In ARM's Way

| About: ARM Holdings, (ARMH)


ARM's acquisition by SoftBank makes financial sense for ARM's shareholders but for no one else.

The investment in ARM by SoftBank has no broader implications for the post-Brexit UK economy and in particular for the attractiveness of the UK to foreign investors.

There are no cost savings to be achieved through this transaction and the potential for additional revenues for ARM through cross-selling is not realistic.

The proposed acquisition of the Cambridge, England-based chip designer ARM Holdings (NASDAQ:ARMH) for over €24 billion (about $32 billion) by Japan's SoftBank (OTCPK:SFTBY) (OTCPK:SFTBF) is a move with many implications that can be viewed through several different perspectives. It can be seen - and is being propagated - as evidence that Brexit does not mean that the UK will become a less attractive environment for investment. It will be seen as Mr. Son's next bold move following the abrupt departure of his erstwhile successor Nikesh Arora. It will be interpreted in terms of a statement about the future of the IoT market and the impact on Intel and other semiconductor vendors.

ARM has operated successfully through delicately calibrated partnership-based relationships with a fractious set of customers, including primarily almost every maker of mobile devices. Mr. Son has stated that he will retain this business model. He has also said that investment and employment in the UK will be increased and ARM's headquarters in Cambridge will be retained. Well of course he would say that to ensure, as has happened, that the new UK Government would welcome this acquisition as evidence of the bright economic future that the UK can anticipate post-Brexit.

However, it is hard to avoid the conclusion that ARM has only accepted this offer because it is one that it cannot refuse on purely financial grounds. ARM does not probably believe that its ownership by SoftBank will strengthen its position and give it additional resources and capabilities and access to new customers so it can exploit additional revenue opportunities as a leader in low cost, low power chips in an IoT-dominated future. ARM has grown at a compound annual rate of about 15% over the past ten years, fueled by the smartphone market that is now showing signs of saturation. From SoftBank's perspective, the acquisition would only make financial sense if it proves possible to increase ARM's operating profit several times over, which in turn implies an "irrationally optimistic" growth rate in revenues. SoftBank and ARM have no overlapping businesses, so any additional value from the acquisition cannot come from cost savings but would have to be built on cross-selling opportunities that are a well-kept secret.

Regarding the message this transaction may contain for a post-Brexit UK economy, sadly ARM is an only too rare albeit admirable example of a world-beater UK-based company based on intellectual property. Hardly any of ARM's revenues come from the UK. Extrapolation of this example to argue that foreign investment in other sectors and companies of the UK economy with completely different profiles will be stimulated or even maintained post-Brexit is not justified.

The SoftBank transaction gives ARM an enterprise value of about £23.3 billion taking its cash of $1 billion into account, or over 24 times its 2015 revenues of just over £968 million, about 20 times its estimated 2016 revenues, and almost 57 times its adjusted profit after tax of almost £429 million. Notably Mr. Son has been involved in over 140 deals over the past decade. His most remarkable and outstanding success was his acquisition of the mobile operator Vodafone Japan in 2006 that has transformed the landscape of the Japanese mobile market. Most of these deals have been consummated since 2012, including notably in the US the No. 4 mobile operator Sprint (NYSE:S), whose turnaround after a long and unbroken series of strategic mistakes and incompetent management prior to its acquisition by SoftBank has still not been assured, and the retailer Brightstar, as well as a Japanese baseball stadium, the online Indian shopping company Snapdeal and the Finnish gaming company Supercell.

SoftBank recently raised some $20 billion by selling part of its stakes in Alibaba (NYSE:BABA) and Supercell. Alibaba, the dominant Chinese e-commerce company, is an example of Mr. Son's investment success, initiated with $20 million in 2000. This investment may rank as one of the most successful investments ever. But past performance is not necessarily a guide to the future, and today SoftBank carries $88 billion of debt. Investors might have preferred to see SoftBank use this cash to reduce this debt. The combination of low interest rates, a weak pound and its cash make the ARM deal easier for SoftBank than it might otherwise have been. Nevertheless this deal has no apparent strategic logic unless the combination of a chip designer, mobile networks and consumer technology businesses is viewed as a fertile basis for synergies and the creation of additional value beyond the sum of its parts.

The only likely obstacle to the consummation of SoftBank's acquisition of ARM, given the complaisant attitude of the UK Government, would be a counterbid from a semiconductor vendor. Intel (NASDAQ:INTC) has repeatedly been rumored as a potential buyer of ARM, given its own multi-billion dollar failures to become a strong force in low power microprocessor markets, notably in the mobile communications space where ARM architecture dominates. Samsung (OTC:SSNLF) is another potential suitor. Both these companies have solid strategic reasons for acquiring ARM, although in contrast to SoftBank they would face antitrust concerns.

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