Nvidia Corporation’s $40bn Acquisition of Arm Holdings
By: Nicole Phung, Tim Li, and Tobias Winczer
Overview of the deal
Nvidia Corporation is acquiring software design company Arm Holdings from the multinational conglomerate, Softbank. This deal is expected to close very soon as the year comes to an end. The equity and debt combination deal would be one of the largest transactions of 2020 and the largest semiconductor deal of all time. In 2016, SoftBank acquired Arm for $31.4bn, and now it will receive $21.5bn worth of Nvidia stock and $12bn in cash. Nvidia will remain the leader in a strengthened semiconductor industry. In terms of diversification, they will be able to expand its range of products, moving away from overly high-end chips. Since Arm’s chips are estimated to be in 90% of smartphones worldwide, Nvidia could use this advantage to steer towards less sophisticated, more versatile, and wide-spread products.
This deal may be challenging for two reasons. First, for regulatory and anti-competition purposes, Nvidia will have to be wary about fairness clauses set out by government and industry regulators to ensure the deal proceeds smoothly. Second, due to the nature of Arm’s products, Arm provides its products to Nvidia’s competitors, namely Intel and AMD. As such, both parties may have to commit to fairness clauses to safeguard their best interests. However, the latest bump on the road may be more concerning—Softbank is attempting to remove key shareholder Allen Wu, Chief Executive and Legal Representative of Arm China. The dispute, which includes wrongful dismissal claims and conflicts of interest, unfolded in early November and may escalate even further, posing as a potential threat to the success of the deal.
Company Details: Virgin Media
Nvidia Corporation is a multinational technology company that focuses on designing graphics processing units (GPU) for the gaming and professional markets, as well as personal computer graphics, artificial intelligence, and components for the mobile computing and automotive market. As of the second quarter of 2020, Nvidia held 19% of the PC GPU market share worldwide. This was similar to AMD which occupied 18% but significantly less than its other main competitor, Intel which held 64% of the market. However, Nvidia’s market capitalisation recently exceeded $300bn, surging 110% since the start of the year. In contrast, Intel’s has fallen 18% amid delays for its next generation of 7-nanometer chips due to manufacturing problems.
Headquarters: Santa Clara, California, USA
President/CEO: Jensen Huang
Number of employees: 13,775
Market capitalisation: $359.39bn
LTM Revenue: $13.07bn
LTM EBITDA: $4.25bn
LTM EV/Revenue: 24.9x
LTM EV/EBITDA: 73.2x
Advisor: Morgan Stanley
Company Details: Arm Holdings
Arm Holdings is a multinational chip design and research company headquartered in Cambridge, UK. Rather than manufacturing and selling of actual semiconductor chips, the firm’s business model involves designing and licensing of intellectual property rights (IP) to a network of partners, who incorporate the technology into their chip designs. Describing itself as the R&D department for the entire semiconductor industry, Arm architecture powers over 90% of the world’s smartphones and a large share of other electronic devices.
As Arm Holdings was taken private in 2016 following the $32bn buyout by SoftBank Group, all figures below have been taken from its last available public financials:
Headquarters: Cambridge, United Kingdom
President/CEO: Simon Segars
Number of employees: 6250
Market capitalisation: $31.2bn
LTM Revenue: $1.4bn
LTM EBITDA: $644.8m L
TM EV/Revenue: 15.1x
LTM EV/EBITDA: 33.5x
Given the impact on anti-trust laws and Nvidia’s competitors, the most significant short-term consequence that must be considered is how much governments and industry regulators will scrutinise this deal. Despite the CEOs of both companies being confident of regulatory approval, many stakeholders and newspaper outlets are unconvinced as to how they will achieve approval from the US, the UK, the European Union, and in particular, China. This forms part of the ongoing dispute between the US and China, with the Chinese government concerned with how Arm technology, which supplies many Chinese tech companies and mobile phones, will be owned by the US.
Moreover, other governments also have some concerns as to how this will impact Nvidia’s competitors. Since they all utilise and rely heavily on Arm technology, this acquisition gives Nvidia a degree of control over the likes of Intel and Apple. Such impacts on competition will be heavily scrutinised and the likely outcome is that Nvidia will have to strike deals and agree to certain restrictions so that a high enough level of competition is maintained.
