Wall Street bankers may be salivating at the upcoming flotation of Arm Holdings, the British company whose chip designs help power most of the world’s smartphones. Yet even though Arm has become the world’s dominant provider of a nearly indispensable product, it has a clear Achilles’ heel: its relationship with China.

With so-called ‘cornerstone’ investors including Apple, Google and Nvidia already signed up, Arm this week said it is aiming for a market capitalization of up to $52 billion with its initial public offering in the United States this fall. 

Whether it can achieve such a valuation will depend in large part on the broader investment community’s view on Arm’s exposure to China, laid bare when its IPO prospectus disclosed a litany of risks relating to the company’s presence in the world’s second-largest economy. 

Arm earned a quarter of its revenue in China in the year to March 2023. Yet as its IPO prospectus makes clear, it does not control the entity — Arm China — through which it generates those sales. Arm, in fact, only has an indirect 4.8 percent stake in Arm China which, it says, “operates independently”: It earns money from China by licensing its intellectual property to Arm China — making it in effect Arm’s biggest customer — which can in turn sell it to phone manufacturers and others inside the country.

But while much attention has been focused on Arm’s tenuous relationship with its Chinese offshoot, it’s not the only risk to the company’s prospects stemming from China. Elsewhere in its prospectus Arm points to the competition it could face in China as the country develops its own rival chip technologies, particularly those based on freely available open-source.

“Currently Arm does not have control of effectively one of the territories which is a huge revenue generator,” says James Ashton, author of The Everything Blueprint: Processing Power, Politics, and the Microchip Design That Conquered the World. “It cannot be optimal to have no more say in that company than [a 4.8 percent holding]. So that clearly I would view as a risk.”

Arm’s presence in China stretches back over two decades: it first opened an office in Shanghai in 2002. The following year, it introduced its technology to China’s semiconductor industry by partnering with Semiconductor Manufacturing International Corporation (SMIC), the country’s leading chip foundry. By 2017, around 95 percent of all advanced chips designed in China were based on Arm’s designs, according to a company estimate.

I think the biggest risk…for Arm could be if the stuff it’s selling into China falls foul of some of the U.S. restrictions.

James Ashton, author of The Everything Blueprint: Processing Power, Politics, and the Microchip Design That Conquered the World

For the first 16 years of Arm’s operations in China, the company operated as a wholly foreign-owned entity. After Japanese tech conglomerate SoftBank acquired Arm for £24 billion ($31 billion) in 2016, Arm sold 51 percent of its stake in its Chinese subsidiary in 2018 to a group of local investors led by Chinese private equity firm Hopu Investment. 

At the time, Arm said the deal would help “expand its opportunities in the Chinese market” — foreign companies in China often enter into similar joint venture arrangements with majority local ownership to make it easier for them to sell to Chinese state-owned enterprises.

Arm China’s complex ownership arrangements shifted again this year, as Arm looked to smooth its path to a U.S. flotation by no longer having to recognize its Chinese business as a subsidiary in its accounts. The company transferred its 48 percent holding in Arm China to a SoftBank-controlled company called Acetone; Hopu continues to hold more than 35 percent of the company with other Chinese investors holding the remaining 17 percent, according to the IPO prospectus.

The original deal to bring in local investors would have suited the Chinese government, making it more likely that Arm China would invest in the local market, helping develop the local ecosystem and supporting the government’s efforts in semiconductors, says Woz Ahmed, managing director at consulting firm Chilli Ventures.

Yet the arrangement has led to major conflict over who controls Arm China. When Softbank — with Hopu’s backing — moved to fire Arm China CEO Allen Wu in 2020, he refused to comply and kept hold of the company’s seal. That triggered a two-year stand-off during which Arm China was prevented from making major business changes. And while Arm announced in April last year that issue had been resolved, its IPO prospectus notes that Wu — who also still owns around 17 percent of Arm China through various holding companies — continues to take legal action against the company in Chinese courts.

Beyond these boardroom shenanigans, Arm’s prospectus predicts an uncertain future in China as the country grapples with the economic impact of its zero-COVID policies, hostile trade and national security policies, and increased levels of public and private debt.

“In light of these issues, we expect to continue to see declining royalty revenues, and we could see a decline in licensing revenues, derived from the PRC,” the prospectus notes.

Although not an American company, Arm has nevertheless sought to comply with increasingly strict U.S. export controls against China, covering chips at the highest performance level. The company opted not to supply Chinese companies with its most advanced Neoverse V design after the most recent round of U.S. controls were announced in October 2022, according to a FT report.

“I think the biggest risk…for Arm could be if the stuff it’s selling into China falls foul of some of the U.S. restrictions,” says Ashton. “The problem… is that, as Arm sells more sophisticated designs [that have] a bit of this and a bit of that…the risk is that more of those are likely to be caught in the net.”

“It is Arm’s policy to operate in strict compliance with all applicable export and trade controls, economic sanctions laws and regulations, and other requirements for global technology transfers,” Arm CEO Rene Haas said in a statement last year.

I think no one in the chip design business…wants to have to deal with replacing Arm…because they are such a core player in the ecosystem.

Chris Miller, associate professor at Tufts University and author of Chip War: The Fight for the World’s Most Critical Technology

Meanwhile, Chinese companies are becoming increasingly interested in alternatives to Arm’s technologies. One option is to rely on the so-called RISC-V architecture, an alternative to Arm which is available as an open-source resource, meaning users are not required to pay licensing fees. 

“There are some people in China who argue that they’re better off building a RISC-V architecture because, given that it’s open source, it’ll be less likely to be subject to export controls in the future,” says Chris Miller, associate professor at Tufts University and author of Chip War: The Fight for the World’s Most Critical Technology.

Although RISC-V did not originate in China, other observers see the international character of the RISC-V community as a potential benefit for China’s chip companies. Of the 21 premier members of RISC-V International, the Switzerland-based non-profit that supports RISC-V architecture, 11 are Chinese entities, including major companies like Huawei, Alibaba and Tencent. Premier members pay a $250,000 annual fee and have a seat on the non-profit’s board of directors.

“The advantage of RISC-V… would be that it’s not solely Chinese — there are other contributors to the RISC-V platform outside of China, so you can get the benefit of this larger tech community,” says Douglas Fuller, associate professor at Copenhagen Business School.

At present, RISC-V is primarily used for what observers refer to as “low-end devices” that require less processing power, such as applications in home appliances or in vehicles.

“The question here is — can you scale it up to be an architecture that can power a data center or a PC?” says Glenn O’Donnell, research director at market research firm Forrester. “We certainly see Chinese companies being aggressive in their development to take it to that level.”

Yet with Arm’s designs firmly embedded in the global semiconductor industry, whether any alternative can become truly widespread is questionable.

“No one in the chip design business… wants to have to deal with replacing Arm… because they are such a core player in the ecosystem,” says Miller from Tufts. “If China were to, hypothetically, have to design chips based on other architectures, that could be a very costly endeavor.”

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