The Shrinking of Arm

In the wake of the implosion of Nvidia’s attempted acquisition, Arm yesterday announced that it would cut up to 1,000 jobs. During its attempt to get regulatory approval for the deal, Arm management testified to UK regulators that without the deal the company would have to make job cuts. So one interpretation of the latest news is ‘Arm management was right’. That being said, another interpretation of the news is ‘What have they been spending so much money on?’.

As we detailed in our earlier notes, Arm has an effective monopoly on its supply of processor Instruction Set Architectures (ISA) for its customers, which is everyone in mobile, and many other fields. But for reasons going back a long way, Arm has mis-priced its technology, to the point that they collect only a few pennies even on the most expensive phones (not really pennies, but a small amount). At the same time, they have considerable expenses. Developing ISAs requires a big staff of expensive computer scientists.

When Softbank acquired Arm, everyone assumed that the Japanese conglomerate would pour cash on Arm allowing that company to create all kinds of wonderful things. Today’s news implies that the former was true, the latter not so much. During the five years Softbank owned Arm, the most noteworthy thing Arm produced was…well, it is actually pretty hard to come up with anything that stands out. They advanced their roadmap (some would say too slowly), and they made a lot of announcements around servers, IOT and other new areas (some would say nowhere near enough). They made some attempts to change their pricing structure to attract start-ups (with little to show for it). Scan back Arm news over the period, and other than the Nvidia deal, the biggest headlines about Arm focus on its ill-fated China JV. As we noted in our piece from last month when the deal fell apart, Arm has done very little to build new ecosystems.

Arm management did warn that being a public company, as they are now likely to become again, would mean cost cuts to satisfy “short-term” public market investors. A generous take on that sentiment holds that the company needs to completely overhaul its Investor Relations strategy. With an IPO the company has the ability to calibrate expectations, to lay out their strategy, and set targets they think they can achieve. As we always tell companies, determine what is right for your business first, and then work out how to communicate this to the Street. Public market investors are willing to judge companies on the metrics they set for themselves.

A less generous interpretation of Arm management’s view is that they have had things easy for six years and are now in the process of resigning themselves to the return of public market scrutiny. But even here, the logic falters. Anyone who owns a company – whether public market shareholders, a ‘visionary’ tycoon, or another public company – is going to expect some return on their investment and hold company management accountable to those goals. The fact that Softbank appears to have been somewhat lax in setting goals for Arm is no excuse for Arm’s need to now rethink its cost structure.

A cynical interpretation of all this is that Softbank is looking to maximize its return. They lost out on the opportunity to sell to Nvidia for $40 billion, and are now stuck with a much slower exit at a presumably much lower valuation. And one way to juice enhance their return is to ratchet down costs to make the numbers look better. This is exactly the situation we wrote a book about – the mismatch in incentives between outgoing investors and incoming buyers during an IPO. The trouble with that is the likelihood it leaves newly-public Arm with a set of goals it cannot hope to achieve.

This looks like a set-up for a very difficult future for Arm. They are cutting jobs, and presumably scaling back their ambitions. This diminishes their growth outlook at what is a fairly crucial time. They have so many challenges to overcome – they need to fix China; fix their server, IoT and Auto offerings; and fend off RISC V – all while going public in what is likely to be a challenging offering for the Street to accept.

We are really looking forward to seeing their latest financials when they file to go public.

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