A further concern is how one of Arm’s co-founders, Hermann Hauser, raised his own concerns over the deal. He mentioned multiple factors such as how it would negatively impact the UK’s economic sovereignty independent of US interests and UK employment. In particular, he was especially concerned about the implications on the basic business model of Arm. According to Hauser, the deal undermines the assumption that Arm can sell to anyone, which has both short- and long-term effects.
On a more positive note, Nvidia is currently trying to build the UK’s most powerful supercomputer, and this may be aided by the implementation of Arm tech. Named Cambridge-1, it is focused on utilising artificial intelligence to solve pressing medical issues and discover new drugs. This will utilise machine learning algorithms to rapidly analyse millions of molecules before deciding which ones are most likely to be useful in clinical trials, accelerating the typically costly and time-intensive journey of drug discovery.
Finally, Nvidia’s share price surged as much as 8% on Monday 14th September, the day after the deal was announced. Investors reacted positively to this news, especially since the acquisition is expected to be immediately accretive to Nvidia’s adjusted earnings per share and gross margins. However, as seen in the graph (Market Watch), that trend did not continue, and their share price been fluctuating a fair amount since then.
Despite the deal’s probability of failure due to the removal of Allen Wu, it is still plausible to expect the US and China to come to an agreement that ensures China-based chipmakers can access Arm’s Intellectual Property post-acquisition. This is due to the leverage China Arm gives the Chinese government in upcoming negotiations. In the long run, this acquisition will lead to both parties having a strong footing in the industry compared to their competitors. Since Nvidia operates on a licensing model where they license their designs to various companies, which incorporate the designs into their products, this acquisition puts Nvidia in a better position. Moreover, they could also utilise Arm to venture into new industries and achieve diversification at greater ease. More importantly, this acquisition would enable Nvidia to select who can use Arm’s technology. This power extends to their competitors as well. However, this might raise regulatory concerns.
Furthermore, this industry’s growth over the upcoming years is foreseeable. After experiencing a steep decline in M&A activity in the 2010s, 2020 has been the second-highest year of M&A activity in the semiconductor industry. This upward trend is likely pointing towards the potential of a steady growth in the immediate future. Moreover, Covid-19 has resulted in an increase reliance on technology due to work from home arrangements and social distancing measures. This has created a surge in demand in the semi-conductor industry, in which products will be needed to support virtual spaces, connectivity, cloud usage, and servers. On the other hand, regardless of optimism in growth, uncertainty in this industry remains an issue. Covid-19 has been detrimental to the wider macroeconomic environment and so some caution should be applied when considering the future prospects of the industry and both companies involved n this deal.
Risk and uncertainties
Valued at $40bn, Nvidia’s acquisition of Arm is not only the largest-ever transaction in the microchip industry, but also one with significant strategic and geopolitical implications. Given these circumstances, the transaction faces vast uncertainty in terms of obtaining regulatory approval. Three of the main concerns from critics are that Nvidia could destroy Arm’s neutrality-based business model, cut jobs and research capacities in the U.K. and jeopardize Chinese economical sovereignty.
Previously, Arm’s business model was based on designing ‘neutral’ products that companies could license and customise to their needs. This positioning will be put at risk once the firm is owned by Nvidia, as many of Arm’s customers are Nvidia’s direct competitors. According to Hermann Hauser, the co-founder of Arm, such conflict of interest could “destroy the firm’s business model and restrict its future sales significantly.”
Another risk is represented by Nvidia’s history of internalising the production of all its products. While Nvidia has previously issued a statement saying Arm will remain headquartered in Cambridge under the deal and will create more jobs in the U.K., many suspect such commitments will not be held onto unless legal guarantees are put in place. The U.K.’s opposition Labour Party remains concerned the Arm takeover is not in the public interest and criticised the ruling Conservative Party for failing to protect the British chip designer. This could result in the deal being blocked by the U.K. government or the Competition and Markets Authority (CMA).
The last of the three risks, and perhaps the largest one, could be posed by the ongoing US-China trade war. As many Chinese tech companies are dependent on Arm and Chinese investors hold a majority stake in Arm’s China operations, the proposed transaction will need regulatory approval not only from the US and the U.K., but also from the government in Beijing. This is, however, projected to be a very difficult and lengthy process. According to an article in the Chinese state-backed media Global Times, “Arm’s acquisition by an American company would place Chinese companies at a big disadvantage in the market and provide the US government with better means to sanction and control China’s access to technology.” Nevertheless, this barrier to deal closure could be off the table if the trade war eases with the new presidential administration in the US.