Arm & NVIDIA – The unthinkable pt. V

An IPO of Arm beckons.

• The risk to NVIDIA’s acquisition of Arm from Softbank continues to increase as the problems with its China unit seem to be getting worse rather than better and now the UK government is investigating on the grounds of national security.
• The dispute started around 12 months ago when Arm China’s board voted 7-1 to remove its CEO, Mr Allen Wu, as a result of conflicts of interest.
• However, Mr Wu refused to be removed and Mr Wu still has control of the company under the old Chinese corporate system as he still has physical possession of the company’s official stamp.
• I had always assumed that this was a dispute over money and that SoftBank would end up paying to make it go away but the situation has become more complicated.
• Arm China has now filed lawsuits against three Arm China executives that the board had designated as candidates to replace Mr Wu.
• These executives were fired by Mr Wu and were subsequently reinstated by the board but now the company is suing them demanding that they return company property.
• The lawsuits themselves look frivolous and immaterial but they could drag on for years meaning that Mr Wu looks increasingly entrenched in his position.
• While this dispute drags on, the acquisition of Arm by NVIDIA is very unlikely to be completed.
• NVIDIA is clearly unwilling to take on this dispute as it has not yet filed for regulatory clearance for the acquisition with the Chinese regulator.
• I think that this because it is waiting for a resolution to this dispute before it is willing to proceed to apply for regulatory clearance which on its own could take a significant amount of time.
• The problem now is that it could be years before the dispute is resolved which in turn will increase pressure on NVIDIA to back away from the transaction.
• Pressure has also been brought to bear by a number of Arm’s key customers who are understandably uncomfortable with technology upon which they are dependent being owned by a competitor.
• This is not a new issue and has for years prevented Arm from being acquired by anyone in the semiconductor industry.
• Hence, the logical thing to have done when considering a transaction of this nature would have been to visit Arm’s customers, explain how independence would be maintained and gain their approval before proceeding.
• I had assumed that NVIDIA and SoftBank had cleared this hurdle with Qualcomm, MediaTek, Apple, Google, Samsung etc. before proceeding and it beggars belief that Softbank did not go down this road.
• The problem for SoftBank is that to break even on the transaction, SoftBank would need to achieve an EV / revenues of around 15.0x.
• The Philadelphia Semiconductor Index (SOX) is trading around 7.6x with the long-term average of 5.2x which would make this target pretty challenging.
• Consequently, this would all be about how well SoftBank can position Arm as an enabler of next-generation technologies which are in vogue in the currently non-sensical, narrative-driven market.
• Failure to achieve this would result in a heavy loss being realised on a relisting of Arm which is why I expect SoftBank to try and get this acquisition through with IPO as a last resort.
• With the increasingly problematic situation at Arm China, customer objections and the UK’s investigation, the probability of Softbank falling back on this last resort is daily becoming more likely.
• I think that this is the best outcome as it is increasingly becoming clear that the technology industry would be best served with Arm being a publicly owned, fully independent company.