W(h)ither Arm?

Nvidia’s bid for Arm appears to be at an end. Late last year, the US officially stated its opposition to the deal, adding to pressure from UK authorities and a silence-that-speaks-volumes from Chinese regulators. Last week, the leaks began, with Nvidia (or its bankers) testing the waters on formally ending the bid. In the past week, we have been fielding a lot of questions about what will happen to Arm now.

Japanese neo-conglomerate Softbank owns Arm today. And while they have kept largely silent on the topic, it seems likely that want an exit. This is by no means a foregone conclusion. When they initially started the sale to Nvidia, Softbank was under heavy financial pressure. Those pressures are largely eased, so they have more options, but our guess is that Softbank is still looking for a way out. Or more precisely, they are looking to maximize the return on their investment. They have some time to decide, but the most likely outcome is an IPO for Arm.

We say most likely because there seems to be some opposition to this. Last week, eeTimes published a article looking at Arm’s regulatory filings to the UK which specifically call out the deficiencies for an IPO. Admittedly, this is a very biased document, pleading with the UK to allow the Nvidia deal because all the options are so bad. Nonetheless, we found this quote highly revealing:

As Arm’s CEO, Simon Segars, explained: “We contemplated an IPO but determined that the
pressure to deliver short-term revenue growth and profitability would suffocate our ability to
invest, expand, move fast and innovate.”

This is a common refrain we hear from management teams and we find it wholly disingenuous. Blaming Wall Street for a company’s short-term focus misses the whole point of shareholder capitalism. Companies should set their business objectives and then communicate those to the owners. Public market investors can then decide if they want to stay in the stock or not. Quarterly earnings reports should not drive business strategy, this all works the other way around. Every management team worth its weight should be measuring itself against its stated objectives, and they should be doing it every month not every quarter. The fact that they have to present quarterly results is just a communications problem. One which we have a few thoughts in how to manage.

Arm has a monopoly on some of the most important Intellectual Property (IP) in the entire semiconductor industry. They should have no problem generating sufficient cash flow to fund investments in that IP.

Arm’s biggest problem is not the expectations of shareholders, it is their ongoing organizational and management structure. For starters, they have long mis-priced their core IP, giving their biggest customers outsize discounts. (And let’s not forget they probably signed a bunch of sweetheart deals in recent months to bring big customers on board the Nvidia deal.) On the other side of that coin, they are over-charging new entrants. RISC-V, the open source Arm alternative, does not exist because it is superior technologically, it exists because no rational start-up can afford to pay for Arm’s upfront licensing charges. A brand new chip company has choices today in choosing its processor IP, by contrast the big, long-term customers have no choice. Companies like Qualcomm or Nvidia are never going to port their core products off Arm. They have far too much invested in tooling and processes to make that effort worthwhile.

Second, Arm has completely failed to invest in developing software ecosystems around markets it wants to enter – notably Data Center, Automotive and IoT. Ask anyone around the ARM server CPU space what actions Arm has taken to bring software developers on board – crickets. Arm should have been holding quarterly developer conferences in the Bay Area, San Francisco should be swamped with Arm t-shirts and Patagonia vests, but our guess is that few software developers even know who Arm is, let alone care enough to port their products over. Arm is concerned that they will not have sufficient funds to do this kind of work as a public company, but they were not doing that work when they had a parent with the deepest pockets around.

Now, regardless of their personal feelings about being public, it seems very likely that Arm will have an IPO some time in the near-ish future. Ultimately, this will come down to Softbank’s interests. We suspect that what they would like to do is first list Arm China (assuming that soap opera reaches some conclusion). China’s public markets afford much higher multiples to semis companies than US and UK markets. Then they could list the parent company and value it off that China piece (much like Yahoo! was once valued for its stake in Alibaba). Our friends in China tell us the practicalities of this structure are not feasible in China’s regulatory climate today. So we will likely see an Arm IPO next year in London (but please at least consider New York), and then Arm management will have to contend with public investors. For management, the good news is that they may be surprised how little public investors care about near-term results, but they will likely be very uncomfortable about how public investors feel about the long-term questions.

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