Did China Just Buy One of the World’s Most Important Companies?
This company holds the keys to the future of electronics.
It’s not hyperbole.
Like a spider sitting in the middle of the web, this company sits firmly at the heart of the future of electronics.
I’m talking about ARM Holdings (ARMH).
ARMH’s microprocessors power more than 95% of the world’s smartphones. They have a 65% share of the computer accessory market. And a 90% share of the hard drive and SSD market. Their reach and dominance extends far beyond the world of the internet. For example, they have a 95% share of the auto processor market. (Full disclosure: They are also the only stock I still own.)
ARMH‘s business model is simple: they specialize in the design of microprocessors and they license the designs to other semiconductor companies. For $10M a year, any company can go through the ARMH library and choose any of ARMH’s designs. The advantage of being a design house means that everyone uses them: Samsung, Intel, Apple.
It has been said that ARMH is the biggest consumer product in the world.
I agree: In 2015, 20 billion chips shipped using ARMH technology. Their designs are the core of the critical components of virtually all consumer electronics: smartphones, tablets, TVs, and so on. For example, most of today’s tablets and phones run on Qualcomm chips: they did $26 billion in sales last year. These chips re-package ARMH designs.
And it is for this reason SoftBank offered to buy ARM Holdings for $32 billion last week (July 18) – a 42% premium to its previous day’s closing price.
Meanwhile, Softbank’s acquisition of ARMH will deliver a huge blow to Intel (INTC) for two reasons.
Intel was interested in buying ARMH. And in this post-PC world, Intel is struggling.
Their first problem is that they have the wrong type of products. Intel specializes in large, powerful and power-hungry semiconductor chips. But the future lies in small, application specific, energy-thrifty chips.
The second problem is that Intel does everything in-house and they don’t “play well” with others.
Compare that to ARMH which deliberately makes their technology available to anybody.
The easy solution was to buy ARMH. ARMH would’ve been its life preserver. And a way to buy their way back in. Unfortunately, anti-trust issues were likely a major factor preventing Intel from purchasing ARMH.
It might not be game over yet. With ARMH in play, perhaps Intel will field an offer of their own. Or, as I will discuss in a moment, Intel may be part of the ARMH deal after all.
But the real question is: Who is Softbank?
Who is Softbank?
One thing stands out when reviewing Softbank’s business… there is absolutely no synergy between the two companies. That is exactly the point.
Softbank comes out of the 1990s Internet boom. Its history is long…
Based in Japan, they started as a mobile phone telecom company. They then bought the big annual computing conference COMDEX. And also partnered with Yahoo! to establish Yahoo! Japan.
Using massive debt, Softbank then embarked on a series of investments, mostly focused on the telecoms and internet space (They recently bought Sprint.)
Today, they carry $89 billion in debt… and have always had cash flow problems which affect their ability to pay off that debt.
However, one of the investments was to a start-up by Jack Ma – called Alibaba. Leveraging the Yahoo! partnership, Softbank and Yahoo! each took a 1/3 share of Alibaba.
Softbank’s investment in Alibaba is where things get interesting.
Today, Softbank’s stake in Alibaba is single-handedly saving them from bankruptcy.
Why? Because Alibaba isn’t just an “internet company.” It dominates China’s internet economy. They’ve spent approximately $35 billion in various (mostly Chinese) companies in the last two years alone. Investments ranging from e-commerce to travel to shipping.
Alibaba is everywhere.
Alibaba didn’t get to dominate the internet economy today because it is the “best.” It dominates the internet economy because it got China’s official blessing.
If you know China, then you know relationships matter.
And where Alibaba dominates the Chinese economy, Softbank is behind the scenes as a controlling shareholder. Softbank may be based in Japan, but it is absolutely a Chinese company.
It is a clear indication that hardware and semiconductors are no longer a part of Softbank’s current business focus.
The China Angle
I believe that ARMH is China’s way to become a dominant semiconductor player.
