The Nvidia-ARM Deal Will Likely Be Shot Down by Paulo Santos (Good update)

The Nvidia-ARM Deal Will Likely Be Shot Down
Jan. 14, 2021 12:54 PM ETNVIDIA Corporation (NVDA)SFTBF, SFTBY, SMICY…205 Comments61 Likes
Summary

The ARM acquisition by Nvidia is interesting at a point where ARM is set to dominate.
Historically, this acquisition would close normally.
However, presently, I believe the acquisition will be shot down by regulators.
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Nvidia (NVDA) acquiring ARM from SoftBank (OTCPK:SFTBY) seems like an interesting deal, in spite of the large price tag. It seems like an interesting deal because, increasingly, ARM-based designs seem poised to rule the computing landscape, from mobile devices, to PCs, to servers (and also microcontrollers, which it already dominates). However, I think this deal will fail regulatory scrutiny. This article will explain why.

First, as is typical for such deals impacting the entire world, many countries’ regulatory agencies dealing with competition will have their say on the matter. Entities in the U.S., Europe, the United Kingdom, China and Japan will certainly have a say in approving or disapproving this deal.

If this deal happened a few years ago, in my view only the United Kingdom might have some problems with it. The problems would revolve around intellectual property, headquarters and research facilities remaining in the United Kingdom, and they’d probably be solvable – just like they were solvable when Softbank, Japanese, acquired ARM back in 2016.

However, that was then and this is now. And now, the world has changed a lot. There are at least three geographic zones which might oppose this deal, with varying intensity. Let me start by the most intense:

China

China will not approve the Nvidia/ARM deal, period. It won’t approve it unless the U.S. posture toward China changes very significantly during the Biden administration. China can’t even rationally approve the deal. Let me explain why.

In 2019, in the context of an ever more aggressive posture toward China and an ongoing trade war, the U.S. placed Huawei in an entity list. This action limited the ability of U.S. companies to supply Huawei with components for its various products from smartphones to 5G base stations.

This already was a large problem because among components Huawei used were such things as Google Android, namely its Google Play and Google Services components. The lack of these components immediately put Huawei smartphones at a large disadvantage in the international marketplace. Other products which were impacted were things like laptops because of a lack of OEM Windows support or x86 CPUs. US companies provide lots of other supplies, so the situation was immediately very difficult for Huawei.

However, the U.S. went further. In what I think is a very controversial measure, the U.S. expanded the Huawei blockade not just include supplies by U.S. companies, but also supplies by foreign companies using U.S. design software of semiconductor fabrication equipment. That is, the law now also applied to foreigners in foreign lands (with associated sanctions for non-compliance).

This escalation meant that Huawei was basically shut out of all modern components, including DRAM as well as semiconductor fabrication services at TSMC (TSM). That is, although Huawei could (very ably) design its own chips, it couldn’t then produce them in the most advanced process, and as a result it would always have less competitive CPUs going forward. This measure basically affected all of Huawei’s business up to and including selling smartphones in China, which had until this point been sheltered from impact.

Now, notice the following:

Huawei is China’s technology champion. Yet a foreign power, applying laws outside its country and to foreign corporate citizens, basically declared war on Huawei. A blockade, which was what Huawei was subjected to, is an actual act of war (when applied to ports, cities, countries).

Later on, the U.S. also did the same to another critical Chinese technology company, Semiconductor Manufacturing International Corporation (OTCQX:SMICY), which is a competitor to TSMC.

And to add insult to injury, this action by the U.S. had the most impact on Huawei through making TSMC obey U.S. law. TSMC is Taiwanese, and China considers Taiwan to be Chinese. So, in practice, this was the equivalent of a foreign power writing laws applying to Texas forbidding Texan companies from supplying U.S. companies. Imagine how that would go down in the U.S.

A brief background. In the course of China’s Communist revolution and civil war, in 1949 the defeated Nationalists withdrew towards Taiwan, handing full control of the mainland to communist forces. Communist China was about to also invade Taiwan (which was part of China), however in 1950 the U.S. started military patrols on the Taiwan strait which prevented this invasion from taking place. Since then, there’s something of a role play where China says Taiwan is Chinese but doesn’t force unification through military force, yet doesn’t exclude those means either. Indeed, China’s posture towards Taiwan is that military force would be used it Taiwan seceded (implying Taiwan hasn’t seceded).

