Why The Nvidia-Arm Acquisition Should Be Approved

All eyes are on big tech mergers and acquisitions as political leaders from both parties have expressed concern about the concentration of power.

Most Americans agree that companies like Amazon and Facebook should be broken up, including a majority of Democrats and Republicans, according to a Jan. poll by Vox and Data for Progress.

In this uncertain business environment, Nvidia announced last September that it reached a deal with Softbank to acquire U.K. based semiconductor and software design company Arm Ltd. for $40 billion, making it one of the biggest acquisitions in tech.

Behemoths like Google and Microsoft are opposed to the deal, which requires approval from authorities in at least four governments, including the U.S., U.K., E.U., and China. Qualcomm is fighting the acquisition, as the company relies heavily on Arm for microprocessor intellectual property (IP).

Apple is also concerned as Arm’s IP powers 90% of the world’s mobile processors/smartphones, with both Qualcomm and Apple as major customers. Should the acquisition be approved, it is easy to imagine Nvidia creeping into their territory.

Most of the naysayers, who have themselves been accused of anti-trust and controlling the market as monopolies for decades, are concerned about whether they’ll have equal access to Arm technology after the acquisition closes.

These companies want Arm to be Switzerland — but this may be unrealistic as remaining neutral has resulted in thin profit from designs and licensing. Who will own Arm unless it strategically benefits the company’s core business?

Arm Acquisition Is Not Dead

SoftBank owning Arm is not viewed as a threat right now because Arm does not add meaningfully to its business (more on this below). Therefore, SoftBank is looking for a buyer. As with most M&A in the free markets, the only reason to pursue Arm is if it adds strategically to the business.

In terms of market share of licensing and designs, Arm is incredibly successful. Yet, despite near omnipotence in mobile, televisions, and ADAS automotive systems, the top line is only $2 billion annually and the bottom line is $50 million in profit.

Therefore, Arm will need to be a strategic target that furthers the acquirer’s market share — there is no other outcome as accretive does not work with these numbers. Nvidia’s bottom line in the current fiscal year is about $4.3 billion.

Any potential bidder will be seen as a threat because Arm must be a strategic acquisition. The problem lies with the fact Arm, a tech company, is attempting to be neutral. Being neutral does not work in a competitive industry.

The governments reviewing the acquisition will likely consider Nvidia an excellent candidate to push forward their agendas for AI and edge computing. Nvidia has proven itself as a GPU-leader in the data center with 98% of cloud infrastructure-as-a-service using Nvidia’s graphics processing units (GPU). There needs to a similar, ubiquitous approach for trillions of edge devices, where more AI-decisions will be made.

Therefore, I predict there is a stronger chance that the Nvidia-Arm deal goes through than what the critics believe.

This is because the governments reviewing the acquisition will need AI to power their economies. Competition is healthy for the tech market, yet moving forward as an ecosystem owner is also paramount. You cannot block innovation at its most crucial point and I believe Nvidia is best equipped to deliver AI to devices for future development.

Please note, I’ve covered Nvidia at length here and here. This analysis will primarily focus on Arm.

History of Arm

The name Arm stands for “Acorn RISC Machine” and comes from founders Sophie Wilson and Steve Furber discovering that a CPU can run faster on a small set of instructions. The discovery these two made in the early 1980s was to let the operating system break down tasks rather than add more instructions to the processor. While most CPU designs were adding more instructions to chips, Arm patented the technique of using fewer instructions that run more quickly and efficiently. Due to power constraints of the mobile device, which was introduced much later, Arm found a massive market where it dominates at 90%.

Around 2012, mobile phones began using the 64-bit architecture that PCs had been using for some time. Arm introduced the ARMv8 64-bit architecture for mobile in 2011. This architecture has two execution states to run 32-bit code and 64-bit code. To run on both Arm and Intel architectures, a developer might compile native code for both or run code emulation, although it is more common to choose one and stick with that choice. This is why we see near ubiquity with Arm on mobile whereas Intel and AMD have done quite well in the data center.

Generally speaking, Arm’s architecture is the best choice for mobile and Intel’s is the best choice for the data center and PCs like Windows. Another important difference is Intel maintains its IP in-house and sells chips while Arm licenses its IP.

For mobile, Arm’s design known as “heterogenous compute” has helped facilitate lower power requirements as the architecture allows different CPU parts to work together for improved efficiency. This enables workloads to work across both high-performance and low-performance CPU cores to lower energy by balancing performance.

