The Risky Dependence: China’s Dominance of Arm Jeopardizes New Investors

Arm’s IPO Raises Concerns Over China Business

Arm, the British chip designer, is set to raise approximately $5 billion in an initial public offering (IPO), but concerns over its China business have become a significant point of concern. In its IPO prospectus, the SoftBank-owned firm devoted several pages to warning investors about the risks associated with its exposure to China amidst rising tensions between Washington and Beijing over chip technology. Arm China, an entity that operates independently of Arm and SoftBank, is Arm’s largest customer, contributing a quarter of its sales. The unique relationship between Arm and Arm China, along with the complex history between the two entities, has raised regulatory concerns.

The Vulnerability of Arm in China

Arm’s business in China makes it particularly susceptible to economic and political risks, as highlighted by the company in its prospectus. The company’s slower growth in royalty revenues from China in the fiscal year to March was attributed to an economic slowdown in China, as well as factors related to export control and national security matters. Arm heavily relies on royalties and licensing for its income, making China’s impact on the company’s financials significant.

Geopolitical Tensions and the Semiconductor Industry

Arm’s return to the stock market comes at a time of increasing tension between the United States and China in the semiconductor industry. Both countries are striving to enhance their capabilities in the sector, and export controls have been imposed by each side to limit the other’s capacity. The semiconductor industry acts as a source of tension in US-China relations, and political and regulatory pressure is likely to increase.

Complex Corporate Structures and Risk Assessment

In its IPO filing, Arm revealed its convoluted ownership structure with Arm China. The company holds 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. Investors are becoming increasingly aware of such corporate structures in China, and this structure has raised concerns among experts. Arm China has also had a history of late payments and a legal battle with its former CEO, potentially posing future risks for Arm.

Editorial and Advice

Arm’s IPO and its exposure to the Chinese market highlight the challenges and risks faced by companies operating in a geopolitically volatile industry. As China continues to advance its technological capabilities and strengthen its position in key sectors, the risks associated with doing business with China become more apparent. Companies must conduct thorough risk assessments and consider the potential impact of geopolitical tensions and regulatory pressures.

Regulatory Framework and Risk Disclosure

Regulators should require large public companies with significant exposure to China to disclose specific risks associated with the country. Investors need a clear understanding of the potential risks and complications arising from geopolitical tensions, export controls, and complex corporate structures. Companies should be prompted to disclose their scenario planning in the event of abrupt decoupling or other adverse developments.

Strategic Diversification

Companies operating in industries with geopolitical risks should consider diversifying their supply chains and customer bases. Reducing reliance on a single market, particularly when there are tensions and uncertainties, can mitigate potential disruptions. Exploring opportunities in alternative markets and building strategic partnerships can help companies navigate geopolitical challenges and enhance their resilience.

Ethical Considerations

Companies should also assess the ethical implications of their business models, especially when operating in countries with differing political and human rights standards. Maintaining transparency and adhering to responsible business practices can help companies mitigate reputational risks and align their operations with ethical standards.

Conclusion

Arm’s IPO showcases the complexities and risks associated with doing business in China’s rapidly evolving tech industry. As geopolitical tensions persist and governments implement stricter regulations, companies must carefully evaluate the risks, diversify their strategies, and consider ethical implications. The success of Arm’s IPO will depend on investors’ ability to assess and price in the risks associated with its China business, as well as the company’s ability to navigate these challenges in the long term.