{"id":10230,"date":"2023-09-11T18:37:05","date_gmt":"2023-09-11T18:37:05","guid":{"rendered":"https:\/\/prosfunds.com\/investing\/dont-bail-out-this-private-equity-giant\/"},"modified":"2023-09-11T18:37:07","modified_gmt":"2023-09-11T18:37:07","slug":"dont-bail-out-this-private-equity-giant","status":"publish","type":"post","link":"https:\/\/prosfunds.com\/?p=10230","title":{"rendered":"Don\u2019t Bail Out This Private Equity Giant"},"content":{"rendered":"
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Arm Holdings (ARM), the chip design giant, is expected to start trading September 14, 2023 at a ~$49 billion valuation. At $49\/share, the midpoint of its IPO price range, Arm Holdings earns an unattractive Stock Rating and is this week\u2019s Danger Zone pick.<\/p>\n

I think it is fair to say that the ~$49 billion valuation mark is based more on Softbank\u2019s self-dealing in private markets to manipulate the valuation higher than the fundamentals of the company.<\/p>\n

Specifically, at the midpoint of its IPO price range, the stock\u2019s valuation implies the company will 10x profits and achieve revenue growth well above industry expectations. ARM looks more than fully valued and does not provide investors any upside potential, as I\u2019ll illustrate with my reverse discounted cash flow (DCF) model.<\/p>\n

Softbank\u2019s Self-Dealing Valuation<\/strong><\/h3>\n

In what has now become a well-worn strategy, Softbank famously (and artificially) increased WeWork\u2019s (WE) \u201con-paper\u201d valuation prior to its attempted IPO. First, in August 2017, SoftBank and its Vision Fund invested in WeWork at a ~$20 billion valuation. In June 2018, SoftBank invested further capital, but this time at a $35-$40 billion valuation. Lastly, in January 2019, just six months before WeWork filed its S-1, SoftBank invested in WeWork again at a $47 billion valuation. I think that self-dealing was a big part of the basis for attempting to IPO WeWork at a $40+ billion valuation. We all know how that story ended.<\/p>\n

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I think the same ploy could be happening with Arm. Softbank took Arm private at a $32 billion valuation in 2016 and, in 2017, sold a 25% stake to the Vision Fund, a fund managed by SoftBank. Fast forward to August 2023, just weeks before Arm would file its F-1, SoftBank bought back Vision Fund\u2019s stake in Arm, but this time at a $64 billion valuation. In other words, SoftBank doubled the \u201con-paper\u201d valuation of Arm by buying shares from itself, just as it did before the WeWork IPO. That\u2019s not a great precedent.<\/p>\n

While Arm\u2019s midpoint IPO valuation of $49 billion may seem cheap relative to the recent $64 billion mark, that mark is a result of self-dealing, not an efficient market.<\/p>\n

Other Big Red Flags for Investors From the Footnotes<\/strong><\/h3>\n

Self-dealing is not the only reason I caution investors against buying into this IPO. Softbank is making this deal bad for public investors for other reasons.<\/p>\n

Public Shareholders Will Have No Rights<\/strong><\/h3>\n

Upon completion of the IPO, Softbank Group is expected to own between 90-91% (varies based on underwriter\u2019s decision to exercise option to purchase more) of Arm\u2019s outstanding shares. As a result, Arm will be considered a \u201ccontrolled company\u201d. As a controlled company, new investors will have no say in determining the outcome of matters submitted for shareholder approval.<\/p>\n

Additionally, Arm notes in its F-1:<\/p>\n

\u201cAs a controlled company, we have elected not to comply with certain corporate governance requirements applicable to most Nasdaq-listed companies. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all of these corporate governance requirements.\u201d<\/em><\/p>\n

In other words, this IPO will take investors\u2019 money while giving them no voting power or control of corporate governance.<\/p>\n

Status as Foreign Private Issuer Minimizes Transparency<\/strong><\/h3>\n

Investors should take note and beware of Arm\u2019s intentional exploitation of its status as a Foreign Private Issuer.<\/p>\n

Under the rules of the SEC, Arm Holdings qualifies as a foreign private issuer, which exempts the company from compliance with certain laws and rules of the SEC and NASDAQ. For instance:<\/p>\n