Arm: Product Overview

Arm is an intellectual property company (IP) that works quietly in the background with 22 billion chips shipped globally in 2019 and a cumulative total of 166 billion chips in 2019. The company hit 180 billion chips as of the press release on the acquisition.

Revenue is generated from licenses for Arm’s technology and royalties that come from the subsequent sale of the licensees’ chips that contain Arm’s technology. To compare, Nvidia announced it had shipped 1 billion processors in 2011 and there has not been an update for the 2 billion mark yet, with estimates of Nvidia’s shipments hitting around 100 million chips per year.

Arm is most dominant in mobile with 90% market share in mobile processors, and dominates in-vehicle infotainment and advanced-driver assistance system (ADAS) processor market at 75%. The overall share of Arm’s related markets is 34%.

Arm-based technology is found in electronic devices and PCs, including Microsoft’s Arm-based Surface and Apple’s custom CPUs for Macs. The majority of tablets and digital TVs also use Arm’s architecture.

In fact, Arm offers the most popular CPU architecture in the world. The company’s dominant market share is achieved through its developer ecosystem, which fits neatly into one of our primary theses for Nvidia, its GPU-powered cloud and developer ecosystem.

Arm will bring an estimated 15 million software programmers to Nvidia. In Nvidia’s recent earnings report, the company announced it had doubled from 1 million to 2 million developers — so Arm increases Nvidia’s reach by 7X.

CPUs require instruction sets that tell the processor to move data between registers and memory or to perform calculations with a specific execution unit. Architecture is defined by providing the link between instructions and processor hardware designs.

Here’s what Arm’s instruction set looks like.

When comparing processor architectures, Arm’s architecture is a competitor to Intel’s x86. The major fundamental difference between Arm’s approach and Intel’s approach is that Arm favors energy efficiency and Intel favors peak performance.

Arm is based on lower power instruction sets and hardware. When reading about Arm’s architecture, you may come across the acronym RISC-V (pronounced risk-5). This stands for Reduced Instruction Set Computing, which describes Arm’s approach to energy efficiency by reducing the number of instruction sets required. Intel’s CISC, or Complex Instruction Set Computing, offers more complex instructions that execute multiple operations. This may lead to better performance but more power consumption due to the need to decode the complex instructions.

Arm’s Financials:

As stated above, despite dominating mobile, televisions, and ADAS automotive systems, Arm generates less than $2 billion in annual revenue and $50 million in profit.

For the fiscal year ending March 31, 2020, the Arm segment reported 202,966 million Yen, according to Softbank’s filing. This translates into $1.9 billion of SoftBank’s total $55.3 billion total sales in 2020. For the full year 2020:

· Arm reported 2.6 million Yen in cash or $24 million.

· Revenue from technology royalties fell 1.5% year-over-year to $1.1 billion.

· Technology licensing revenue increased 6.4% to $582 million

In 2018, Arm sold a 51% equity interest in its Chinese subsidiary, “Arm China,” for $845 million to form a joint venture for Arm’s semiconductor technology IP business in China. In the investor presentation, Nvidia stated they believe the acquisition will double Nvidia’s addressable market to $250 billion.

The acquisition of Arm will be paid from a mix of cash from balance sheet and equity. Nvidia will not raise debt to finance the transaction. Per the press release, Nvidia will pay SoftBank $21.5 billion in common stock and $12 billion in cash.

The number of shares to be issued is 44.3 million, which increases the number of shares outstanding by about 7%. Arm employees will get $1.5 billion in Nvidia stock at time of closing. There is an additional $5 billion in cash or common stock being offered subject to specific financial performance targets by Arm.

Nvidia’s Move Into Edge Devices

If Nvidia does not acquire Arm for a proposed $40 billion, there are rumors Arm may be spun off as a public company through the initial public offering (IPO) process in the $40 billion range.

As seen in Arm’s financials, owning the majority of a market and maxing out your TAM has a drawback. The upside for Arm is limited. To increase the top line, Arm must move into new markets. Even then, it may resemble the same relationship the company has in the mobile market where the Switzerland makes very little while competitive tech giants see large gains.

Despite Arm powering 90% of the mobile market, its $2 billion a year does not compare to Qualcomm’s $25 billion or Apple’s roughly $260 billion in revenue a year. Given this, stock investors are likely to choose the manufacturers over Arm in any market where Arm supplies IP.

The letter to Arm employees was fairly clear as to Nvidia’s goal: “We are joining arms with Arm to create the leading computing company for the age of AI.” The letter discusses how AI supercomputers can write software that no human can and how AI will facilitate trillions of computers running AI to create a new internet-of-things.