It’s in this context that China simply cannot give its approval to a U.S. company acquiring ARM. Simply put, that acquisition would take away the only relevant CPU architecture which China can still use without requiring US approval. China cannot allow this to happen and thus will not approve the merger, and will likely set draconian measures in case it still goes through without its approval.

United Kingdom

United Kingdom’s first priority is to keep jobs, technological know-how and IP in the United Kingdom. Softbank offered assurances and was trusted in those assurances. Assurances from a US company might be harder to trust, especially when Nvidia will want to realize synergies – something which didn’t bother Softbank.

The above would happen with any acquirer. However, surprisingly, even the UK has been paying attention to the Chinese situation, and some fear its own companies could one day suffer from the same coercion or export control limitations. You don’t need to trust me on this. Even an ARM co-founder expressed this same opinion:

Hermann Hauser said the sale to the American chip maker would be a ‘disaster for Cambridge, the UK and Europe’ and see the ‘last European technology company with any global relevance sold off to the Americans’.

…

Hauser said the UK government should impose rules on the sale in order to protect jobs, retain Arm’s long-standing ‘open business model’, and protect against ‘US security reviews on its client relationships’.

Anyway, the UK is a very close US ally, so although there is some resistance the deal might still be pushed through.

Europe

Where I think a surprise could happen would be in unforeseen resistance to the deal in Europe. Indeed, Peter Mandelson, a former EU trade commissioner, already has publicly expressed doubts about the deal. His main reason again is similar to what I expressed for China and (partially) the United Kingdom:

Nvidia being an American company, the acquisition would transfer powers to the U.S. administration which could then impose export restrictions on chips to protect national security interests and promote foreign policy objectives.

“The U.S. would have the power to shut-off chips … in companies or countries the U.S. doesn’t like,” he said.

The former minister contended that “at the European level, they talk about Europe’s strategic interest, without really seeing how this concept operates in the real world.” ARM is the “biggest example” which touches on the concepts of “sovereignty and autonomy.”

He added: “Europe’s got to have a much better and clear understanding on how geopolitical power can be used to Europe’s detriment. Not just by China, but even by one of its closest allies, the United States.”

As I said, a decade ago this would have been seen as some kind of lunacy. The U.S.? Interfering in Europe’s sovereignty? Bollocks!

The thing is, the world changed a lot in the last 10 years. And Europe, amazingly, already has had the chance to taste a bit of what Peter Mandelson alludes to. How? Through the events which took place regarding Nordstream 2, a natural gas pipeline between Russia and Germany.

This is a project between Russia and Germany. It only concerns Russia and Germany (and Europe in general). Yet, the U.S. already is coercing European companies to not work on this project by imposing sanctions if they do. That is, the U.S. is writing law for foreign companies working in foreign lands, just like it did to Taiwan vis-à-vis China.

Likewise, Europe already is tasting this effect in tech, with companies like STMicroelectronics or ASML being forced to stop selling to Chinese customers, lest them be hit with U.S. sanctions as well. Again, a foreign company in a foreign country selling to another foreign country. Odder still, the U.S. often opens exceptions for U.S. companies while not approving licenses foreigners (this is beyond believable, but real).

Between the need to protect European access to advanced technology, the need to serve the Chinese market and the need to keep sovereignty and independence, this factor might well be enough to push Europe to also not approve the ARM/Nvidia merger. Notice if this happens, it will be a truly amazing outcome – implying it’s more acceptable for Europe that ARM is owned by Japanese owners than U.S. owners. Both are equally foreign (to Europe).
The Alternative

If Softbank fails to sell ARM to Nvidia, it will likely IPO ARM. In fact, in the current extremely hot market, Softbank might even get a larger valuation for it. This was viewed as a possible plan by Softbank, before it turned to a pure sale.

For Nvidia, things would remain the same – Nvidia would still have access to ARM technology, as ARM licenses its technology to all comers (including Chinese companies). If the deal is shot down, it could however have a temporarily negative impact on Nvidia’s share price. It also could limit Nvidia’s future potential, as we seem in the cusp of a move away from x86 and towards ARM on every computing device.
Conclusion

Mostly due to recent events (which took place within the last two years), it now seems quite possible that one or more foreign regulators will disapprove of Nvidia’s intent to acquire ARM.

This seems a certainty for the Chinese regulator. But it also seems possible that either the United Kingdom, or more likely Europe, also will oppose the deal.

This conclusion would have been very different five or 10 years ago.