Arm China – Turning point

SoftBank & Arm finally get the upper hand.

• The fight for Arm China that is causing consternation to Arm’s IPO looks to be in its final stages but it has taken an intervention from the Chinese state to unfreeze the process.
• Arm China is a joint venture between Arm and local Chinese investors that was set up to both allow the dissemination of Arm’s technology into China and to facilitate the development of China-specific IP that would be sold alongside Arm’s IP.
• Arm owns a 49% stake in the venture and until a couple of years ago, this structure was of very little interest until the board ousted its CEO with a 7 to 1 vote.
• Unfortunately, Arm China’s CEO, Mr Allen Wu refused to leave and because he had physical possession of the corporate stamp, no one else was able to issue any official documents or get rid of him.
• This situation has been at an effective stalemate for 2 years as I suspect that SoftBank was unwilling to meet the ever-increasing settlement demands from Mr Wu.
• All through this, Mr Wu had an edge which was that China’s ancient corporate laws mean that whoever has possession of the stamp effectively controls the company.
• The obvious move was to file a petition with the Chinese state to remove Mr Wu and allow Arm to create a new stamp to replace the one that Mr Wu has been refusing to relinquish.
• The problem with this is that until recently, the probability that the state would do much beyond pointing at the courts was very low, but the impending IPO changed that.
• This is because an IPO needs audited documents to be made available and the current situation was preventing an audit on Arm China from being carried out.
• One remedy for this was to move the Arm China shares out of Arm and into SoftBank which would fix the audit issue but would remove a large amount of revenue from Arm.
• This would make it even harder to achieve the target valuation as the revenue and profit from operations numbers would all be significantly lower, therefore, demanding a higher multiple at the same price.
• Consequently, the best solution is one which gets rid of Allen Wu and returns the company to the control of the shareholders of Arm China without an ownership transfer.
• According to the FT (see here) it was the possibility that Arm China would effectively leave China that spurred the government to act which is what has given Arm and SoftBank the upper hand.
• The process has been a drama worthy of a series on Netflix, but the end result is that Arm China shareholders have control of the Shenzhen office and have installed new co-CEOs, Dr Liu Renchen (effectively the state’s representative) and Eric Chen from SoftBank.
• The Shanghai office has yet to be reclaimed by Arm China shareholders, but this probably has more to do with the lockdown in Shanghai rather than any resistance being put up by Mr Wu.
• Hence, I think that this debacle is entering its final straight and the outcome is likely to be that Mr Wu is ousted and Arm China returns to normal operations.
• This is the best outcome for the IPO as I think that a messy workaround such as the one proposed would not have helped the situation.
• In hindsight, it is possible that SoftBank proposed this workaround in order to galvanise the Chinese state to act in exactly the way that it has.
• In this environment, realising the same return from the IPO that it would have done had SoftBank closed the deal with Nvidia is going to be a major challenge.
• This combined with the fact that Arm needs time to return to the high level of profitability that it once enjoyed and deal with the growing competition from RISC-V makes the case for a delay to the IPO.
• This is why it might be better to delay the IPO as the return may be much greater if SoftBank was to wait for a year or two.