By Charles King, Pund-IT, Inc. July 20, 2016
The proposed acquisition of UK-based ARM Holdings, LTD by Japan-based Softbank has generated more than a little controversy and commentary since its announcement on Sunday. That’s certainly related to the $32B size of the all-cash offer, but the deal also touches a number of economic, business and political third rails. Those are worth examining, as is the likelihood of the success of the venture if it closes according to Softbank’s plans.
Do the dollars make sense?
In an IT industry used to “unicorn” company valuations, ARM’s $32B price tag should make eminent sense. After all, the company is deeply entrenched in its core markets, is solidly profitable (which is more than any unicorns can say) and appears well-positioned to pursue opportunities in emerging growth markets, particularly Internet of Things (IoT) applications.
But ARM’s long term outlook may also be problematic for the company’s proposed suitor, especially in the short term. While profitable, ARM is not a huge engine for cash. The company’s business is growing at roughly 20% annually, with FY 2015 revenues amounting to about $1.49B and netted $473M. That’s a nice chunk of change, especially for a company that makes its living designing/licensing microprocessor intellectual property (IP).
But $473M looks fairly puny next to Softbank’s $32B offer and the related debt it’s taking on for the deal (adding to the billions in debt the company is already carrying). How will Softbank prosper from its investment? That’s hard to say. Growth in many of ARM’s traditional mobile markets is slowing, and perceived opportunities in data center and IoT applications have yet to take flight. Outside of raising licensing fees and/or renegotiating contracts with ARM customers, the short term outlook seems pretty bleak.
So why is Softbank making so large a bet on those longer term prospects? I expect the company hoped to discourage other potential buyers, thus escaping a potentially higher price. ARM could be a handsome prize for many companies, and a number of vendors would likely have considered bidding. By coming in on the high side with its own offer, Softbank likely eliminated serious competition and, it would argue, minimized its own risk.
Call it a $32B strategic feint that was deeply appreciated by ARM’s shareholders. But for Softbank shareholders (who trimmed 10% or $7B off the company’s stock price the day after the deal was announced)? Not so much.
Business as unusual
Some issues have been raised about the purchase, including concerns about the depth of Softbank’s understanding of ARM’s core business. That’s a reasonable concern since Softbank is best known for its investments in high-flying Internet firms. To its credit, the company addressed those points fairly straightforwardly, including highlighting the common values of “technology-oriented culture, long-term vision, focus on innovation and commitment to attracting, developing and retaining top talent” that is shares with ARM.
Some other issues are not as easy to deal with, including potential competitive conflicts that may arise when the world’s preeminent designer of wireless CPUs is purchased by a company that also owns a major cellular provider (Sprint). That issue seems less important from my perspective since Softbank has actively attempted to sell or spinoff Sprint, an effort I expect will continue after the ARM deal concludes.
In addition, the IT industry has numerous examples of vendors that commonly collaborate and directly compete with their partners. Microsoft’s Surface devices were hardly welcomed by PC vendors but that didn’t slow their development of Windows-based products. Add in Sprint’s relatively minor market position (as the fourth place U.S. carrier) and competitive issues don’t appear to be a huge threat. Overall, so long as Softbank maximizes transparency into its own and ARM’s business dealings, it should be able to minimize or eliminate appearances of conflict.
Politics – Balancing negatives/positives
Not surprisingly, political concerns related to the deal are somewhat murky. With ARM being the UK’s largest and most financially successful IT company, its sale to a foreign concern is lighting up opinion pages and letters to the editor both on and offline. The deal is also being tied, not too successfully, to the recent Brexit vote. Softbank has addressed this with expressions of respect for the company’s management and engineering leadership, as well as promises of further technology and workforce investments.
Concerns about the deal’s impact on other regions have been less focused, an interesting point given Softbank’s position in its home region. Considering the longstanding tensions between Japan and China which have been heightened by the latter’s offshore territorial claims, it would be easy to assume that ownership by a Japanese corporation might risk a sizable portion of ARM’s business, over half of which is with Asian companies, many of them in China.
But while Softbank is best known in the U.S. as the owner of Sprint and a major Yahoo Japan shareholder, it was also an early investor in and remains significant (28%) shareholder of Alibaba, the Chinese ecommerce giant. Given the care that the Chinese government takes with investments by companies outside its borders, it seems reasonable to conclude that Softbank holds a position of trust in China. That could eventually pay significant dividends for ARM, especially if problems between the Chinese and Western governments become intractable or escalate.
So taking the title of this commentary to heart, is Softbank and ARM a match made in heaven or one headed for hellish rocks? Frankly, I’d argue that it’s a little of both. The deal’s greatest and most immediate beneficiaries are ARM’s shareholders who will enjoy a 50% premium on a stock that pays minimal dividends and has traded in a fairly narrow range for the past three years.
On the other side, Softbank’s existing shareholders may feel as if they’ve landed in purgatory. That’s what comes of watching the company take on additional billions in obligations, even as it fails to find bidders for a failed previous $20B+ investment (Sprint) and has been forced to selloff valuable Alibaba shares to reduce its debt load.
Softbank may eventually prove its doubters wrong, and have a quiet laugh at their lack of courage and foresight regarding purchase ARM Holdings. But as things look today, the way from here to “I told you so” is going to be a long and difficult road.
© 2016 Pund-IT, Inc. All rights reserved.