AI: Arm and rising tides

...separating financial and secular cycles

The tide has come in for AI driven IPOs in the public markets. A few days ago, I highlighted that the then anticipated Arm IPO “is likely to test so many current technology and geopolitical tail and head winds”. For now, the tail winds seem to have won. As Barron’s highlighted late last week, 

“Arm holdings (ARM) stock hit the market Thursday, and it soared 25% to about $63 for a market capitalization of about $68 billion. That implies a roughly 20 times multiple over where one can reasonably expect sales to be in the coming year.”

Of course much of the tail-wind comes from the current private and public market enthusiasm over the AI infrastructure gold rush, I’ve written about earlier. Barron’s again notes:

“Driving that multiple, in part, is the advent of artificial-intelligence advancements, which has boosted profit growth estimates. That is pushing more money into these IPOs—making them more expensive—since so many Nasdaq 100 stocks have already risen on the back of AI trends. Basically, investors looking for growth opportunities outside of the Nasdaq 100 are clamoring for anything else they can find. Arm mentioned the use of AI in its prospectus, but that doesn’t mean it’s going to grow as rapidly as the leaders in AI technology such as Nvidia (NVDA).”

Two things of note here while discussing relative financial valuations. First, as a follow-on Barron’s piece noted:

“Arm stock now trades in rare territory. It needs to figure out AI, and fast.”

Further noting:

“The public market is valuing Arm at $65 billion, about $10 billion below memory chip leader Micron Technology (MU), which generates 10 times as much revenue as Arm .

Arm is now trading for about 25 times its most recent full year of revenue—and at more than 100 times profit. And that could be where things get tricky for the new stock. Needham analyst Charles Shi picked up coverage after the first day of trading with a Hold rating, writing that “valuation looks full.”

Second thing of note is that AI wonder-stock Nvidia, which currently enjoyed a near-monopoly the the AI GPU chip infrastructure for the AI Tech Wave, at least into 2025, is trading at current Arm valuations on price to revenues. This was noted by a long-time proponent of Nvidia in the public markets, Ark ETF CEO Cathie Wood, in a separate interview in Barron’s:

“Over the next five years, we think [Nvidia is] in a beautiful position with the picks and shovels. But everyone knows it and it is valued accordingly. On this year’s revenue, it is somewhere in let’s say the 25 to 27 times sales range, depending on one’s estimate.” 

Of course Nvidia is in a different boat on the profits side, with margins that are more software like than hardware in the AI Tech stack below.

Especially given the white hot global demand for the company’s developer driven GPU chip infrastructure for LLM AI deployment of all types running into the tens of billions of dollars (Boxes 1 through 5 above). As Bloomberg notes in a recent piece titled “Nvidia is growing its way into a cheaper valuation”, 

“Investor concerns about Nvidia Corp.’s scorching valuation are being eased every time the chipmaker reports earnings.”

“That’s because its forecasts have dwarfed Wall Street projections by so much that estimates used to value the stock have risen faster than Nvidia’s shares. Its price relative to projected profits has fallen below 39 times after it delivered its latest eye-popping projection on Wednesday. That’s down from 63 times before its May earnings report.”

“There have been questions about whether Nvidia would grow into its valuation, and now it seems like there’s a decent chance it will,” said Michael Kirkbride, portfolio manager at Evercore Wealth Management. “This is not crazy expensive, given the kind of extraordinary growth we’re seeing.”

The point here is not the relative merits of Arm vs Nvidia, but the general point that a rising tide lifts all boats. I’ve previously maintained that Financial and Secular cycles in the public markets particularly, need to analyzed separately:

“The promise of AI is great, but technologies always take longer to cook than we think, and investors especially need to keep in mind that financial cycles are not always correlated with the underlying technology cycles.”

This is true especially vis a vis technology companies and their technologies, that need to be deeply analyzed in the context of the underlying secular cycles that are driving technology and eventual growth.

There will generally be distinctly different ebb and flow between the two types of cycles, with varying correlation over time. The current financial enthusiasm in the private and public markets needs to be viewed in this context. The recent events around Arm and Nvidia are anecdotal cases in point that are illustrative of the two cycles. Stay tuned. 

(NOTE: The discussions here are for information purposes only, and not meant as investment advice at any time. Thanks for joining us here)