By striking a deal for its chip unit ARM Ltd. that includes a significant portion of shares in buyer NVIDIA Corp., parent SoftBank Group Corp. is hoping for long-term gains on its 2016 investment. But the transaction comes with valuation and execution risks for the Japanese tech company, analysts told S&P Global Market Intelligence.
Nvidia agreed to pay SoftBank Group Corp. $10 billion in cash and $21.5 billion in common stock. Another $5 billion could be added to the deal price if Arm meets certain financial targets, pushing the gross transaction value to $36.5 billion.
While this total is higher than the approximately $32 billion SoftBank paid for Arm in 2016, whether the Japanese company achieved an optimal return on investment remains to be seen, analysts said.
"The whole idea [behind SoftBank's purchase of Arm] was, the cost increase, the increase in Arm investment to drive growth. But the growth has not happened yet. So they are selling it before the growth happens," Stacy Rasgon, managing director and senior analyst at Sanford C. Bernstein & Co. LLC, said.
SoftBank delisted Arm on purchase, freeing the company up to make substantial investments without the scrutiny of profit-focused shareholders. At the time, SoftBank said it would relist Arm by 2023.
"If you look at Arm's growth in the last couple years, it has flattened out. They have been investing heavily which brought down the profitability. And we have not seen evidence of that investment resulting in any incremental growth, at least not so far," said Srinivas Pajjuri, a senior semiconductor research analyst at SMBC Nikko Securities America.
"It seems reasonable that they are getting close to 44 million consideration. Could an IPO bring in a better valuation? Potentially. We have to see what the revenue forecasts are for Arm and what the margin expectation is over the next couple of years," Pajjuri said.
A key aspect of the transaction is that Arm's internet of things division is not included, the analysts said. The IoT business enjoyed particularly high investment levels under SoftBank.
On deal close — expected in 18 months — SoftBank will hold a less than 10% stake in Nvidia, and the upside potential is strong, analysts said. "There are clear synergies between Nvidia and Arm, so long term they could probably create much better value by leveraging the tech from both," Pajjuri said.
The Nvidia holding will also lessen SoftBank's reliance on Alibaba and could "serve as a strong support for future buybacks," Jefferies analyst Atul Goyal wrote in a note. "In our view, buybacks remain the most important factor for SoftBank investors in near/medium term."
Nevertheless, the stock-heavy deal bears some risk for SoftBank, the analysts said. Nvidia's stock rose by 164% in the 12 months leading up to the deal announcement. There is considerable potential for growth, analysts said.
"[Nvidia's] number one strategic focus is to add a CPU to their GPU leadership into the data center and I think that is where you are going to see a lot of value added in the overall Arm ecosystem if the deal is closed," Ruben Roy, a senior analyst in Benchmark Co.'s semiconductor research division, said.
"I think there is a lot of value in Arm, especially as we get to the 5G era," he said. "I think a lot of the ancillary markets beyond handsets that get turned on through 5G are going to be Arm-based, such as automobiles."
But there is also a good chance the value of Nvidia stock will drop, the analysts said. The transaction also has several execution risks, the analysts said.
Regulatory scrutiny, along with possible opposition from Arm's rivals and customers, could derail the acquisition altogether, the analysts noted. The deal is subject to approval from authorities in China, the U.S., the U.K. and the EU.
A failed deal would threaten SoftBank's plans to monetize $41 billion worth of assets, amid pressure from activist investor Elliot Management to reduce the gap between the value of its holdings and its enterprise value. Elliot Management declined to comment on the deal.
