Arm Holdings, a leading technology company, is on the verge of becoming the market's next big chip stock with its upcoming public listing. While Arm draws inspiration from the success of Nvidia, it still has to establish itself as a major player in the artificial intelligence (AI) realm.

A regulatory filing released by Arm ahead of its planned initial public offering on the Nasdaq not only revealed its AI ambitions but also disclosed its recent valuation of approximately $64 billion in a stake sale involving its current owner, SoftBank.

Considering that Arm generated $2.68 billion in revenue during its previous fiscal year, the potential valuation is quite significant. This would result in an even higher price-to-revenue ratio compared to Nvidia, a fellow semiconductor company that currently trades at around 45 times its most recent annual sales.

However, it is worth questioning whether Arm can achieve a similar valuation to Nvidia, which is currently the market's favorite player in the AI growth story.

Nvidia's success lies in selling graphics-processing units (GPUs), which have become the go-to tool for training AI systems. On the other hand, Arm's core strength revolves around licensing designs for central processing units (CPUs).

Arm's CPUs are already widely used in running AI applications, especially in smartphones. While there has been a surge in investment in AI technology, resulting in increased spending on chips for data centers, it remains uncertain how quickly this trend will translate into higher demand for advanced chips in devices like computers and smartphones.

Arm Holdings faces the challenge of proving its capabilities in the AI space, particularly in comparison to Nvidia. However, with its upcoming public listing and strong presence in smartphone AI, there is potential for Arm to become a significant player in this rapidly evolving market.

Arm's Exposure to the Smartphone Market

Arm, a leading semiconductor company, finds itself heavily exposed to the smartphone market. According to independent analyst Richard Windsor, Arm's profile bears a striking resemblance to smartphone chip specialist Qualcomm, rather than Nvidia, whose stock has soared this year due to the excitement surrounding Artificial Intelligence. In contrast, Qualcomm has experienced little growth, largely due to concerns surrounding declining smartphone sales.

Windsor further highlighted potential concerns regarding Arm's exposure to China. To manage its sales in the country, Arm has established Arm China as a separate and independent entity, majority-owned by Chinese investors. While Arm maintains a minority interest in this venture through SoftBank, Windsor argues that the risk profile of Arm in China equals, if not surpasses, that of Qualcomm. Of particular concern is the potential for geopolitical challenges in relation to the transfer of intellectual property into China.

Arm revealed in its filing that China accounted for approximately 25% of its revenue in the most recent fiscal year, a notable increase from the previous year's 18%. By comparison, Nvidia generated 21% of its revenue from China over the last 12 months, as reported by FactSet.

Analyzing Arm's financial situation, analysts at Macquarie acknowledge that in a year characterized by sluggish smartphone and semiconductor markets, Arm's flat year-on-year revenues appear reassuring. Furthermore, their margin expansion indicates that investments in research and development as well as headcount are paying off. However, they caution that the rising concentration of revenue from China poses an increasingly risky backdrop given current geopolitical circumstances.

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