To really unpack the synergies between Nvidia and Arm, we have to look at future AI technologies. The number of smartphones is not increasing meaningfully, yet there could be a time when smartphones utilize machine learning and leverage AI-assistants. Demands on 5G base stations, switches and routers are limited yet will need to deliver large workloads. Data centers see pressure from lower cost and improving power efficiency. The bigger picture down the line is the internet of things, which will require an exponential amount of data to be downloaded.

As stated on the call, Nvidia-Arm has three areas for potential growth: the cloud data center where data is analyzed and stored, edge computing where data is filtered and downloaded/streamed, and trillions of devices, where more AI-decisions will be made.

Arm’s presence is expected to see the most growth in the networking equipment market grow from 32% to 65% over the next ten years, and data center/cloud market, growing from 5% to 25% over the next ten years.

The most dominant markets for Arm are mobile application processors, IoT application processor and in-vehicle infotainment and ADA, where Arm owns 90% of these markets.

According to these numbers provided by SoftBank, it is unlikely Nvidia is acquiring Arm for the estimated 25% data center penetration in 2028 but rather for Arm’s true strengths and areas of dominance, which is edge devices. Edge devices go beyond mobile and vehicles to include street lights, parking meters, etcetera, plus industrial automation. Arm set a goal of shipping 1 trillion connected Arm-based devices by 2035 in what the company calls “Project Trillium.”

There are also edge servers to consider, which will be a new market that brings computation and data storage closer to the location where it is needed. Arm’s architecture may be a good candidate as this part of the infrastructure stack requires fast processing speeds.

Huang, whose company gets over 40% of its revenue from data center products following the recent Mellanox Technologies acquisition, stressed that Nvidia will build on ARM’s already-sizable investments in its Neoverse platform for server CPUs and other “infrastructure” processors.

As stated, he also signaled Nvidia plans to use its server GPUs, Mellanox’s data processing units (DPUs) and ARM’s server CPU IP to develop end-to-end silicon and software platforms for servers.

Nvidia has (quietly) Become the Global Leader in AI

Most investors are aware of what mobile and cloud did for tech stocks. These gains will seem minor in comparison to the gains artificial intelligence will produce.

Between the years 2025–2030, AI is expected to add $13T to $15T to global economic activity, or 1.2% to GDP every year. We are in the early days of returns from AI. But as adoption accelerates, the penalty for laggards will be steep. We should see AI acceleration around 2022–2023 and I predict the last window for substantial gains in AI will be 2025.

In order to truly excel, a programming language has to be universal. GPUs have become integral for AI and machine learning. Nvidia has a special language called CUDA that is universally known due to the company’s first mover advantage in GPU.

Nvidia is already the universal platform for development, but this won’t become obvious until innovation in artificial intelligence matures.

Developers are programming the future of artificial intelligence applications on Nvidia because of the CUDA platform and its GPUs are easier and more flexible than customized ASICs or TPU chips from Google and FPGA chips used by Microsoft and AMD-Xilinx.

Despite a selloff in the name, Nvidia smashed records for quarterly revenue, full year revenue, and earnings when it announced Q4 results Feb. 24. The chip manufacturer posted revenue of more than $5B for the first time, up approximately 61% YoY, beating expectations by $180M.

Adjusted EPS of $3.10 beat by $0.29.

Gaming and Data Center also hit new records. Gaming saw $2.5B in sales, up 67% YoY, and data center sales hit $1.9B, up 97% YoY.

For the full year, revenue was $16.68B, up 53% YoY. GAAP earnings was $6.90, up 53%YOY. Non-GAAP earnings per diluted share was $10, up 73% YoY.

The company also provided strong guidance, with revenue of $5.3B, plus or minus 2%, versus expectations of $4.51B.

Gaming has become an integral part of global culture and will remain robust going forward, said Nvidia Executive Vice President and CFO Colette Kress during the call. She also expressed optimism about growth in virtual experiences, data center, and AI.

“We are on the cusp of a new age in which AI fuels industries ranging from healthcare to scientific research to the environment,” Kress said. “With this transaction, our vision is to boost Arm’s potential so it can thrive in this new era and grow into promising new markets.”

The Pros and Cons of Nvidia-Arm AcquisitionPros:

The pros to this deal include combining Arm’s developer following with Nvidia’s developer following to advance artificial intelligence at the edge. Apple would not be a good choice because it competes directly with developers and this would harm the ecosystem. Qualcomm does not have AI experience, per se, as the leader in 5G. Rather, bringing AI acceleration from the data center to the edge is the correct path, which is unique to Nvidia.

