How Japanese conglomerate SoftBank wrested back control of Arm China
Masayoshi Son, billionaire head of SoftBank Group Corp. may finally be able to push ahead with launching a US IPO for semiconductor and software design giant Arm Ltd., after wresting control of Arm China back from ousted CEO Allen Wu. It was no mean feat and a saga of twists and turns. But even now, some questions of Arm China's shareholding and business remain unanswered.
(By Caixin journalists Zhang Erchi, Qu Yunxu and Guo Yingzhe)
Masayoshi Son, billionaire head of SoftBank Group Corp., may have heaved a sigh of relief after wresting control of the Chinese venture of British semiconductor designer Arm Ltd. back from its wily CEO.
Securing Arm Technology (China) Co. Ltd. means the Japanese conglomerate will be able to move ahead with launching a US IPO for Arm Ltd., a potential bright spot in what has otherwise been a streak of bad luck for a company which has been buffeted by Beijing's crackdown on tech.
"We were not able to audit the accounts of Arm China over the past two years. But in the future, the auditor will conduct a rigorous review. The only obstacle that prevented Arm from going public has thus been resolved," Son said last month.
Arm's designs are some of the most widely used in the world. The company's business model is based on licensing its architecture to other companies, who can incorporate them into their own designs to suit their needs. In the fiscal year ending 31 March, 29.2 billion chips based on Arm architecture were shipped worldwide and used in more than 95% of smartphones, 63% of Internet of Things devices and 24% of cars.
SoftBank bought the company in 2016 for £24.3 billion (then worth US$32 billion) and planned to sell it to hardware and software giant Nvidia Corp. in 2020. But the plan was doomed by pushback from Western regulators and big chip purchasers that feared it would give Nvidia a near monopoly.
Then, Son announced a plan to float Arm on the stock market. But that plan was put on hold as SoftBank and its Chinese partner Hopu Investment battled with Arm China's chairman and CEO Allen Wu over control of the company. Victory came when the government of Arm China's hometown, Shenzhen, decided in their favour.
Founded in April 2018, Arm China is the only authorised platform for Arm Ltd.'s intellectual property in China. While most of its revenue comes from selling Arm Ltd.'s designs, Arm China also sells its own designs. Chinese investors, including those backed by the state, have hoped that Arm China could achieve its own breakthroughs and contribute to the national goal of achieving self-reliance in semiconductors.
He had signed an action-in-tandem agreement with Hopu Investment which gave him the right to veto changes to top management, including his replacement as chairman, a source close to Wu said.
Start of the game
Wu joined Arm's China branch in 2004 and rose to become head of the sales department in 2007, where he rapidly expanded the company's client list. He was made head of the branch in 2009.
After SoftBank's purchase of Arm, Son decided to form a joint venture in China, partnering with a group of investors led by private-equity investor Hopu Investment, whose funding came from state-owned financial institutions including China Investment Corp. and an enterprise backed by Shenzhen.
SoftBank and Chinese investors initially planned to split ownership 49% to 51%, respectively, and name Wu as CEO. But when the final deal was sealed in 2018, Wu ended up managing funds that held a combined 15% stake and was both chairman and CEO, people familiar with the company told Caixin. That left SoftBank with a 47.3% stake and Hopu Investment with 36%.
"The alliance between the two Chinese shareholders, Hopu and Wu, could check and balance SoftBank's power," a source with knowledge of the deal said.
But Wu's actual power over the company was greater than his minority stake would imply.
He had signed an action-in-tandem agreement with Hopu Investment which gave him the right to veto changes to top management, including his replacement as chairman, a source close to Wu said.
Wu rejected the board resolution and refused to hand over the company's business licenses and official seal - without which it cannot issue new documents, effectively paralysing its operations.
The saga of Wu's removal began in 2019. That year, several Arm China employees told the parent company that Wu may have been acting unethically. They said that a private equity fund in which he had invested - Alphatecture (Hong Kong) Ltd. - had in turn invested in Arm China affiliates.
After Arm Ltd. completed a six-month investigation, SoftBank decided to fire Wu and won support from Hopu. In June 2020, they removed Wu from the position of chairman and organised a board meeting - which Wu refused to attend - to remove him as CEO.
However, Wu rejected the board resolution and refused to hand over the company's business licenses and official seal - without which it cannot issue new documents, effectively paralysing its operations.
He also convinced over 100 employees to put their names to a public letter backing him.
The following month, Wu filed a lawsuit in Shenzhen against Arm China, alleging the board resolution was illegal because it violated procedures.
At that time, Shenzhen took a wait-and-see attitude. The government declined to make the personnel changes official by updating the company's business registration information, citing the ongoing lawsuit.
SoftBank's negotiations with Wu were then put on hold by the attempted sale of Arm Ltd. to Nvidia.
Failed acquisition
The US$40 billion sale was proposed in September 2020, after SoftBank dropped an earlier listing plan due to a disappointing valuation.
Son believed that dealing with Arm China's Wu problem could be left for Nvidia after the sale, a source familiar with SoftBank told Caixin.
But the dispute over Arm China's control was a major hurdle, because SoftBank was unable to obtain its financial statements and present a complete picture of Arm Ltd.'s finances to the US Securities and Exchange Commission.
But the deal was opposed by several governments, including the US, UK, and some European countries. They cited a number of reasons, the chief of which was that the acquisition would give Nvidia excessive power over the global chip market.
