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On September 13th, 2020, NVIDIA founder and CEO Jensen Huang sent a letter to NVIDIA employees mentioning that they have just “signed a definitive agreement to purchase Arm”.

The amount of this future transaction: $ 40bn. Let’s briefly present those two companies and their main operating segments. It is essential to go through this complex step before talking about the future possible synergies as you will understand that those two companies are totally complementary.

NVIDIA description: what is NVIDIA selling, in which industry is it operating? NVIDIA is an american multinational technology company that was created in 1993 by Jensen Huang. It operates in two segments:

  • GPU (Graphics Processing Unit): it provides its customers processors for PC gaming, Artificial Intelligence (AI), datacentres, video editing, servers providers, etc. GPU is an electronic circuit that enables the manipulation of computer graphics and image processing.
  • Tegra Processor: it provides its customers processors to harness the power of mobile-cloud, AI, gaming, etc. This processor integrates another type of processors called CPU, that will be defined later, which belong to the target company Arm as well as memory controllers and GPU.

To keep it simple, NVIDIA is building high quality and innovative computer hardware and is selling it to retailers, automotive manufacturers (self-driving car needs NVIDIA’s technology), cloud service providers and other type of customers.

ARM description: what is Arm selling, in which industry is it operating? Arm is a British company specialised in software design as well as the creation and manufacture of semiconductors. It operates in two main segments:

  • CPU (Central Processing Unit): it provides its customers processors and chips, that execute instructions within a computer, for computer manufacturers, phone manufacturers, etc.
  • Software design: it provides its customers development tools to accelerate product engineering for software application development for example.

To keep it simple, Arm is both building high quality and innovative computer hardware and different software. Then, it is selling those products to prestigious customers such as Apple for example.

Overview of the current semiconductors market situation

Nvidia company study

The GPU (Graphic Processing Unit) industry represents NVIDIA’s biggest strength. In fact, in the second quarter of 2020 NVIDIA claimed 80% of the discrete GPU market which means that they have stolen some of the market shares from its main competitor in this industry which is AMD.

NVIDIA is also a diversified company which represents an advantage over some of its competitors such as AMD. In addition to this diversification, it is a company that is investing a lot in innovation. They are creating what they expect will be the future of computer graphics.

Jensen Huang said: “NVIDIA RTX ray tracing (a graphic card) is reinventing computer graphics, driving powerful adoption across gaming, Virtual Reality and design markets, while opening new opportunities in rendering and cloud gaming. NVIDIA AI is enabling breakthroughs in language understanding, conversational AI and recommendation engines ― the core algorithms that power the internet today. And new NVIDIA computing applications in 5G, genomics, robotics and autonomous vehicles enable us to continue important work that has great impact. We are well positioned for the greatest technology trends of our time”. For example, NVIDIA has built a software-defined for self-driving cars and is trying to constantly improve its technology.

From a financial point of view, for fiscal 2020, NVIDIA’s revenue was $ 10.92bn compared to $ 11.72bn in 2019, which is equal to a decrease of 7%. Nevertheless, as we can see on the table below, the two last quarters of 2020 were a huge success as for the 4th one, the revenue was up by 41% compared to the 4th quarter of 2019 meaning that the strategy adopted in the beginning of 2020 started to pay off. Moreover, the major announcement of the acquisition of ARM proves that NVIDIA is doing well financially and as we will see later on, NVIDIA is sticking to its strategy that, to my mind, is a brilliant one which will pay dividend.

Source: NVIDIA Financial Statement

Market future expectations

Advanced micro devices industry had a wonderful 2020. Overall, the gross margin increased by 41% compared to 2019, which is the highest growth in 8 years. Based on this number, on the fact that “digitalisation” might be one of the most used word in the world, on the fact that having a computer is a necessity for almost every job, on the fact that almost all of the new technologies require those processors, we can predict with few doubts that this market will continue growing through the next decade.

