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Archive for July, 2016

Reverse Acquisition

Monday, July 25th, 2016

Gabe Moretti, Senior Editor

It has been now one week since SoftBank of Japan has announced its intention to acquire ARM for a little over $32 billion in cash, an eye popping 43% premium from the stock price before the announcement.  As I have remarked in my previous blog:“ The ARM – SoftBank Deal : Heart Before Mind) the financials do not make sense, but, after a week of consideration and after reading Junko Yoshida’s interview of Masayoshi Son, SoftBank CEO, I can see how it makes strategic sense.  This is of course my interpretation, not something SoftBank would ever confirm.

I started by considering how Japan has not been able to recover from its industrial near collapse, in spite of its use of every financial tool, both conventional and somewhat unconventional.  There is only one thing left to do: get foreign companies, especially those leading in their fields, to invest in Japanese companies.  But of course, there have been no takers. What to do next: buy one!  And that is what SoftBank has done.

I should have trusted my intuition immediately.  Looking at the title of my blog I wrote ARM- SoftBank Deal.  It should in fact have been SoftBank – ARM deal, since SoftBank is the acquiring party.  Here is what is actually happening.

SoftBank is “lending” ARM $32 billion to “purchase” SoftBank.  Masayoshi Son has stated: “I may choose to become ARM’s Chairman of the Board”.  He has also stated that the reason for the purchase is to use ARM products within all of the fiscal deals SoftBank is involved in at this point like: Vodaphone Japan, Alibaba, and TaoBao.  Any entry in new markets is analysts speculation.

Yoshida reports Son stating: ““ARM will become central to SoftBank’s core business in three, five and 10 years’ time,” he said.  Note he did not say that ARM will provide new markets, only that it will strengthen existing ones.  And since ARM will be a wholly owned division of SoftBank, there will be no regulations compelling SoftBank to divulge operational details of ARM that it does not choose to make public.  Thus much of what SoftBank will do under the ARM cover will remain private.

Should we expect another such move from Japan,Inc.?  I will be watching the financial news carefully for a while now.

The ARM – Softbank Deal: Heart Before Mind

Tuesday, July 19th, 2016

Gabe Moretti, Senior Editor

If you happen to hold ARM stock, congratulation, you are likely to make a nice profit on your investment.  SoftBank, a Japanese company with diversifies interests, including Internet provider, has offered to purchase ARM for cash by tendering $32.4 billion dollars.  SoftBank is a large company whose latest financial result show that it made a profit of $9.82 before interest payments and tax obligations.

ARM, on the other hand, reported for 2015 fiscal year revenue of $1.488.6 billion with a profit of $414.8 million and an operating margin of 42%.  This is a very healthy operating margin, showing a remarkable efficiency by all aspects of the company.  So, there is little to improve in the way ARM operates.

What seems logical, then is that SoftBank expects a significant increase in ARM revenue after the acquisition, or an effect on its profit due to ARM’s impact on other parts of the company.  ARM profit for 2015 were 414.8 million British sterling and the revenue in sterling was 968.3 million for a ratio of 42.8%.  Let’s assume that SoftBank instead invested all of the $32.4 billion and obtained a 5% return or $1.62 billion per year.  To obtain the same result from the ARM acquisition it would mean that ARM must generate a profit of 3.9 times what it generated in 2015.  This is a very large increase since if we assume that all other financial ratios stay the same revenue would have to be a little over $5.5 billion. Yet, using the growth of 15% realized between 2014 an2015 for every year between 2015 and 2020 we “only” achieve a $2,913.6 billion mark.  And keeping the growth ratio constant as revenue increase gets harder and harder since it means a large increase every year.

So the numbers do not make sense to me.  I can believe that ARM could be worth $16 billion, but not twice as much.  And here is another observation.  I have read in many publications that financial analysts expect the IoT market to be $20 billion by 2020.  Assuming that the SoftBank investment, net of interest charges, returns 5% per year in 2020, it would mean that ARM’s revenue would be $5.5 billion or over 25% of TAM (Total Available Market).  This, I consider impossible to achieve, simply because the IoT market will be price sensitive, thus opening ARM to competition by other companies offering competitive microcontrollers.  SoftBank cannot possibly believe that Intel will go away, or that every person will own three cell phones each, or that Google will use only ARM processors in its offerings, or even that IP companies like Cadence and Synopsys will decide to ignore the IoT market.

I am afraid that the acquisition marks the end of ARM as we know it.  It will be squeezed for revenue and profit like it has never been before and the quality of its products will suffer.