Nvidia’s Failed Acquisition of Arm, Explained
Nvidia, the US-based tech giant which also happens to be the world’s second-largest chip maker (by market cap), had a bit of a contrarian day.
In the early hours, news broke that it is abandoning a $40bn megadeal to acquire the UK-based chip designing company Arm from SoftBank.
But as the day picked up, Nvidia also emerged as the seventh-largest US company by market cap, overtaking Meta.
The second development was quite expected in light of Meta’s disastrous earnings parade in Wall Street recently.
However, today, we focus on the first news which, frankly, wasn’t all that surprising either given months of speculation that the deal might fall apart.
But here’s what makes it interesting. Later in the day, SoftBank did an amazing pivot by dusting off an earlier plan — a brand new IPO for Arm. Analysts and valuation pundits immediately sat down to evaluate if the IPO would fetch a similar payday as the takeover offer.
Being a bunch of jolly old analysts ourselves, we bring you our own insights on the merits of the deal-that-would-have-been and the reasons why it possibly fell apart.
Background
Before we delve into the details, here are some basics. Nvidia is a 1993-born Delaware-incorporated Santa Clara-based multinational company. It has built its fortunes successfully by a) forecasting the chip market and b) mastering the art of semiconductor technology.
At a time when the world’s computing platforms ran exclusively on CPU (Central Processing Unit) engines, Nvidia bet big on GPU (Graphics Processing Unit), a more evolved form of computing processing technology. Its business is essentially focused on improving the computational capacity of computers, supercomputers and mobile systems by making specialised chips or microprocessors. And it is THIS strategy that has helped it to beat and overtake contemporaries like Intel which still function somewhat as relics of the CPU-era.
Meanwhile, Arm is a Cambridge-based company that specialises in chip design. Note that it doesn’t manufacture chips but merely designs, licenses and sells them.
Now, Arm’s designs are bought by two categories of companies. The first includes tech heavyweights (Apple, Amazon’s AWS, Alphabet, Microsoft etc.) who make their own chips based on Arm’s designs that run their proprietary devices like smartphones, smart TVs, PCs, laptops, gaming consoles etc.
The second category includes the chip manufacturing companies like Intel, AMD, Qualcomm and, you guessed it right, Nvidia.
Beginning to sense the problem yet?!
The Arm-Wrestling, Explained
If Nvidia were to buy Arm, that would effectively make it a bigger powerhouse in the global chip industry than it already is. Currently, Arm is the Switzerland of the industry because it is famously neutral in selling its designs to other companies. Once merged with Nvidia, the neutrality will effectively evaporate.
To top it off, the merged entity would combine the design specialisation of Arm and the manufacturing strengths of Nvidia to gain a degree of monopoly hitherto unknown.
That’s one monumental way to skirt antitrust laws.
This is why ever since September 2020 (when the deal was first announced), the proposed acquisition has been fraught with opposition. The first to oppose were Arm’s own customers, the Big Tech biggies. For them, the prospect of a monopolistic market, dominated by someone other than themselves, chippedaway at the prospect of profits.
The second and the more radical opposition came from the regulatory side. Both the US Federal Trade Commission (FTC) and UK Competition and Markets Authority (CMA) have fiercely opposed the deal citing two chief reasons:
- Competition — The acquisition would lead to a realistic possibility of less competition, less innovation and more expensive products.
- National Security — The UK’s high-tech portfolio would pass on to a foreign-owned entity.
The deal, if it had still been in the pipeline, would require approval from regulators in the EU and China as well where it’s currently under review. But in light of the FTC suing the parties involved in the transaction, getting regulatory clearance from either jurisdiction had a fat chance.
This isn’t even the first time the FTC has come down heavily on a merger in the chip industry. Remember how it pulled the plug on Qualcomm’s proposed takeover of NXP Semiconductors in 2018? Talk about a two-year-long ball-buster.
The CMA has its own concerns as well. Arm is nothing short of a prize for the British nation which has historically found it hard to let go of its crown jewels. UK politicians view Arm as a strategic national asset and allowing it to pass on to Nvidia would mean shifting it under US control.
And then there is China where not even the tiniest microchip escapes regulatory gaze, let alone a $40bn chip design company. The US may be home to the majority of the world’s chip companies by revenue but China is the world’s biggest semiconductor market. Plus, it exercises domicile control over Taiwan, ergo TSMC, the world’s largest chipmaker.
If Arm is the Switzerland of the industry then TSMC is the Ukraine, a geopolitical tinderbox that invites a veritable quagmire of conflicts. Point is, Nvidia taking over Arm would pose a serious threat to TSMC’s dominance in a crowded and volatile market. So, gaining the CPC’s approval for the merger was equally unlikely as it was from the Western regulators.
A Shot Through Nvidia’s Arm
The thing about being a prized asset — if it’s too valuable then it’s too difficult to sell.
Now that the Nvidia deal is on the back burner, let’s see how profitable an Arm IPO could turn out to be.
Interestingly, Arm went public for the first time in 1998 and remained publicly-held until SoftBank acquired it in 2016 for $32bn. This amount was almost equal to Nvidia’s market cap back then. Today, Nvidia has a market value of $300bn, roughly 10x what SoftBank paid for Arm in 2016.
Coming to the recent deal, that was initially valued at $40bn, has soared in value since, by almost a double. This is because Nvidia’s business is booming. It may have lamented the loss of an arm but from the looks of things, the failed deal hasn’t put much of a pall on its stock (146% rise this year). This is important because the $40bn deal was to be a mix of both cash and stock.
Now, what does this tell us?
Two things, precisely. First, while Nvidia agreed to pay more for the asset than SoftBank did, the price also reflects Arm’s underperformance under the latter. Second, had the deal gone through, it would have been an ideal synergistic alliance. Arm would have transformed Nvidia’s product line-up and, in exchange, its designs would have found a broader application beyond mobile devices, data centres, PCs and Macs.
Given that is no longer a possibility, an IPO route is probably the way to go considering SoftBank’s firm desire to offload interest in the company. Although it’s too soon to predict, some say Arm’s valuation could lie in the range of $45bn if it opted for an IPO (which is a significant haircut compared to the takeover’s current valuation).
But SoftBank seems as determined as ever in reattaching a severed arm (sorry, last arm-related pun! ;)), having wasted no time in effecting a change in leadership at the top by appointing Rene Haas as the CEO.
In any case, the deal managed to bring one of the most important behind-the-scenes businesses of the world into the spotlight before going out again. The last time the semiconductor business witnessed this much action was when Apple decided to ditch Intel in favour of its in-house chip designs which, again, it built with Arm’s help.
(Originally published February 9th 2022 in transfin.in)
