The Arm Holdings Plc initial public offering is generating a lot of excitement among IPO and tech fans, and for good reason—it’s the first significant tech IPO in more than two years.
A lot depends on how well it does. Investors’ “success” in this instance included strong demand and an increase in price in the days and weeks after the IPO.
However, at first, Exchange Traded Funds will be the only logical buyer for the deal.
On Thursday, Arm will begin trading on the Nasdaq, selling 95.5 million shares at $51, which is the upper end of the anticipated price range of $47 to $51.
The usage of ETFs by tech investors to get exposure to major tech sectors and subsectors like semiconductors is on the rise.
However, some investors may be let down if they were hoping to gain instant exposure to the Arm IPO through ETFs.
ETF index inclusion guidelines
Due to the ownership base’s lean towards passive and long-term ownership, ETFs are typically a favourable target for firms looking to sell shares to.
This particular IPO, however, brings to light a number of challenges that even huge corporations like Arm face when trying to expand their shareholder base through ETFs.
ETFs are typically supported by indexes. To be eligible for inclusion, one must strictly abide by the standards of these indexes.
Unfortunately, ARM initially looks to be ineligible for the main ETFs, both as a result of Arm’s own choices and partially owing to the way the key indexes are built.
First issue: Arm isn’t included in the S&P 500
S&P Global is the largest index provider. Arm is not a stock in the S&P 500, which is a prerequisite for inclusion in broad technology ETFs like the SPDR Technology ETF (XLK), which tracks the S&P 500 Technology index.
The first issue is that Arm is a British firm rather than a U.S. one, which would typically keep it out of the S&P indexes.
Given that it has its domicile in the UK, Matt Bartolini, head of SPDR Americas Research at State Street Global Advisors, told me that it is doubtful that it will be included in the S&P 500. “That would rule it out of inclusion right away.”
A wide range of ETF products offered by State Street are connected to S&P indexes, including the SPDR S&P 500 ETF, the biggest ETF globally.
The most recent quarter’s GAAP should be positive along with the most recent four consecutive quarters’ GAAP, according to Howard Silverblatt of S&P Global. S&P also needs a stock to have traded for a year.
A free float below 10% is the following issue.
Because limiting supply enhances the likelihood of higher prices, many IT companies now routinely floated extremely tiny amounts of stock (10%–15% of the shares outstanding).
But according to Renaissance Capital, Arm looks to be exceptionally frugal, only floating around 9.3% of the business.
This presents another issue for many ETFs as they typically need a firm to float 10% of its shares or more in order to qualify for inclusion.
According to Bartolini, this is true for both the largest semiconductor ETF, the S&P 500, and the S&P indexes.
Van Eck Semiconductor ETF (SMH), which also needs a 10% or more free float.
Eck, Van On Monday, CEO Jan Van Eck told CNBC that his company was still determining whether or not Arm would be qualified for inclusion in his ETF.
There are float restrictions for other index providers that ETFs utilise. Using the CRSP U.S. Total Market Index, Todd Sohn, who covers ETFs at Strategas, informs me that Vanguard Total U.S. Market (VTI), likewise needs a 10% float for fast-track IPOs.
It is possible to increase the float above 10%. The greenshoe, an optional over-allotment of stock that might add an extra 15% of shares, would put SoftBank slightly above a 10% float, so they could first exercise it.
What timeframe would that be?InThough it may be, in general, it is not publicised in conjunction with the pricing, according to Renaissance Capital’s Matt Kennedy. It may also be revealed a few days later when they make the closing announcement. Or, at the latest, a few weeks later in a 10-Q or 8-K filing.
Another option is to just sell more shares once the six-month lockup period has passed.
Nasdaq-100 ETF and IPO ETFs are two potential ETF purchasers.
There are some prospective purchasers of ETFs.
For instance, as there are no float or market capitalization criteria for the Nasdaq-100, which represents the top 100 non-financial companies listed on the Nasdaq, Arm may be able to participate. Every December, the Nasdaq-100 is recreated.
One of the biggest ETFs in the United States is the Invesco Nasdaq-100 ETF (QQQ), which utilises the Nasdaq-100 index as its benchmark.
Potential Arm holders include other ETFs that focus in purchasing initial public offerings, but their purchasing ability is limited.
Arm could be qualified for inclusion in the Renaissance Capital IPO ETF (IPO), a collection of recent IPOs, as it just requires a 5% free float.
Nate Geraci of the ETF Store, however, issued a warning about attempting to play IPOs in this way.
He said to me, “I’m just not a fan of investors trying to play IPOs in the first place.
“One advantage of investing in ETFs is that you don’t have to be concerned about company-specific occurrences like these. Investors should understand the inner workings of any ETF they purchase, but I would advise against purchasing an ETF just because it includes a holding in the newest, hottest IPO.
