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Breakingviews

Breakingviews - Nvidia's $40 bln Arm deal is risky chess move

An ARM and SoftBank Group branded board is displayed at a news conference in London, Britain July 18, 2016. REUTERS/Neil Hall

HONG KONG (Reuters Breakingviews) - Nvidia has played a risky opening chess move. The U.S. listed graphics-chip specialist led by Jensen Huang will buy UK chip designer Arm from SoftBank and its Vision Fund in a deal worth up to $40 billion. But Arm’s customers and regulators may baulk, and the chunky price tag presupposes huge growth and market share gains.

Huang is the industry’s most prescient boss. His track record of moving into promising, fast-growing markets like chips for video games and more recently, data centres, has helped more than triple Nvidia’s market capitalisation to $300 billion since 2019. Now it will pay $21.5 billion in shares and $12 billion in cash for Arm, and an additional $5 billion if the target hits certain financial targets down the line. SoftBank will end up with as much as 8.1% in the enlarged group, which will also issue $1.5 billion worth of stock to Arm employees.

Combining Arm’s computing expertise with its new parent’s technology in artificial intelligence, high-performance computing and more will create a powerful player in booming markets: Nvidia forecasts the addressable market for data centres will hit $80 billion by 2023, for example. Arm’s business model of licensing out intellectual property will also benefit from more R&D as well as from offering Nvidia’s technologies to customers. The deal implies an enterprise value of at least $33.5 billion or, with the earn-out, a decent increase on the $32 billion SoftBank paid in 2016.

Yet Huang will have to stretch to earn a return on Nvidia’s minimum investment of $35 billion, including the stock granted to Arm employees. Nvidia is betting that the considerable investment made by SoftBank into Arm’s operations will help profit ramp up quickly. Even so, on the last fiscal year’s roughly $1.8 billion in sales, Arm made an operating loss. For Nvidia to bag, say, a 10% return, the target will have to generate a massive $4.4 billion in operating profit, assuming a 21% U.S. corporate tax rate, according to a Breakingviews calculation.

Growth will depend on winning over many of Arm’s customers like Intel, which compete with Nvidia, as well as anti-trust regulators around the world. And appeasing politicians will further squeeze returns: Nvidia has pledged to expand Arm’s UK operations as lawmakers there worry about a loss of jobs. Huang’s designs on the chip industry will be tested.

This article has been corrected to show SoftBank paid $32 billion for Arm, and that the sum from Nvidia deal represents a decent increase in the third paragraph.

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