IPO "Giant" makes its debut at its peak? Whether ARM can support a valuation of 170 times depends on whether it can withstand the "Qualcomm tax".

After the listing of "not very profitable" Arm, its P/E ratio has reached an astonishing 170 times, and doubts have arisen. SoftBank claims that Arm will charge fees in the form of "Qualcomm tax," and future revenue will continue to grow at a double-digit rate. However, whether it can truly achieve its wishes and how effective the new pricing model will be remains unknown.

On Thursday, Arm successfully listed in the United States and became the most watched "new star" among investors. It soared 25% on its first day of trading, with an intraday increase of up to 30%. However, on Friday, Arm's stock price fell, closing down 4.47% at $60.75, with a market value of $62.333 billion. Will this IPO "giant" encounter the dilemma of peaking at its debut?

Arm is not very profitable

ARM has equipped 99% of the world's smartphones with its own designed chip architecture, but it is not very profitable.

ARM's revenue mainly comes from licensing fees and royalties, with licensing fees accounting for 40% and royalties accounting for about 60% of revenue.

Licensing revenue refers to the licensing fee that other companies need to pay when using Arm's architecture to design chips. Royalties are the share that Arm takes after chip manufacturers sell their chips.

Some media outlets have exclaimed that Arm's royalty pricing is extremely low and can be called a "great philanthropist." According to data from 2019, the average royalty for one CPU from Arm is only 16 cents (1.1 yuan).

In 2022, the total value of chips based on ARM technology reached $98.9 billion, accounting for nearly half of the market share. However, Arm's royalty revenue was only $1.68 billion, accounting for 1.7% of the chip value. This is also a significant reason why its market share is as high as 99%, but its revenue and profit scale are not particularly large.

On the one hand, most products based on ARM architecture are microcontrollers (MCUs), which are relatively cheap. On the other hand, Arm takes a share from the chip price rather than charging fees for end products, resulting in relatively low revenue.

As a comparison, Qualcomm's revenue generation method is also "taxation." Taking the exclusive agreement signed between Qualcomm and Apple in 2010 as an example: Qualcomm pays Apple $1 billion annually in exchange for exclusive supply rights for iPhones. However, Apple pays Qualcomm patent fees: 5% of the selling price of each iPhone. Arm Wants to Increase Prices and Make Money

In the mobile industry, there is a famous "Qualcomm Tax" referring to Qualcomm's patent fees. It is not calculated based on the number or value of patents used in a phone, but rather based on a certain percentage of the phone's price. The more expensive the phone, the higher the fee, and the cheaper the phone, the lower the fee.

This pricing model has always been controversial, and Qualcomm has been investigated and fined by antitrust agencies in multiple countries. However, Qualcomm has not changed its model because it maximizes profits. Qualcomm has achieved rapid growth in revenue and profits through high fees such as entry fees, chip sales, and patent licensing.

Qualcomm's pricing model is based on a certain percentage of the cost or selling price of the entire device that uses Qualcomm's intellectual property (IP), not just the components directly related to wireless communication. This means that regardless of whether the device contains Qualcomm's wireless communication technology, a licensing fee will be paid to Qualcomm based on a certain percentage of the overall cost or selling price of the device.

Clearly, Arm sees similarities between itself and Qualcomm in terms of market position. In 2021, Arm attempted to adopt a similar pricing strategy.

Starting in 2022, Arm issued an ultimatum, stating that it would completely change its pricing method. Looking at the new licensing fees after Arm's change in authorization mode, the previous licensing fee was 1%-2% of the chip price, but now it has been changed to 1% of the end product price, which is roughly a 10-fold increase.

Conservatively estimating, excluding Apple phones, if Arm directly charges fees based on end products, it will charge $12, $6, and $3 for high-end, mid-range, and low-end segments, respectively. This means that Arm will generate an additional $5.4 billion in revenue from non-Apple high-end smartphones in one year.

Some analysts believe that Arm's dominant position in the architecture field gives it the ability to flexibly execute various strategies. The strategy of collecting "Qualcomm Tax" can increase Arm's sales revenue from end products, but the precondition is that this pricing strategy will be accepted by the market.

Will Anyone Pay the Bill?

Arm's unshakable position in the mobile sector comes from its "ecosystem": how many downstream customers are willing to adopt Arm's architecture to design chips. If Arm's "tax rate" is too high, it may push downstream chip companies to seek new architecture solutions, and many customers may leave.

Since 2022, the lawsuit between Arm and Qualcomm has shown that major customers are already wary of Arm's ecosystem. Arm accused Qualcomm of using Arm's intellectual property without permission, as Qualcomm acquired a company called NUVIA in 2021 (which is engaged in Arm architecture CPU development). After the acquisition, Arm hoped to renegotiate the licensing agreement with Qualcomm regarding NUVIA products to increase fees, but Qualcomm was clearly unwilling. Two giants stick to their own words, and Arm once threatened to terminate all licensing agreements with Qualcomm. Although this threat was not put into practice, it has clearly made Qualcomm and all of Arm's major clients wary.

Industry insiders analyze that the price increase will accelerate the exodus of some of ARM's partners from the ARM ecosystem, and they will turn to embrace X86, RISC-V, and other ecosystems.

The open-source and free RISC-V architecture is eyeing the opportunity and continuously trying to penetrate the existing customers of ARM.

With its advantages of open-source, simplicity, and modularity, the RISC-V architecture has become a "rising star" in the chip architecture field. The open-source nature of RISC-V has attracted the attention of many companies, especially for small and startup companies, as it allows them to obtain chip design authorization more easily and thus reduce costs.

ARM also mentioned in its prospectus that "many of our customers are also major supporters of the RISC-V architecture and related technologies." If the technologies related to RISC-V continue to develop and market support for RISC-V increases, our customers may choose to use this free open-source architecture instead of our products.

Fundamentally, ARM may not make big money because it lacks the power of discourse in the industry chain. Some analysis points out that the most profitable companies in the entire industry chain are those that control the software ecosystem of chips, as they directly determine the competitiveness of a certain chip in the market.

ARM has always been in a neutral position, and the open licensing of its architecture standards has led to its unstable position. In contrast, its competitor Intel not only designs IP but also owns its chip factories. It monopolizes the ecosystem by forming the Wintel alliance with Windows, thereby controlling the discourse power of the industry chain.