The Chinese Conundrum
British chip designer Arm is poised to embark on a substantial financial endeavor with its upcoming initial public offering (IPO), aiming to secure approximately $5 billion. However, within this ambitious move lies a significant cause for concern—its engagement with the Chinese market. In this comprehensive analysis, we delve into the intricacies of Arm’s relationship with China, shedding light on the potential risks and implications for its IPO.
A Quarter of Sales from China
In its IPO prospectus, Arm dedicates considerable attention to cautioning potential investors about the intricate web of connections it maintains with China. Astonishingly, one-fourth of Arm’s sales are derived from this colossal market. However, this is no ordinary business relationship; Arm’s dealings with China are characterized by a lack of control and a complex historical backdrop.
The Enigmatic Arm China
Arm China, an entity operating independently of its parent company, stands as Arm’s single largest customer. Neither Arm nor SoftBank Group exercise control over its operations. This arrangement not only highlights Arm’s vulnerability but also its unique dependence on a market that operates autonomously.
Vulnerability to Economic and Political Risks
Given the sheer scale of its presence in China, Arm finds itself particularly susceptible to economic and political uncertainties. Tensions between China and either the United States or the United Kingdom could exacerbate these risks, a factor that has already contributed to a lower market valuation than anticipated.
The Impact on Royalties
Royalties are the lifeblood of Arm, constituting a significant portion of its income. The company’s revenue is intricately tied to fees collected from every chip developed using its products. Any disruption in this chain could have far-reaching consequences.
The IPO Pricing
Arm recently set the price of its shares at $51 each, aiming to raise nearly $4.9 billion, with the potential to reach $5.2 billion if banks opt to purchase additional shares. This valuation falls short of the $64 billion implied by SoftBank’s recent purchase of a 25% stake in the company.
The Geopolitical Equation
Arm’s return to the stock market is garnering widespread attention, primarily due to its strategic importance in the semiconductor industry. The ongoing tension between the United States and China over technology supremacy further complicates Arm’s situation.
The Regulatory Spotlight
Former US Securities and Exchange Commission Chairman Jay Clayton has advocated for public companies with substantial exposure to China to disclose specific risks tied to the country. This has raised questions about how Arm, given its complex relationship with Arm China, will navigate this regulatory scrutiny.
The Complexity of Arm China
Arm’s indirect ownership in Arm China, standing at just 4.8%, is channeled through a convoluted corporate structure. While such arrangements are not uncommon in China, they pose challenges, particularly amidst increasing tensions.
Past Troubles and Ongoing Legal Battles
Arm China has a history of late payments, which, though not substantially impacting operations so far, raise concerns. Additionally, a legal battle involving its former CEO, Allen Wu, remains unresolved. These factors could potentially cast a shadow over Arm’s future.
Big Tech’s Confidence in Arm
Despite these challenges, major global tech giants, including Apple, Google, Nvidia, AMD, Samsung, and TSMC, have expressed interest in being cornerstone investors in Arm’s IPO. This underscores Arm’s strong industry position but also leaves investors to grapple with the China risk.
Timing and Investor Perspective
As Arm navigates these complexities on its path to IPO, it stands at a crossroads. The timing of this offering appears opportune, but investors must carefully assess and account for the China risk in their evaluations.