Following the shock result of the Brexit referendum and the subsequent collapse in the value of the pound, the next shock – at least in technology circles – was the announcement that Japanese telecoms and internet giant, Softbank, had made an agreed offer to buy leading UK chip designer, ARM. This was, apparently, waved through by the Prime Minister, notwithstanding the recent announcement of her support for a new industrial policy which might be thought to favour encouraging growth of businesses like ARM into global giants like Softbank and therefore preserving ARM’s independence.
In this short article we consider from a corporate governance point of view the pros and cons of the decision of the ARM board to sell the business.
History of Arm
ARM was set up by the manufacturer of Acorn microcomputers in 1983 as Acorn Risc Machine (standing for Reduced Instruction Set Computing), being a design which used simplified instructions to enable faster processing. This Cambridge, UK operation started a successful collaboration with Apple shortly afterwards and separated off the business as an independent company, Advanced Risc Machines in 1990, in a joint venture with Apple. This company later became ARM Ltd after flotation of its parent company, ARM Holdings in 1998.
The development of these low-power highly efficient chips led to their being used in the emerging market for mobile devices, in preference to those of the market leader in chips for desktop computers, Intel. This rapidly growing new industry, increasingly led by Apple, provided the transformative catalyst for ARM, which was able to establish a dominant position in the market for mobile devices, despite its relatively tiny status in the global technology world.
Through relentless innovation ARM progressively built a very profitable business licensing its core technology to producers of chips who were able to build their own special capabilities around the ARM core. And from a business which had flirted with bankruptcy in the mid-1980s, by 2015 it had revenues of nearly £1bn and after tax profits of nearly £0.5bn.
ARM’s designs are behind 15bn chips currently sold and Intel has withdrawn from the market for mobile processors. However, this steady growth now has a small cloud appearing in the sky which is the approaching saturation of the market for mobile phones. Hence ARM has been developing its presence in the market for networking and the new “internet of things”.
History of Softbank
Softbank was the creation of Japanese entrepreneur Masayoshi Son, who founded his Tokyo-based company in 1981 as a distributor of packaged software. He quickly extended into publishing magazines about personal computers and software and by the early 1990s set up Softbank Holdings in the USA directing itself at the growing internet businesses. He then moved into the events business, taking a stake in the technology business which owned Comdex, the PC fair. In 1996 he set up a joint venture with Yahoo in Japan and in the same year bought Ziff-Davis Publishing, owner of PC Week and a source of technology information, formed a partnership with News Corporation and relocated the business to Tokyo.
Over the next few years he built the technology business and in 2004 acquired Japan Telecom. In 2000 he had invested around $20m in the early days of Jack Ma’s Alibaba and in 2005, together with Yahoo, he established a strategic partnership in China with Alibaba. In 2006 he bought the Japanese subsidiary of Vodafone. By 2012 Softbank was big enough to acquire US mobile telecoms company Sprint Corporation for $20bn and in July 2016 it made an agreed offer of £24bn for ARM.
Mr Son is a visionary entrepreneur who is a lifelong believer in the future of technology and is prepared to gamble big in the furtherance of his beliefs.
Takeover approach by Softbank
In June 2016, Mr Son approached, first the CEO of ARM in Silicon Valley, then its chairman, on holiday in Turkey, to propose that Softbank should acquire ARM. Within two weeks a deal had been agreed between the board of ARM and Mr Son. During this time Mr Son had taken the precaution of enlisting the support of the new British Prime Minister, Teresa May, and her new chancellor of the exchequer.
The deal valued ARM at £24bn, 56 times 2015 earnings and 24 times turnover and priced the shares at a 43% premium to their pre-bid level.
Mr Son thus pre-empted mooted bids by Intel and Samsung, both of which would, however, have faced regulatory or competition issues.
Since the flurry of interest in late July, everything has gone quiet but Softbank’s website indicates steady progress towards completion, which has been reported as planned for early September.
Mr Son’s approach included verbal commitments to support ARM’s UK operation and to invest to enable it to be a leader in the new Internet of Things – the prime reason, he says, that he was attracted to the deal.
“The UK has been very good at inventions but very poor at exploiting them”
Let’s look briefly at how the interests of the various stakeholders are likely to be affected by this takeover.
ARM shareholders: those shareholders who wanted to cash out will presumably be pleased at the windfall gain. Those in it for the long haul and looking for the building of a major technology company with a global reach will see the opportunity removed from their grasp.
ARM employees: the employees have been promised enthusiastic backing and massive financial support. At first sight, therefore, they should have nothing to worry about and every reason to feel confident that they have an owner who thinks long-term. A possible concern is whether the current management, which has been so successful in recent years, will be subject to unforeseen pressures as a result of becoming a small part of a gigantic conglomerate based in Japan.
ARM customers: ARM’s current strength is substantially related to being a designer of chips which can license its technology to other chip manufacturers and users of chips without fear of conflicts of interest. It will probably be at least a partial comfort to many of its customers that ARM is not being sold to another chip manufacturer, though there is bound to be uncertainty about the loss of independence.
UK technology capability: here there is more cause for concern. One of the abiding criticisms of British technology over many decades is that the UK has been very good at inventions but very poor at exploiting them compared, for instance with the USA. This extends to the seeming impossibility of growing UK technology companies into global corporations like Apple or Oracle or IBM. In the context of Teresa May’s declaration about the need for a new industrial policy to address this failing, the sale of one of the few globally significant UK technology companies to an overseas owner looks unhelpful to say the least.
Softbank shareholders: there doesn’t seem to be any industrial logic in putting ARM into the stable of businesses currently owned by Softbank, but Softbank shareholders will presumably believe in Mr Son’s eye for a deal, which enabled him to make a very large fortune out of a very small investment in Alibaba. Outside analysts will look on this more sceptically – until ARM generates the growth in value which Jack Ma has achieved. Of course, that was based on Mr Ma’s leadership and owed nothing directly to Mr Son, and it would therefore seem to require a similar standard of entrepreneurship from the future leadership of ARM.
Applying our Five Golden Rules to the decision faced by the ARM board, let’s consider them in turn:
Ethics: nothing in Softbank’s record would suggest any problems here
Goal; the key issue would seem to be whether a decision to sell adequately reflected the goals of the key stakeholders. Softbank appears not only to endorse ARM’s current policies but willing to support growth and expansion into related applications and hence the future wellbeing of the business. So the only major issue is whether those shareholders who wanted to stay in for the ride are being denied this wish. Unfortunately for those who don’t wish to sell, they would appear to be outnumbered by those who do.
Strategic management: the change of owner is unlikely to change the style of management, based on Softbank’s track record
Organisation: the extra financial resources being promised should, if delivered, enhance ARM’s organisational and financial strength
Accountability and transparency: here the jury must be out since, as part of a Japanese controlled conglomerate, there will probably be less information publicly available.
Hermann Hauser, one of ARM’s founders, regretting the sale, told the Financial Times:
“The future of Arm could have been determined by the UK management team. Now it will be determined in Japan”
If ARM was still owned by Mr Hauser, clearly it would have been wrong for the board to advocate a sale against his express wishes. On balance, however, notwithstanding his recent remarks, we would judge that the board made the right decision.