SoftBank faces inferior exit options for chipmaker Arm if Nvidia deal fails

SoftBank Group Corp. may struggle to find an alternative exit route for Arm Ltd. if the chipmaking unit's sale to NVIDIA Corp. falls through, analysts told S&P Global Market Intelligence.

The $40 billion transaction, announced in September 2020, is facing an in-depth investigation by the European Commission, one of several regulators yet to approve the deal.

Announcing the phase II probe Oct. 27, the EC's Executive Vice President Margrethe Vestager said Nvidia's rivals must have access to Arm's intellectual property, which is highly valued in the semiconductor industry. The deal has attracted controversy for putting Arm's status as an independent supplier at risk. The EC has until March 15, 2022, to make a decision.

As the timeline for the deal — originally expected to have been completed in September — is drawn out, analysts have begun to speculate about the SoftBank Group Corp. unit's future.

The Japanese company acquired Arm in September 2016 and now wants to sell it to reduce debt.

Relisting

Heavy investment in research and development has affected Arm's profit margins, making an IPO more difficult.

"SoftBank has ruined Arm's profitability by forcing them to move outside their core expertise and invest too heavily in artificial intelligence-driven internet of things products and add head count," said Mio Kato, analyst at LightStream Research.

In its earnings release for the June quarter, SoftBank said Arm had made a profit for the first time since the quarter ended March 2017. The Japanese company acquired Arm in September 2016.

"Arm's investments in R&D, that resulted in the segment losses in prior years, are now driving the segment income gains," SoftBank said. The unit posted a net income of ¥8.78 million in the three months ended June 30, up from a net loss of ¥6.55 million in the prior-year period.

Not including Arm's IoT business in the Nvidia deal was SoftBank's way of making the sale "more palatable," Kato added. SoftBank has heavily invested in the IoT business, targeting sectors such as automotive, connectivity and data management.

"Arm is yet to show sustained profitability, so an IPO value seems a long way away from the $40 billion NVIDIA price tag right now," said Dan Baker, director of equity research at Morningstar. He added that an IPO would only be possible in two years so Arm could improve its profitability.

Arm declined to comment. An NVIDIA spokesperson said: "We are working through the global regulatory process and we look forward to addressing any concerns they may have." SoftBank did not respond to S&P Global Market Intelligence's request for a comment.

'Neutral' buyers

A sale to a trade buyer such as Apple Inc. or QUALCOMM Inc. would achieve a better valuation than an IPO, analysts said. Apple and Qualcomm did not respond to S&P Global Market Intelligence's requests for comment.

In 2020, Apple started using its own custom-designed Arm processors, rather than Intel's, for its Mac range. Acquiring Arm would allow the smartphone-maker to make supply chain efficiencies, Baker said.

Meanwhile, QUALCOMM CEO Cristiano Amon told Bloomberg Studio 1.0 on Sept. 15 that the company would be willing to invest in Arm through a consortium to avoid NVIDIA from acquiring it.

Other chip companies could face the same regulatory issues as NVIDIA, as authorities globally are worried about the "structure" of the chip industry, said Jefferies analyst Atul Goyal.

Private equity funds could instead step in as "neutral" buyers, Baker said. Established U.S. firms such as Bain Capital and KKR could "easily" invest over $10 billion each, Kato said.

Bain Capital declined to comment. KKR did not respond to S&P Global Market Intelligence's request for comment.

NVIDIA's $40 billion valuation of Arm has made the asset "more attractive," according to Kirk Boodry, an analyst at Redex Holdings.

"Before NVIDIA announced the bid, investors did not think Arm would be valued at more than $32 billion, when SoftBank bought it in 2016. With NVIDIA's bid, investors are bound to think there is more value," Boodry said.

NVIDIA agreed to pay SoftBank a total of $21.5 billion in NVIDIA common stock and $12 billion in cash, including $2 billion at signing. SoftBank will also receive almost 44.3 million NVIDIA shares and, subject to meeting certain performance targets, up to $5 billion in cash or common stock.

NVIDIA's share price has climbed to $222.42 as of Sept. 16, up from $128.72 when the company first announced the Arm acquisition in September 2020.

China lawsuits

Whichever exit option SoftBank pursues, it may have to first reassure investors that an ongoing dispute concerning the CEO of Arm China, Allen Wu, will not impact the unit's success, analysts said.

Arm China's board voted to dismiss Wu in June 2020 for failing to disclose having created a competing fund that invests in companies that use Arm technology, according to a South China Morning Post report.

Wu refused to leave and remains in charge of the unit, which is majority-owned by a consortium of Chinese investors, with Arm retaining a 49% stake. One of the Chinese investors, Ningbo Meishan Bonded Port Area ARM Investment Management Partnership, launched a case against the board's attempt to oust Wu.

The status of the dispute will have to be disclosed to potential bidders and investors, Boodry said. They may want reassurance that it will not impact Arm China's performance, analysts said.

Arm China did not respond to S&P Global Market Intelligence's request for comment on the matter.

In 2017, approximately 20% of Arm's revenue came from China, SoftBank said in a 2018 presentation.

NVIDIA was willing to overlook uncertainty around the lawsuits because of the competitive edge that it would receive over Advanced Micro Devices Inc. and Intel Corp. with Arm under its wing, Kato said.

"AMD and Intel are getting to the point where they can offer a holistic set of solutions comprised of central processing units, graphic processing units and for field-programmable gate arrays, or FPGAs. NVIDIA's offering outside of GPUs are weak so buying Arm would help it compete in a very attractive area," Kato said. CPUs, GPUs and FPGAs are hardware solutions for artificial intelligence operations and data centers.

Both AMD and Intel have bolstered their presence in FPGAs, known to be more efficient for data operations, through acquisitions. AMD is in the process of buying Xilinx, an FPGA market leader, for $35 billion. Intel acquired FPGA-maker Altera in 2015 in a $16.7 billion transaction.