SoftBank’s $118 Billion Arm Problem

Japan’s SoftBank has a prime perch at the artificial intelligence table thanks to its 90% stake in chip designer Arm, which is raking in cash from the AI boom.
Japan’s SoftBank has a prime perch at the artificial intelligence table thanks to its 90% stake in chip designer Arm, which is raking in cash from the AI boom.

Summary

The Japanese firm may have limited time to solve the challenge presented by its stake in the thriving British chip designer.

Japan’s SoftBank has a prime perch at the artificial intelligence table thanks to its 90% stake in chip designer Arm, which is raking in cash from the AI boom.

Monetizing that good luck could be surprisingly challenging. But if the past is prologue, SoftBank will find a way. That could mean its shares head higher, at least until the AI frenzy dies down.

Shares of Arm, whose designs power almost all the mobile devices in the world, have gained 67% since it disclosed better-than-expected results this month. Investors are betting it will also benefit from the rising use of its chip blueprints in data centers. SoftBank’s own stock has surged 29%.

While Arm’s profit outlook did come ahead of analysts’ expectations, the rally is also partly driven by its small public float. SoftBank still owns 90% of the company after listing it on Nasdaq last year. That has led to wild swings when a lot of investors suddenly want to buy. The stock on average traded more than half of its public float every day in the past week or so.

The rally means the value of SoftBank’s stake in Arm, at $118 billion, is now much higher than that of its owner, at $84 billion. Longtime SoftBank watchers will find the situation familiar. The company owned around a third of the Chinese e-commerce giant Alibaba before it sold the stake down in recent years to finance other investments.

SoftBank cannot sell Arm’s stock until March under terms laid out in the initial public offering. But monetizing the stake could be a headache. The small public float that has helped inflate Arm’s stock may also make it harder for SoftBank to sell. A big sale could easily push the stock way down.

That’s probably why SoftBank shares have risen less than they theoretically should given its huge Arm stake. The market fears that Arm’s rally may run out of steam before SoftBank can cash out. Arm now trades at 107 times expected earnings, according to FactSet, compared with around 59 times for Nvidia.

One possibility is to use the Arm stake as collateral. The Japanese company suggested in its earnings call this month that it could use Arm shares for margin loans. That, however, would expose SoftBank if sentiment on AI sours and the stock falls.

SoftBank could also mimic the way it sold down its Alibaba stake, using a type of derivative called prepaid forward contracts. Banks or brokers on the other side of the contract would pay cash upfront and SoftBank could choose to settle the contract a few years later with either stocks or cash.

In the end SoftBank settled those contracts with its Alibaba shares. That avoided dumping the shares directly into the market, but the financial institutions on the other side of the contract would still likely need to sell stocks over time to hedge their exposure.

SoftBank’s issue with Arm—like its one with Alibaba before—is a problem most investors would kill to have. Still, the meteoric rise in the British semiconductor company’s value has left the Japanese technology investor with a dilemma. And quite possibly limited time before the AI rally cools to solve it.

Write to Jacky Wong at jacky.wong@wsj.com

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