UK intervenes in Nvidia’s $40bn takeover of Arm

The UK government has ordered an investigation into Nvidia’s (US:NVDA) proposed $40bn (£29bn) takeover of chip designer Arm Holdings, citing concerns that it could undermine national security.

Culture secretary Oliver Dowden has issued a “public interest intervention notice” and instructed the Competition and Markets Authority (CMA) to take a closer look at the implications of the deal. The CMA will now commence a ‘phase one’ investigation and has until midnight on 30 July to report its findings.

The CMA announced in January that it was looking at the tie-up’s impact on market competition and whether it would create an incentive for Arm to “withdraw, raise prices or reduce the quality of its intellectual property licensing services to Nvidia's rivals”. But it had yet to launch a phase one probe.

Under the Enterprise Act 2002, the culture secretary has “quasi-judicial” powers to intervene in certain mergers on public interest grounds – these include repercussions for national security, media plurality, the stability of the UK financial system and to combat public health emergencies. Having considered advice from officials “across the investment security community”, Dowden has decided to step in on national security grounds.

“We want to support our thriving UK tech industry and welcome foreign investment,” says Dowden. “[B]ut it is appropriate that we properly consider the national security implications of a transaction like this.” Indeed, Arm’s technology is used in critical infrastructure across the UK, as well as in defence applications.

Dowden has the power to clear the Arm takeover, approve it subject to certain undertakings, or ask the CMA to launch a more in-depth ‘phase two’ investigation. While the CMA is due to submit its findings at the end of July, there is no set period in which Dowden must make a decision. Nvidia had envisaged that the acquisition would be completed in early 2022, and the news of a UK inquiry sent its shares down a little over 3 per cent to $614. Still, amid strong global semiconductor demand, the shares are up almost a fifth so far this year.

Arming up for the tech Cold War

The government’s intervention is a sharp contrast to when Arm was taken private by Japanese conglomerate SoftBank (JP:9984) back in 2016 – that deal was essentially waved through. But since then, the importance of semiconductors has become more apparent amid the strains of the US-China trade war and the recent global chip shortage. C.C. Wei, the chief executive of chip making giant Taiwan Semiconductor Manufacturing Company (TW:2330), believes that the supply squeeze could run up until 2023.

There is now an increased focus on technological sovereignty, as countries look to become more self-sufficient in addressing their chip needs. As part of his infrastructure plan, President Biden is proposing investing $50bn in the US semiconductor industry.

Last year, more than 2,000 business leaders signed an open letter from Hermann Hauser – the co-founder of Acorn Computers from which Arm was spun out – which called on prime minister Boris Johnson to stop the merger. Hauser argued that keeping Arm in the UK is “an issue of national economic sovereignty” and that “surrendering [the] UK’s most powerful trade weapon to the US is making Britain a US vassal state”. Hauser also warned that Arm would come under the purview of the US Treasury Department's Office of Foreign Assets Control (OFAC), which would then be able to dictate who it can sell its products to.

Arm is a particularly important player in the semiconductor industry as its chip designs are used by 70 per cent of the world’s population, in everything from smartphones to cars. As a neutral blueprint provider, the company licenses its technology to the likes of Apple (US:AAPL), Microsoft (US:MSFT) and Samsung (KR:005930).

But Hauser says that being taken over by Nvidia would “destroy the very basis of Arm’s business model which is to be the Switzerland of the semiconductor industry”. There are fears that Nvidia could get an unfair advantage by limiting competitors’ access to technology, or raising the cost of access.

The UK is just one pinch point

The UK is not the only country taking a closer look at the Arm takeover; the deal also faces scrutiny from regulators in the US, China and the European Union. Beijing is no doubt nervous about a merger that would hand a lot of power to a US company at a time when Chinese access to American semiconductor technology is being restricted.

But even getting the green light from the US Federal Trade Commission (FTC) could prove tough. Two of its commissioners argued in December that the FTC should take a harder stance on ‘vertical mergers’ – a combination of two companies in the same industry but at different stages in the supply chain – saying that “[w]e look forward to turning the page on the era of lax oversight and to beginning to investigate, analyse, and enforce the antitrust laws against vertical mergers with vigour”.

Not the only weapon in Nvidia’s arsenal

If the deal is blocked, in the absence of another buyer, SoftBank could publicly list Arm as it had previously intended to do. This could provide an attractive option amid the current semiconductor upcycle. Hauser has suggested that the UK government should spend £1bn-£2bn as an anchor investor to take Arm public in London and retain a so-called ‘golden share’ to prevent unwanted takeovers.

For Nvidia, it is hoping that a merger with Arm will create “the premier computing company for the age of AI [artificial intelligence]". But while this is a strategically important acquisition, it is not essential to Nvidia’s growth story. Demand for its graphics processing units (GPUs) should continue to rise alongside the momentum of the video games industry, as well as the need for ever more computing power for data centres.

Stepping onto Intel’s (US:INTC) turf, Nvidia also revealed last week that it is pushing into central processing units (CPUs) for data centres with its Grace CPU, named after computing pioneer Grace Hopper. Based on Arm chip designs, Grace CPUs will be available from 2023 and will be able to handle the large volumes of data required for natural language processing and AI supercomputing.

“Coupled with the GPU and DPU [data processing unit], Grace gives us the third foundational technology for computing, and the ability to rearchitect the data centre to advance AI,” says Nvidia’s chief executive Jensen Huang. “Nvidia is now a three-chip company.”

While Nvidia doesn’t currently plan to take on the entire CPU market, Grace could provide a foothold from which to chip away at Intel’s dominance. So, even with the Arm deal in flux, brokers remain bullish on Nvidia’s prospects, with 31 out of 38 analysts having a ‘buy’ recommendation on the group, according to FactSet. With or without Arm, Nvidia will remain a leader in the semiconductor industry, benefiting from long-term structural tailwinds. Buy.

Last IC View: Buy, $527, 07 Jan 2020