After the deal was kaput, SoftBank dusted off its listing plan. Son hoped to complete the listing by March 2023, with the Nasdaq as the likely venue and a targeted valuation in excess of US$60 billion backed by sharply rising revenue, the person familiar with Arm said.
According to SoftBank's financial statements, Arm's revenue was US$1.7 billion in 2016, the year it took Arm private, and stayed around US$1.8 billion for a few years before suddenly jumping to US$2.7 billion in 2021.
But the dispute over Arm China's control was a major hurdle, because SoftBank was unable to obtain its financial statements and present a complete picture of Arm Ltd.'s finances to the US Securities and Exchange Commission.
Wu maintained that Arm China was willing to be audited at any time, the person close to him said, and the company's financial data was audited by KPMG and sent to Arm monthly. The real reason why that data wasn't used is that the auditor required the legal representative of Arm China to sign the audit reports, which Wu did, but SoftBank refused to recognise Wu as the legal representative, the person claimed.
SoftBank then played its trump cards.
By treating Arm China as a financial investment, Arm Ltd. would be able to go public in the US without auditing the venture...
First, it informed Arm China and its other shareholders that Arm Ltd. had transferred its stake in the joint venture to a special purpose vehicle (SPV) jointly owned by SoftBank and Arm.
Through the stake transfer, Arm Ltd. went from being the venture's single largest shareholder to an indirect shareholder. This allowed it to, on paper, regard Arm China's financial statements as a financial investment interest rather than those of a subsidiary. By treating Arm China as a financial investment, Arm Ltd. would be able to go public in the US without auditing the venture, Han Lijie, a lawyer at law firm Katten Muchin Rosenman LLP, told Caixin.
Second, SoftBank threatened that Arm would not license new IP rights to the joint venture if Wu remained in the top job, though existing contracts would continue to be valid.
SoftBank also pushed hard in its negotiations with the Shenzhen government, which acted both as the regulator of Shenzhen-based Arm China and as an investor in Hopu Investment.
In April, Shenzhen chose to support SoftBank and allowed the update to Arm China's business registration information. Shenzhen and SoftBank made a transitional plan for the joint venture - no chairman for the time being, Liu Renchen and Eric Chen as co-CEOs, with Liu as the legal representative. On 29 April, Liu received the new business license and seal.
The new leadership shows that the Shenzhen government and SoftBank have taken over Arm China...
Liu is a former deputy director of a research institution jointly founded by Shenzhen and Tsinghua University, a source close to the local government said. He is now a member of the Shenzhen People's Political Consultative Conference, a political advisory body.
Eric Chen is a partner of SoftBank Vision Fund and head of its China branch.
The new leadership shows that the Shenzhen government and SoftBank have taken over Arm China, the people with knowledge of the company told Caixin.
Wu's counterattack
But though the battle was all but won, the struggle was not over. Hours after Arm China announced the new leadership registration on 29 April, Wu attempted to counterattack.
In a statement, he said the company couldn't form a valid corporate resolution on leadership changes as the lawsuit over the legitimacy of the earlier board reshuffle was ongoing.
There was also reason to believe that there were material legal defects in the change to the company's business information by the Shenzhen market regulator, Wu alleged.
That day, Wu held a virtual meeting with staff to rally their support. Also on 29 April, an open letter signed by over 400 employees was posted to the company's official WeChat account in opposition to the latest leadership shuffle, claiming that SoftBank was attempting to turn a joint venture into a wholly-owned subsidiary. It also said SoftBank had refused to implement an equity incentive plan it promised to employees. Over 400 employees signed the public letter.
But with the government on their side, the new management team was able to push ahead.
But with the government on their side, the new management team was able to push ahead. On 30 April, Arm, Hopu and SoftBank issued a joint statement saying that Liu Renchen had officially been registered as Arm China's legal representative. The team then called on Arm China's managers one by one, saying they could either fall in line or face legal risks.
On 5 May, Arm China' IT department followed an order to block Wu from the company's mailing system. That day, he sent his last email to staff, asking them not to follow new leaders' orders before the lawsuit was resolved.
The next day, the new co-CEOs held a meeting to reassure staff. They promised that Arm China would remain a joint venture and an equity incentive program would be implemented as soon as possible. They also took control of the company's social media accounts and deleted Wu's open letter.
Some questions regarding Arm China's shareholding and business remain unanswered.
What's next
Some questions regarding Arm China's shareholding and business remain unanswered.
Although Arm's shareholding in the China venture has been transferred to an SPV, the relevant changes to its domestic business registration update have not moved forward because both the Shenzhen government and Hopu have not approved the transfer. It's not yet been decided how this transfer should be registered, an industry insider with knowledge of the case said.
Also, there's the matter of the 15% stake controlled by the Wu-led funds. People familiar with Wu's thinking say he is open to selling it. Some of the funds' investors no longer support him, the people familiar with Arm China said.
Last month, Lotcap Group - a firm shrouded in mystery - said that it had signed a letter of intent to buy 51% of Arm China from its Chinese shareholders. But Arm China told Caixin that it had not received any information about the proposed ownership change. According to Arm China's articles of association, shareholders must gain approval from Arm Ltd. before selling their shares. Arm declined to comment on the matter.
This article was first published by Caixin Global as "In Depth: How SoftBank Wrestled Back Control of Arm China". Caixin Global is one of the most respected sources for macroeconomic, financial and business news and information about China.
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