Main Actors

Source: personal elaboration 

More companies are operating within this market, but you can find the main actors above. From this table, we can see that overall, the companies have a high positive net income. There is an exception: AMD that still succeeded in having a positive net income but that is way lower than its competitors. We can highlight the fact that NVIDIA achieved a net income similar to Qualcomm that has approximately 3 times more employees. If we have to rank those Advanced Micro Devices companies based on their net income, there is a clear leader which is Intel followed by Qualcomm and NVIDIA.

Now let’s take a look at their Market Capitalization. NVIDIA’s market cap has skyrocketed in 2020 which helped it acquire ARM (we will discuss about this point later on). NVIDIA is followed by Intel and then there are three companies that have more or less the same market cap which are AMD, Qualcomm and Broadcom.

We clearly identified the main actors of this industry and it appears that Intel is NVIDIA’s biggest competitors and that on the other hand AMD is not a threat to NVIDIA’s business. Nevertheless, both of those assumptions are incorrect.

Source: Craft

This graph highlights the fact the the GPU industry is divided between three main actors: Intel, NVIDIA and AMD. It represents the market share detained by those three companies of the GPU industry in terms of global GPU PC shipment. In the quarter 2 of 2020, Intel detained 63% of the market shares, followed by NVIDIA with 19% and AMD with 18%.

Let’s first talk about Intel which is the leader of the CPU (Central Processing Unit) industry, the majority of our computers have its technology, that have been described in the introduction part of this article. NVIDIA is focused on creating and manufacturing GPU (Graphic Processing Unit) which is also an industry within which Intel is the leader. Nevertheless, to have a high-quality computer, you require NVIDIA or AMD’s GPUs. Still Intel announced that they will start selling new GPUs that might compete with the ones of NVIDIA and AMD. In fact, the leading actors of this high-quality segment of the GPU industry are AMD and NVIDIA which detain almost all the shares of this segment and thus have a competitive advantage over Intel. This announcement did not affect those two companies even though they need to keep an eye on Intel’s technology in order not to lose market shares.

Which brings me to AMD. AMD is NVIDIA’s main competitor. It is a renowned company within the GPU industry. During the past decade AMD and NVIDIA have been fighting against each other’s to propose the best value for money products to their customers. In 2020, NVIDIA went one step ahead of AMD that is the reason why AMD is currently working on its products to better compete with the ones of NVIDIA.

Corporate finance activities

The M&A activities within this market play an important role, every year there are important transactions that happen. For example, in 2019, NVIDIA decided to acquire Mellanox for $ 6.9bn which highlights the fact that NVIDIA is a growing company that decided to opt for external growth to expand its business. You can find below a table of the last top 5 semiconductor acquisition agreements. Over the past 5 years, some major acquisitions happened and the acquisition that we are studying will be the most important one if the governments give their approval.

Source: Companies, IC Insights

NVIDIA & Arm, the perfect match?

Arm company study

ARM is a private British company founded in 1990. It has been acquired by the Japanese bank Softbank in 2016 for $ 32bn.

Its main business activity is to create, and licence CPUs to technology companies around the world and it is currently specialized on the phone industry even though it operates within other segments. To have a better understanding of this processor you can find on the left a picture of what a phone is composed of and identify Arm’s technology.

Arm operates within different segments. You can find on the right arm’s market shares and what the expected growth of those industries which highlights the opportunities that arm have.

The possible synergies between Arm and NVIDIA

Arm is the official supplier to Apple concerning its devices for CPUs which represents a huge contract. Apple does not know whether they will produce internally their GPUs or outsource it. This merger would give the opportunity to NVIDIA to supply Apple with their GPUs which is more than significant.

NVIDIA wants to develop its presence in the cloud services, and Arm has a partnership with AWS. Therefore, the same way as for Apple, it could represent a huge opportunity for NVIDIA.

