Arm & NVIDIA– The unthinkable pt. IV

IPO may end up being the best way forward.

• The latest revelations with regard to NVIDIA’s acquisition of Arm from SoftBank again increases the probability that the acquisition fails, resulting in an IPO outcome which is increasingly looking like the best outcome for everyone except SoftBank.
• The US has now followed the UK and the EU in increasing its scrutiny of the planned acquisition which was not unexpected.
• However, what was unexpected was that this comes following concerns raised by the very companies that I had assumed would have been consulted about this transaction prior to it being announced.
• According to the FT’s (usually pretty reliable) sources who are identified as “people who are familiar with the matter”, Qualcomm is one of the companies which has raised concerns to regulators.
• Bloomberg, using similar sourcing also identifies Alphabet (Google) and Microsoft as companies who have raised competition concerns with the authorities.
• I always treat anonymous sources like this with caution but both Bloomberg and the FT have separate sources who are saying the same thing which increases the likelihood of these sources being accurate.
• Consequently, I think the probability of this acquisition being completed has fallen yet again.
• For many years, Arm was considered as un-acquirable due to its position in the technology industry as a supplier of key processor IP to almost everyone in the industry.
• Consequently, the minute anyone in the technology industry tried to acquire Arm, it would raise all sorts of competitive issues.
• SoftBank is effectively a private equity company and as such, it was able to acquire Arm mostly for its Vision Fund meaning that Arm’s independence was never questioned and the deal passed pretty easily.
• However, NVIDIA is a competitor to many of Arm’s customers which immediately raises very clear competitive concerns.
• 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 which now appears not to be the case.
• I have also long believed that the main motivation for this transaction was more about SoftBank’s desire to restructure, reduce debt and risk than NVIDIA’s desire to buy the company.
• This transaction is looking increasingly difficult with Arm’s problems in China (see here) and regulatory investigations in Europe (see here) and now that the key customers appear not to have been consulted.
• There is a pretty easy fix for this problem that will keep everyone happy (except perhaps SoftBank) and that would be to relist Arm on the London Stock Exchange.
• This would solve all of the competitive concerns but the big question would be valuation and whether SoftBank would be forced to book a big loss on its investment in Arm.
• SoftBank paid $31.6bn in 2016 to acquire Arm which at the time was extremely profitable.
• Since that time, investments into expanding the reach of Arm into areas outside of smartphones and tablets have meant that profitability has fallen significantly although it is higher than it was a couple of years ago.
• In calendar Q4 2020 Arm reported adjusted EBITDA of $84m on revenues of $556m and looks set to report fiscal year 2021 revenues of around $2.1bn.
• Hence, 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.
• This is unfortunate as it is increasingly becoming clear that the technology industry would be best served with Arm being a publicly owned, fully independent company.