Analysis: Arm IPO filing reveals depth of Chinese risk

Opinion | August 22, 2023

By Peter Clarke

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The filing for an IPO in intellectual property licensor Arm has revealed details of problematic relations in China and risks to its continued business there.

A key factor is that after Arm stages its IPO it will still be SoftBank Group that retains the largest stake in Arm Technology (China) Co. Ltd. which is the gateway to Arm’s China revenues. And SoftBank Group and Arm together only hold a 48 percent interest in the Arm China.

Several years ago, Arm – presumably under pressure from the government of the People’s Republic of China – opted to cease having a wholly- or majority-owned subsidiary to manage licensing and royalty collection. In a series of manoeuvres Arm was moved into a minority ownership position in Arm Technology (China) Co. Ltd.

The filing does not address why Arm made this change under SoftBank ownership but in effect Arm China became a special customer with the right to sub-license Arm’s intellectual property in China and collect payments and royalties. After that move was made Arm had a series of problems in China although these were apparently resolved in 2022 (see ARM moves to regain control in China, to clear path to IPO).

Arm now lists Arm China as its largest customer in which it has a 4.8 percent indirect holding through a joint venture with SoftBank Group called Acetone Ltd. Acetone owns 48 percent of Arm China.

A quarter to a fifth

For Arm’s last three financial years China has accounted for 25, 18 and 20 percent of the company’s total revenue, respectively. The corresponding revenue totals were US$2.03 billion, US$2.70 billion and US$2.68 billion.

The registration statement acknowledges that this is a source of risk as these revenues could be impacted by both political and economic developments.

In the filing Arm states: “We granted Arm China certain exclusive rights to sublicense our IP to PRC customers. We expect that our licensing relationship with Arm China will continue to account for substantially all of our total revenues from the PRC and represent a significant portion of our revenues for the foreseeable future. It would be difficult for us to replace any lost PRC-sourced revenue in the event that our commercial relationship with Arm China were to terminate or deteriorate.”

So much revenue hinges on a special customer that previously has been late to pay monies owing and has been developing its own IP cores and could yet provide competition to Arm in areas such as AI. Arm’s prospectus acknowledges that risks include Arm China not providing accurate and timely IP licensing data or paying royalties on time. And Arm China not protecting Arm IP.

And even though Arm China has agreed not to develop its own microprocessor cores, Arm’s prospectus acknowledges that Arm China could develop other IP that would compete with Arm (see Reports: ARM China makes independent move in autonomous driving).

President Biden’s latest

Arm also points out that as recently as August 9, 2023, President Biden issued an executive order addressing investments by US persons in companies located in the PRC involved in sensitive technology including semiconductors and microelectronics, quantum information technologies and artificial intelligence. The order advises of proposed rulemaking but does not provide substance or timing. So the impact of that executive order is as yet unknown.

And despite lacking a controlling interest in Arm China, Arm is nonetheless obligated to indemnify both Arm China and its sublicensees against damages or costs in lawsuits based upon IP infringement claims.

In the section on risk Arm also addresses the issue of Allen Wu, the former CEO of Arm China that Arm struggled to oust from his position between 2020 and 2022 (see ARM China staff post open letter pledging loyalty to Allen Wu)

The filing states that since April 2022 Allen Wu has initiated several lawsuits in the courts of the PRC seeking to challenge Arm China’s corporate governance. So far, all the cases that have been resolved have been done so in Arm Chinas’ favor but they are subject to appeal.

For any valuation of the Arm shares soon to be traded on Nasdaq the prospective buyer would do well to consider that about one fifth of Arm’s revenue comes from the People’s Republic of China and the revenue is far from certain at a time when the US and China are rapidly decoupling their economic interests.