But overall, in addition to all of those business opportunities, it seems that Arm was the perfect target for NVIDIA aspirations in the medium term. In fact, Jensen Huang said that “AI is the most powerful technology force of our time and has launched a new wave of computing […] in the years ahead, trillions of computers running AI will create a new internet-of-things that is thousands of times larger than today’s internet-of-people. Our combination will create a company fabulously positioned for the age of AI”. It has been proved that Jensen Huang is a visionary and therefore having both a company that produces the best GPUs and a company that produces very high quality CPUs enables NVIDIA to not only create a piece of a computer but an entire computer.

It is difficult to assess the amount of synergies in dollars that might occur thanks to this acquisition, but this transaction makes a lot of sense for NVIDIA and Arm. In fact, there are complementary businesses. First, NVIDIA will be able to compete with Intel on the CPUs segment and will represent a huge threat for the current major leader. Then, Arm wanted to expand in the Artificial Intelligence segment which is one of NIVIDIA’s strength. On the other hand, NVIDIA wanted to expand in the cloud services segment which is something that Arm developed. Lastly, it wants to supply the automotive industry for their autonomous cars with its technology that will be enhanced with Arm’s CPUs.

Is Arm overpriced?

Arm is detained by Softbank which purchased it for $31.4 bn in 2016.

NVIDIA is going to acquire Arm for $40bn which seems to be a disproportionate premium.

However, in addition to the multiple synergies that will create a lot of value. The way this transaction will be financed (if it takes place) might explain this huge premium paid to Softbank.

How are those $ 40bn divided?

  • NVIDIA will issue 44.3 million shares to Softbank for Arm. At the time they agreed on the transaction details, NVIDIA’s share was valued at $487.57. Thus, those 44.3 million shares are worth $21.6 billion.
  • NVIDIA will pay $12 billion in cash to Softbank and $2 billion will be directly transferred at the signing stage of the deal which happened the 13th of September.
  • An earnout clause has been added to the agreement which states that NVIDIA will pay an addition up to $5 billion in cash or up to 10.3 million in shares to Softbank depending on Arm’s future performances.
  • Arm’s employees are going to benefit from this transaction as $1.5 billion are going to be issued in restricted stock units. In September 24th’s price, this amount equalled to 3.1 million shares.

Therefore, it makes a total of 44.3 + 3.1 + 10.3 = 57.7 million shares which will be issued for this transaction if accepted by the different political institutions.

Considering the fact that there are 617 million shares outstanding. It means that this transaction might have a 9.35% dilution which is incredibly low comparing to the amount of the transaction and to Arm’s performances.

It seems that the EV/EBITDA multiple of this future transaction is oversized. In fact, According to InfrontAnalytics, the semi-conductor industry has an average EV/EBITDA of 12.86 in 2020.

NVIDIA’s CEO held a conference on the 14th of September and said the following information: Arm makes “94% gross margins and adjusted pro forma EBITDA margin of approximately 35%.” In addition, he said that arm made “1.8” billion in revenue in the past 12 months. This amount is equal to $ 2.3301bn. The EBITDA is therefore equal to $ 2.3301bn * 0.35 = $ 815.535m As NIVIDA agreed on a price of $ 40bn, it makes a multiple of 40 / 0.815535 = 49.05 which is approximately 4 times the average multiple of this industry.

But, among the $ 40bn, NIVIDIA will “only” pay cash $ 12bn and the $ 28bn remaining will be paid with NVIDIA’s shares that skyrocketed. Thus, it makes a new multiple of 12 / 0.815535 = 14.71 which is aligned to the average multiple of the industry.

To my mind, the way this acquisition has been financed is brilliant as NVIDIA will only have to pay $ 12bn in cash which makes a decent multiple and the impact of the payment of the remaining $ 28bn in shares is a 9.35% dilution which is incredibly low compared to both Arm’s results and the benefits of this transaction.

All of this has been done thanks to the fact that NVIDIA’s share is currently overpriced and skyrocketed in the past 6 months as you can see on the graph below. Otherwise NVIDIA would have not been able to realize it without this increase of its share’s price.