You see, semiconductors are a major capital outflow (expense) for China. China spent approximately $100 billion last year on semiconductors. And it’s a major capital inflow for South Korea and Taiwan, whose economies are driven by semiconductors. Beyond economics, semiconductor strength enables national security strength (think: super computers). And it’s also a point of pride: developed economies tend to have strong domestic semiconductor industries.
The Chinese government want to bring that in-house. It has made the development of a domestic semiconductor industry a major strategic goal.
It used its leverage as the major customer of semiconductors to squeeze semiconductor designers and manufacturers into doing more business in China. It has even earmarked $10 billion for intellectual property development.
But the fastest path to become competitive with its Asian neighbors is through acquisition.
Last year in July, a $23 billion offer was made by Tsinghua Unigroup to buy Micron Technology (MU). Micron sells memory (DRAM) which is, like ARMH processors, a fundamental product used everywhere. The U.S. government blocked the offer for national security reasons.
Of importance is that Tsinghua Unigroup is a semi-government entity – set up and funded by the government as part of the drive for building a semiconductor industry. And speaking of Intel and Tsinghua, Intel just invested $1.5 billion in Tsinghua for a 20% stake. (I’ll come back to this very important point in a moment.)
So let me paint the picture. The Chinese government has an industrial policy to jump-start a domestic, world-class semiconductor capability. They have – through shell companies like Tsinghua – been putting their money where their mouth is.
Having tried to buy a major core semiconductor company and been rebuffed, buying ARMH (through a state-owned enterprise) would’ve struck a nerve. Buying the crown jewels of the internet would’ve ruffled feathers with the Western world.
It also would’ve come at a hefty price.
So instead, it used SoftBank as its proxy.
SoftBank = China
Recall that SoftBank specializes in telecommunications and the internet. Same with their key asset, Alibaba. Why would they want to buy a major semiconductor company? Why, with $89 billion in debt, is Softbank adding another $31 billion? And who would be willing to lend them that type of money?
The answer: Softbank is not buying ARMH for themselves.
One possibility is that Softbank on its own is front-running a bigger China budget. That $10 billion budget is not even table stakes at the big tables. Perhaps, with its strong insight into the Chinese business and political world, Softbank is anticipating that more funds will be made available – which they want to be able to take advantage.
Or perhaps Softbank was tapped to be the buyer, but not the ultimate buyer. After all, who is lending them the $31 billion to close the deal? Especially when they can’t come close to servicing their current debt load.
The Chinese banks have the money.
Softbank will earn a lot of political credits for doing the Chinese government a favor in its effort to ramp-up a semiconductor company.
Don’t be surprised if we see an announcement in a year or two that ARMH is up for sale and the buyer is a major Chinese company.
This was a brilliant move by the Chinese. They are making a play to buy the most important company in the world.
It is a death-blow to Taiwan. Literally.
If ARMH goes to China, Taiwan’s semiconductor economy will rapidly unwind because China will have all the leverage to force more on-shoring (domestic business.)
How to play this: This deal likely won’t happen. Far too many players in the ecosystem want to block it. While ARMH is based in the U.K., Silicon Valley has a strong and vocal lobbying group. And given the impact on Taiwan’s future, perhaps the Ambassador to the U.K. is meeting with his counterparts to review the deal. (Which will be interesting in and of itself – whose leverage is strongest with the U.K.)
This sets up two possible and opposing scenarios:
1) ARMH price drops because the deal gets blocked. Or;
2) ARMH price surges because a competing offer gets placed.
Personally, I am selling and booking profits now. Any counter-offer will be only slightly above Softbank’s whereas there is a real risk of watching the whole deal fall apart.
KEY POINT: China is making a stealth play for ARMH – one of the most important companies in the world. It is using SoftBank as a proxy to catch up to its Asian neighbors – Taiwan and South Korea – to compete in the semiconductor industry. Don’t be surprised if ARMH is up for sale in the next two years… and a Chinese company sweeps it up. But it is also likely that the deal won’t go through in the first place. Too many “players” are at risk if the Chinese get hold of ARMH.
Editor of Moneyball Economics