Breakingviews - Arm M&A offers SoftBank a tricky route to riches

LONDON (Reuters Breakingviews) - SoftBank Chief Executive Masayoshi Son overpaid for UK chip designer Arm when he bought it for $32 billion in 2016. A sale to $257 billion Nvidia, which the U.S. giant has considered according to Bloomberg, offers the best chance of salvaging a return. Yet the qualities that make the purchase attractive would also make it controversial for antitrust agencies – and for Arm’s customers.

SoftBank’s acquisition, which was priced a 43% premium to the Cambridge-based group’s undisturbed value, always looked punchy. Arm’s EBITDA subsequently fell by 21% in the year to March 2019, as Son pushed the company to focus on research investments. To earn, say, a 10% internal rate of return on the investment - ignoring debt financing, currency swings and spinoffs for sake of simplicity – a sale this year would have to fetch about $47 billion.

Public markets investors are unlikely to assign that kind of valuation to Arm. It would represent 25 times the past financial year’s revenue. That’s implausibly high, since fast-growing semiconductor star Nvidia only trades at 21 times trailing sales, according to Refinitiv data. The industry as a whole is valued on a multiple of just 4 times.

Selling to the Californian company run by Jensen Huang might ensure Son a more valuable exit. Nvidia could make sure that Arm’s designs for general processor chips fit with its strategy for graphics chips, the type in which it specialises. The two groups might also be able to share costs. A half-cash, half-stock acquisition at $32 billion would leave Nvidia’s net debt at a comfortable 1.1 times EBITDA. Son would probably gladly take shares, since he has invested in Huang’s company before.

Competition authorities would be less relaxed, though. Arm’s designs are so ubiquitous in computers, smartphones and other gadgets that Nvidia would have the power to discriminate against competitors like Qualcomm. European antitrust agencies usually take issue with such transactions; so might America’s. A sale could even push other chipmakers to reduce their dependence on Arm, damaging its future revenues. Selling to Nvidia offers the tantalising prospect of rescuing Son from his exuberance. But it will be tricky.