It is not possible to dominate the AI market by remaining at the server level. AI will need to be on-device. The ultimate goal for governments reviewing this acquisition is not for you and I to have a smart refrigerator (human-to-machine), or faster Netflix streaming. The ultimate goal for the governments reviewing this decision is to determine what company is capable of delivering machine-to-machine communication without human operators and enabled through AI so they can increase GDP.

Cons:

Arm’s open source competitor RISC-V could see a wave of interest should the acquisition be approved. Nvidia’s acquisition could start a major push to build on the open RISC-V architecture. Called “RISC-V” this is an alternative to Arm started by a group of academics who did not want to pay licensing fees. The first chip coming out of this open source project was in 2014 from UC Berkeley. This group had a goal of doing for hardware what Linux did for software. When Huawei was first determined to be a security risk, RISC-V rose in popularity in China, for instance.

Despite Nvidia promising to keep Arm open, the company has plenty of baggage with both open source systems, like Linux, and also closed ecosystems, such as Apple.

Linux is the most popular OS for Arm chips, yet Nvidia has not been willing to open source its drivers. In 2012, Linus Torvalds was asked why Nvidia support on Linux was so poor, and Torvalds famously responded, “Nvidia has been the single worst company we’ve ever dealt with. Nvidia, [expletive] you!”

The translation here is that Arm’s 17 million developers may not all convert to the Nvidia-Arm combination, especially outside of mobile, as Arm is well tolerated by the open-source community while Nvidia is more commercialized.

The acquisition could also drive competitors to use Intel or AMD in situations where these two are seen as less of a competitor in the data center. Hermann Hauser, co-founder of ARM, has stated he wants a guarantee that Nvidia won’t get any preferential treatment from ARM post-acquisition. This could be hard to enforce once the acquisition is complete.

The linchpin to the complexity of the deal is China. The Global Times China has published a series of articles that do not seem optimistic about China’s views of this proposal, such as stating, “To a certain extent, the purchase of Arm by Nvidia, if settled, could serve as another trump card for the US government in the global semiconductor industry. Given the US-China tensions and US suppression on a range of Chinese technology enterprises, if Arm falls into US hands, Chinese technology companies would certainly be placed at a big disadvantage in the market.”

Another article stated, “Xiang Ligang, director-general of the Beijing-based Information Consumption Alliance, told the Global Times on Monday that the Chinese government is likely to play a role in reviewing the case and the chance of its approval is low.”

My first and only statement on Twitter was to offer a poll on whether this would be blocked or approved following the news. One thing I did not offer on that poll is a third option: whether the United States would go through with the acquisition even if China blocks it.

That may seem absurd (or perhaps impossible) but we are in the midst of a cold war and tech is the battleground. This includes 5G infrastructure suppliers, semiconductor manufacturing and social media with TikTok.

Artificial intelligence could be the breaking point, in my opinion. Product-wise, this acquisition can advance the United States through artificial intelligence, which is an important element to defense and global dominance. To leave that decision up to our competitor seems illogical. China may try to block the deal and weaken the United States. But will the United States and the UK cooperate with an adversary stunting technological progress required for dominance?

Conclusion:

The acquisition deal is being reviewed by governmental authorities and the process is moving forward as expected, according to Nvidia’s Q4 earnings report. During the call, Kress reiterated Nvidia’s commitment to maintaining Arm’s open licensing model.

“We love and intend to maintain Arm’s open licensing model, a commitment guaranteed both by long-term legally binding contracts as well as our own interest in ensuring this investment is a profitable one for us,” she said. “We are on the cusp of a new age in which AI fuels industries ranging from healthcare to scientific research to the environment. With this transaction, our vision is to boost Arm’s potential so it can thrive in this new era and grow into promising new markets.”

With mobile, Arm has been considered a neutral Switzerland. There is no such thing as remaining neutral with AI, as it is a polarizing technology that will determine the world’s most powerful economy. Eventually some hard decisions will need to be made, as tech produced in the United States but manufactured in China is strengthening China’s lead. Nvidia-Arm brings this to a head.

Long article here, but the take-away is that the Nvidia-Arm acquisition is a move to secure Nvidia’s place for on-device AI, and this will be seen as a threat to China. I foresee the UK being in a tight spot where the country will have to choose if it is with China or the United States, with no neutral ground offered if/when China attempts to block the acquisition. Be prepared for anything to happen, as I believe the United States will view this as a means of defense.

We are optimistic on this acquisition and bullish on Nvidia regardless of the outcome with Arm.

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