, which seemed so retro just a few years ago when “growth at all costs” was the market mantra. Start-ups will also face more sceptical institutional investors, who have been burnt by previous IPOs. According to a 2021 Nasdaq report, about two-thirds of IPOs between 2010 and 2020 underperformed the market in the three years after flotation. 

VC investors have been cheered by this year’s 31 per cent rebound on Nasdaq and are desperate for an IPO revival. Last year, only 90 such deals were completed in the US, raising $8.6bn, according to EY’s IPO report. That compares with 416 new listings in 2021, raising $155.8bn. 

Bill Janeway, the veteran VC market watcher, says many start-ups would benefit from going public but their probable valuations would be below the levels at which they last raised money in private funding rounds. It is only when companies and investors start “marking to reality” that IPOs can happen. “There is a viable industry that will emerge but it is now going through a workout phase,” he says.

Once reality re-marks prices to market, collective amnesia will doubtless work its magic and financial markets and tech valuations will race ahead. But, AI start-ups aside, new heady days of reckless funding, nosebleed valuations and spectacular stock market exits still look a way away.

john.thornhill@ft.com