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Arm’s $5 Billion IPO Amidst China Concerns

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As British chip designer Arm gears up for its massive $5 billion Initial Public Offering (IPO) set to happen this Thursday, its substantial business presence in China has emerged as a critical focal point of concern.

In its IPO prospectus, the SoftBank-owned company devoted significant attention to cautioning potential investors about the risks tied to its involvement with China. This concern arises during a period of escalating tensions between Washington and Beijing over chip technology.

The regulatory filing from last month revealed that a significant quarter of Arm’s sales are generated in China, through a unique arrangement with an entity it doesn’t control, and one with which it shares a complex history.

Arm describes Arm China as “an entity operating independently of us and is our single largest customer.” They clarify that “Neither we nor SoftBank Group control the operations of Arm China.”

Arm’s IPO could potentially value the chip company at a substantial $52 billion, generating interest from tech giants like Apple, Google, and Nvidia. Nevertheless, the company’s vulnerability in China may have contributed to a lower market valuation than anticipated by SoftBank.

Arm attributes the slowdown in China’s economy and “factors related to export control and national security matters” as reasons for slower growth in royalty revenues from China in its fiscal year to March. Despite this, the total revenue from China did show an increase in the same period. Royalties are a significant income source for Arm, relying on fees from each chip developed using its products.

Arm priced its shares at $51 each, potentially raising up to $4.9 billion, with the possibility of reaching $5.2 billion if banks exercise their option to buy additional shares, thus valuing the chip designer at as much as $54.5 billion. This valuation is lower than the implied $64 billion when SoftBank acquired the remaining 25% stake in the company just a month ago.

Concerns about China’s role in Arm’s business may have already been factored into IPO pricing expectations. However, experts suggest that a worst-case scenario involving increased US sanctions or trade restrictions is unlikely.

Arm’s return to the stock market is closely watched, promising to be the most significant US IPO since 2021. SoftBank CEO Masayoshi Son has positioned Arm as an AI-focused company poised for exponential growth, hinting at the possibility of services similar to ChatGPT being offered on Arm-designed machines.

Arm operates as an intermediary in the semiconductor industry, a sector of substantial tension in US-China relations. Both countries are striving to enhance their capabilities in this field, resulting in recent export controls aimed at limiting each other’s capacity.

Former US Securities and Exchange Commission Chairman Jay Clayton has urged large public companies with extensive exposure to China to disclose specific risks related to the country and their contingency plans in case of abrupt disengagement. While the US maintains that it isn’t seeking to disconnect from China, reducing reliance on the world’s second-largest economy is a priority.

Arm’s filing reveals that it holds just a “4.8% indirect ownership interest in Arm China” through a 10% non-voting stake in a SoftBank-controlled entity that owns less than half of the Chinese company. Such intricate corporate structures, while not unique in China, have raised concerns among investors.

Arm’s history with Arm China includes late payment issues and a legal battle with its former CEO, Allen Wu, since April 2022. Wu and entities effectively controlled by him filed several lawsuits against Arm China in Chinese courts, challenging aspects of Arm China’s corporate governance and the actions of its board of directors. As of August, these cases had been resolved in favor of Arm China, but the outcome might still be subject to appeal, potentially impacting the British firm in the future.

Despite these challenges, major global tech players like Apple, Google, Nvidia, AMD, Samsung, and TSMC have expressed interest in being cornerstone investors in Arm’s IPO, a testament to Arm’s robust industry position and its overall valuation.

In conclusion, while Arm faces complex challenges related to its China exposure, it embarks on a significant IPO with high expectations from both investors and the tech industry. The ever-present geopolitical tensions and regulatory pressures in the semiconductor industry add layers of complexity to this high-stakes financial move.

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