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Prospective investors in Arm’s initial public offering have raised concerns over the UK chip designer’s exposure to China, after the release of a prospectus that warned of “significant risks” in the way the company was set up to do business there.
Over the past three years Arm has confronted a succession of difficulties over doing business in China, from losing control of its local unit for nearly two years to a renegade chief executive, to facing obstacles registering a deal to offload its stake in the ailing venture.
Now the company — which derived a quarter of its revenues from China in its most recent financial year, according to its IPO prospectus filed on Monday — is heading for a US listing at a time of increasing worry over the direction of China’s economy and geopolitical tensions over control of vital technology such as chips.
Managers at four separate funds considering an investment in Arm told the Financial Times that the prospectus for the planned listing on Nasdaq in September confirmed some of their fears about the global semiconductor industry as stances harden in Washington and Beijing.
Arm warned investors that its large concentration of revenue from the Chinese market made it “particularly susceptible” to economic and political risks, and noted that these could even be exacerbated by tensions between China and either the US and UK with respect to trade and security.
These issues undercut SoftBank’s pitch that Arm would benefit from the growth of the tech industry alongside the likes of Nvidia, the US chipmaker which has leapt to a $1tn market capitalisation on the back of huge demand for chips that can develop artificial intelligence products.
“When you read through the risks that Arm has flagged here, it seems a lot for an investor to digest,” said one institutional investor who said they had yet to decide whether to invest in the IPO. “They are asking the market to buy what they admit are some pretty big China risks but at Nvidia multiples, and that will take some effort.”
Not all will be put off, though. Shares in SoftBank, which owns Arm, briefly rose 1.4 per cent. An internal transaction earlier this month between SoftBank Group and its Vision Fund — an investment vehicle that the Japanese conglomerate manages — valued Arm at $64bn.
The Arm prospectus said China had been a significant source of semiconductor industry revenues and growth, but its prospects were now unclear.
The warnings swept from macroeconomic issues affecting China and the global economy to more granular issues concerning the running of a company whose designs were embedded in more than 90 per cent of the world’s smartphones.
The prospectus also flagged the fact that neither Arm or SoftBank controlled the operations of Arm China.
“Despite our significant reliance on Arm China through our commercial relationship with them, both as a source of revenue and as a conduit to the important [Chinese] market, Arm China operates independently of us,” the prospectus warned, adding that Arm did not have any direct management rights or the right to representation on Arm China’s board.
David Gibson, an analyst who covers SoftBank at MST Financial, said the China risk described in the prospectus was larger than the market was expecting, and that the investment case would have to be made strongly during the upcoming investor roadshow.
“These royalty revenues have been under pressure in the second half of the period which increases those concerns of growth for Arm longer term,” he said.
Arm’s business has already been rocked by growing tensions between Beijing and Washington. Blocked from buying some of its most advanced chip designs because of US export controls, Chinese companies are increasingly moving to design chips on top of the open source Risc-V standards. Sales from Arm China in the second quarter dropped 16 per cent year on year to $139mn.
“Management expects China revenue to moderate going forward,” said Kirk Boodry, a SoftBank analyst at Astris Advisory in Tokyo. “But it also puts more pressure on the rest of the world to deliver the high growth needed for higher valuations.”
Arm’s prospectus skips over the stand-off surrounding its exit from its problematic Chinese joint venture. The UK group said it transferred its 48 per cent stake in Arm China to a SoftBank entity last year. According to people familiar with the move, Chinese officials concerned about losing Arm’s participation in the local unit have declined to register the share transfer.
Lawyers and officials in China say that without the official government registration, the status of the share transfer is complicated. “If a transfer is not registered, it’s just a civil matter between the two shareholders, and the true shareholders remain as shown in the registry system,” said Xia Hailong, a lawyer at the Shanghai Shenlun law firm.
Despite the muddied situation, Arm has de-consolidated Arm China’s results from its financials. In April the chip designer acknowledged the share transfer was “not registered with the PRC authorities” in a UK financial filing, but claimed it was completed and had been advised the “registration status does not affect the validity” of the transfer.
Legal experts familiar with the IPO situation say the ownership structure of Arm China was described in accordance with US regulatory requirements even if the share transfer is not yet reflected in the Chinese registry. Arm declined to comment.
For Arm, distancing itself from Arm China helps to separate the UK group from thorny unresolved issues in the country. For instance, the ousted chief executive Allen Wu has launched a number of suits against the company and remains in control of about 15 per cent of shares. In addition, the man chosen by the government to replace Wu was a government adviser who spent more than a decade facilitating technology transfer to China.
In its IPO filing, Arm acknowledged “several lawsuits” filed by Wu and his associates could still cause a “material adverse effect” if the Chinese courts decided against its local partner and forced changes to Arm China’s governance or management structure.
“To date, all cases that have been resolved at the trial court level have been resolved favourably to Arm China but are subject to appeal,” Arm said.
Additional reporting from Tim Bradshaw in London