Source: Yahoo Finance

The current geopolitical uncertainties

Arm’s business model is to license chip designs to technology companies around the world. A lot of Chinese companies rely on arm’s licences for their smartphones. Therefore, if arm switches from being a British company to an US owned company (as NVIDIA is a US company) this would give more leverage to this US on some negotiations that is currently happening between China and the US. 

NVIDIA and Arm have offices in the U.S., in the U.K., in the EU, and in China (and of course other regions). Thus, the announced transaction requires regulatory approval from those four governmental organizations. 

Jensen Huand said that “he had every confidence” that this transaction will be approved by Chinese regulators. But it would give the power to the US government to control the technology access of China which will result of a technological disadvantage of Chinese companies in the market. It is the reason why this transaction will probably not be approved by the Chinese regulators, to my mind. 

Conclusion

To conclude, the semiconductor industry is currently a growing industry. NVIDIA arises as the leading company within the GPU segment and has strong aspirations.

Even though, $ 40bn seems to be an amount that overvalues arm, NVIDIA managed to finance this future acquisition in a brilliant way that creates a coherent EV/EBITDA multiple. Furthermore, the synergies that might occur thanks to this acquisition will benefit both companies as their technologies are complementary and will help both companies to grow and to achieve their objectives.

Nevertheless, there is a dark side of this transaction announced which is linked to the current geopolitical tensions. This acquisition is expected to take 18 months to complete (around March 2022). There are a lot of uncertainties regarding the fact that the approval of this transaction. Some analysts say that there is a 50% chance and others are less optimistic.

By way of opening, one month and a half after NVIDIA’s announcement to acquire Arm, AMD declared that they will acquire Xilinx, another company specialised in the advanced micro devices industry, for $ 35bn. We can wonder whether the synergies created thanks to this transaction would enable AMD to surpass NVIDIA’s market shares.

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Sources:

Introduction: https://finance.yahoo.com/quote/NVDA/profile/

https://www.nvidia.com/en-us/

https://www.arm.com/

https://blogs.nvidia.com/blog/2020/09/13/jensen-employee-letter-arm/

Spotlight 1: Overview of the current semiconductors market situation

NVIDIA company study: https://www.techradar.com/news/nvidia-crushes-amd-with-80-gpu-market-share-ahead-of-ampere-launch

NVIDIA annual report 2019

https://nvidianews.nvidia.com/news/nvidia-to-acquire-arm-for-40-billion-creating-worlds-premier-computing-company-for-the-age-of-ai#:~:text=(SBG)%20today%20announced%20a%20definitive,transaction%20valued%20at%20%2440%20billion.&text=SoftBank%20will%20remain%20committed%20to,to%20be%20under%2010%20percent.

Main actors: https://blog.mywallst.com/top-competitors-to-nvidia/

https://craft.co/nvidia/competitors

Spotlight 2: NVIDIA & Arm, the perfect match?

Arm company study: Arm annual report 2019

Is Arm overpriced? https://investorplace.com/2020/09/nvda-stock-at-nosebleed-valuation-is-being-used-for-to-pay-for-chip-unit/)

https://www.marketwatch.com/story/semiconductor-sands-shift-as-nvidia-and-amd-have-big-plans-with-acquisitions-2020-10-13 

Financial times: https://www.ft.com/content/0286eaf6-e841-4585-aa01-e0677c09c71c 

Reuters: https://www.reuters.com/article/idUSKBN2650RQ

https://www.tomshardware.com/news/nvidia-announces-arm-acquisition-for-dollar40-billion

https://www.infrontanalytics.com/fe-EN/31230EX/ARM-Holdings-plc/financial-ratios

https://group.softbank/system/files/pdf/ir/presentations/2019/arm-roadshow-slides_q4fy2019_01_en.pdf

https://group.softbank/system/files/pdf/ir/presentations/2019/earnings-presentation_q4fy2019_01_en.pdf

Spotlight 3: The current geopolitical uncertainties

https://www.cnbc.com/2020/09/24/nvidias-acquisition-of-arm-could-be-a-nightmare-for-china-clsa.html#close

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