Last week, UK semiconductor designer Arm (US:ARM) listed its shares in the US. The following day, German sandal company Birkenstock announced it would be doing the same.
It might seem an odd comparison, but Arm's architecture and Birkenstock's sandals actually have a lot in common. Both were imported from Europe to California, before becoming part of everyday life. Both have strong intelluctual property and are more environmentally friendly than their peers. But, based on their stock market valuations, one is considered to have much stronger prospects than the other.
Arm designs microprocessor architecture and then licenses it to customers, the most famous of which is Apple (US:APPL). Steve Jobs chose Arm’s architecture for the original iPhone because it was more power efficient than the x86 architecture used by Intel (US:INTC). The iPhone, became a global phenomenon and has been driving Arm’s growth ever since. The problem is the smartphone market is stagnating.
Apple’s iPhone revenue dropped 2 per cent year-on-year last quarter. Correspondingly, Arm’s revenue was flat last year. Over a two-year period, sales increased 32 per cent, which is not bad, but not quite as good as Birkenstock’s 71 per cent (as the chart below shows).
Fashion comes in waves and currently Birkenstock is riding the crest of one. The sandal was first brought to the US in the 1960s and sold in health food stores. They circulated in the hippie community, where comfort rather than style was prioritised. But like yoga, cannabis, and the Burning Man festival, Birkenstocks moved from the fringe to the centre of culture. Now, they can be found on all sorts of feet, from painters to bankers.
This dissemination of the sandal is seen in the numbers. Between 2020 and 2022, Birkenstock’s revenue increased from €728mn to €1.2bn while operating profit was up 181 per cent. In the last year, operating profit was 29 per cent, ahead of Arm's 25 per cent.
Given the rapid growth and superior margins for the German sandal maker, it may confuse investors as to why they have to pay so much more for Arm. After the 25 per cent jump in its share price on the opening day, Arm is valued at more than $60bn while Birkenstock is seeking just a $8bn valuation. That’s a 100 times-plus earnings-based valuation for Arm and just 40 times for Birkenstock.
The argument Arm has been making during its initial public offering is that the rise of artificial intelligence has offered a new avenue for growth; a way to pull it out of its smartphone stagnation. There is some evidence this is the case; Arm’s architecture has recently been licensed by Amazon (US:AMZN) and Alphabet (US:GOOGL) to design proprietary chips for their data centres.
Rather than training AI models, where Nvidia’s (US:NVDA) GPUs are dominant, Arm’s architecture is expected to be good at efficient AI 'inferencing'. Inferencing is like speaking a second language rather than learning it. It takes effort to bring the right words to mind, but most of the heavy lifting has already been done in classroom. The key is to be able to do it efficiently.
Arm has only made recent inroads into the data centre market, with more expected to come. Incumbents Intel and AMD (US:AMD) have around 90 per cent market share, according to Counterpoint Research, but Arm has increased its share from 7.2 per cent to 10.1 per cent in the past two years alone. Amazon and Alphabet also prefer Arm because they can licence its architecture but design their own chips, whereas they have to take off the shelf designs from AMD and Intel.
The rise of artificial intelligence is moving Arm from the fringe to the mainstream in the data centre market. At least, that's the story investors have bought into.
Birkenstock says it has just 1 per cent of the footwear market and there is still room for growth. But the reality is that not all shoes are the same. The eye test suggests Birkenstock is already mainstream and, unless it can convince men to have open toes in the office or to purchase its new closed toe products, its growth story is a bit of a stretch.
For Arm to justify its extraordinary price, it won’t be able to stay on the fringes for long. It must quickly move into the data centre mainstream before a new architecture surpasses it. Unlike footwear, retro technology is never in fashion.
