Softbank’s acquisition of ARM Holdings was not only unexpected, but also the valuation was astonishingly high. Softbank is acquiring ARM for $32.2B or 23x CY15 revenue and 46x CY16 earnings. This was a 46% premium to the prior day’s closing price before the announcement of the acquisition. The questions to ask are: Why is Softbank buying ARM, and why are they paying so much?
Softbank is primarily a communications and media company. It is accustomed to making large investments with long-term pay offs that create an annuity. For example, investment in communication infrastructure and wireless spectrum are large up front investments that provide long-term dividends and cash flow. Softbank’s long-term goal is to become a technology company that focuses on information technology. The importance and growth of artificial intelligence and the automatic accumulation of knowledge frames the company’s long-term vision. Over time, ARM could have the potential of leveraging Softbank into a leadership role in the data economy along with the Magnificent Seven: Google, Facebook, Amazon, Microsoft, Alibaba, Baidu, and Tencent.
In the PC era, technology was dominated by Microsoft and Intel who together captured a majority of the profits. The hardware and software in the current mobile technology era is dominated by ARM and Android with Apple, Google and Facebook who monetize this generation of technology. I would argue that the next era will be the data era which will be dominated by connecting things commonly known as the “Internet of Things” (IoT). IoT’s dominant microprocessor architecture and operating system are yet to be determined; however, increasingly the value creation will be in the data generated by the large number of connected things. In the coming years, the data economy is estimated to be worth $1.6T. This includes value from productivity improvements, proactive maintenance, and ad placement on the web. ARM is the entry price for Softbank’s participation in the data economy.
In 2015, ARM had a 32% unit share in its served markets. According to the company, this is up from 22% in 2011. ARM base chips’ market share as measured by revenue in 2015 was roughly 50% surpassing Intel’s overall processor market share. Softbank has indicated that it would double ARM’s R&D budget, which would accelerate its roadmap and drive further market share gains, thus squeezing out all other architectures except Intel. This would result in unit market share of processors in the 60-80% range over the next 10 years and would be equivalent to 60-80B ARM based chips a year. I believe roughly 20-30B of these chips would have an IP address and would be connected to the Internet. With this level of dominance, it would take decades to displace ARM due to the massive amount of code written for ARM’s instruction set. This dominant position would potentially provide Softbank with tremendous leverage in the data economy. What is yet to be determined is how Softbank would monetize this market position.
ARM is the processor of choice in IoT applications along with Synopsis’s ARC processor. ARM is also developing an operating system and platform for the IoT, called mbed. With control and/or over site of the architecture, operating system, and platform specifications of IoT, ARM would be positioned to extract more profit out of the proliferation of connected things. In simple terms, if Softbank could generate $1 of recurring revenue for each ARM processor connected to the Internet in 2025, this would generate roughly $30B in revenue per year far surpassing ARM’s current revenue of $1.5B.
Here are a few possible avenues for monetizing ARM’s architecture: