ARM shows SoftBank does tech PE the right way

Published June 12, 2019

Private equity firms get a bad rap — and not without reason. In the prototypical example, a bunch of men in suits (and these folks always seem to be men for some reason) swoop in from Manhattan with Excel spreadsheets and pink slips, slashing and burning through an organization while ladening the balance sheet with debt in an algebraic alchemy of monetary extraction.

Vultures, parasites, octopuses — these are folks who almost certainly won popularity contests in high school and now seem to be shooting for most unpopular person to be compared to a crustacean in the Finance section of the WSJ (and there is some damn strong competition in those pages).

Sometimes that restructuring can save an org, and yes, many companies need a Marie Kondo armed with a business plan. But it’s a model that works best for, say, retail chains, and traditionally has been wholly incompatible with the tech industry.

Tech is a tough place for private equity buyouts, as the biggest expense for most companies is talent (i.e. R&D), and cutting R&D is usually the quickest path to cutting the valuation of the asset you just acquired. Unlike retail or manufacturing, there are just fewer cost levers to manipulate to make the numbers look better, and so PE firms have generally shied away from big tech acquisitions.

So it was interesting talking to Simon Segars this week in New York. Segars is the CEO and longtime executive at ARM Holdings, the U.K.-headquartered chip designer that powers billions of devices worldwide. Over the past two decades, ARM has had an incredible run: Last year, its designs were imprinted on 22.9 billion chips, thanks largely to the now ubiquitous adoption of smartphones across the world.

That success has been under stress though. As Brian Heater analyzed in his State of the Smartphone, smartphone growth has slowed in most markets as consumers extend their upgrade cycles and the pace of innovation has slowed. Add in the ongoing trade kerfuffle between the U.S. and China, and suddenly being the worldwide leading designer of smartphone chips isn’t as enviable as it was even just a few years ago.

As a public company facing this landscape, ARM would have faced incredible pressure from investors to meet short-term revenue targets while cutting back on R&D — the very source of future growth the company has relied on its entire history. But ARM isn’t a public company — instead, SoftBank founder and CEO Masayoshi Son bought out the company entirely in 2016 for $32 billion.

Rather than being pegged to its stock price or a quick return to a PE shop, ARM is now seemingly evaluated on growth in its intellectual property and strategy for capturing new markets. “I’m in a very fortunate position where, despite the slowing of the smartphone market … I’ve got an owner that says, invest, you know, invest like crazy to make sure you capture these ways of growth in the future, which is what we’re doing,” Segars explained to TechCrunch.

The company could have just doubled down on its existing product lines, but SoftBank’s ownership has opened the floodgates to explore other areas that could use ARM expertise. The company is now focused (if one can focus on many things) on everything from 5G and networking to IoT and autonomous driving. “We look to be in the right place at the right time with the right technology to catch the upswing into the future,“ Segars said.

That strategy requires some serious audacity though. ARM’s EBITDA was $225 million last year (21% lower than the year before) on $1.8 billion in net sales, which year-over-year grew a paltry 0.2% according to SoftBank’s latest financials. Meanwhile, operating expenses are up from the addition of hundreds of new employees and a new headquarters campus in Cambridge, outside London. R&D isn’t cheap, nor does it payoff quickly.

Yet, that is exactly how Son and SoftBank approach this take-private transaction. “During the acquisition process, Masa said to me, ‘You run the business, I only care about long-term strategy, not going to interfere, you know, you know what you’re doing.’ … [and] Masa has been absolutely true to his word on that,” Segars said. “From a day-to-day basis, SoftBank leaves us completely alone.”

And unlike the bean counters that plague most PE shops, Son isn’t interested in detailed operational data from the firm. “When I give tactical updates… he’s asleep, [but] try stopping him when he’s talking about long-term strategy,” Segars said.

And unlike the PE model of dumping a bunch of high-interest corporate debt on the balance sheet to eke out returns, SoftBank has — at least, so far — avoided that particular tactic. While there were ruminations that SoftBank was considering cashing out some dollars from ARM using loans early last year, such rumors have apparently not panned out. Segars confirmed that “we have none” when we asked about leverage, which has otherwise plagued much of the rest of SoftBank Group and its various entities.

While ARM clearly has a bullish owner who somehow uses financial wizardry to give the company the resources it needs to grow, Son doesn’t have an infinite timeline for the company. Much like classic PE firms with five to seven-year time horizons to harvest returns, Son has already spoken out loud about pushing ARM back into the public markets in roughly five years’ time.

“I’m pretty sure, the night before we go public again, I’m going to be thinking ‘Man, I wish we’d had more time, you know, five years sounds like a lot,” Segars said. But “the way I talk about it within ARM is we’re in an investment phase now … and the goal is that by the time we re-list … the revenues from these new markets are taking off and that’s flowing to the bottom line and we get back to a world of growing top line and expanding margins.”

In other words, ARM is a classic PE deal, but with the focus on actually getting the fundamentals in the business right without that financial alchemy and employee firing sadness. Maybe the plan will work, or maybe it won’t, but it is the right approach to handling the growth of a tech company.

How many other tech companies could use such an approach? How many other companies are currently languishing if only they had more focused owners with a true growth mindset to invest in the future? Silicon Valley has created trillions of dollars in market value over the past two decades, but there is even more waiting to be unlocked. And the best part is, it doesn’t even require an Excel macro to make it happen.