The Capital Note

Nvidia’s Acquisition of Arm in Jeopardy

The logo of Nvidia Corporation during the annual Computex computer exhibition in Taipei, Taiwan, May 30, 2017 (Tyrone Siu/Reuters)

Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: the U.K. announces a national-security review of Arms Holdings acquisition, Taiwan’s exports balloon thanks to semiconductor shortage, a hedge-fund behemoth warns of a SPAC bubble, and Biden’s $50 billion semiconductor subsidy. To sign up for the Capital Note, follow this link.

Arms Sales
The ongoing semiconductor shortage has put the strategic importance of computer chips front and center in international politics. The Biden administration allocated $50 billion of its infrastructure proposal to domestic chip manufacturing, shortly after Intel announced plans to build two new fabricating plants in Arizona. Meanwhile, China has spent the past year beefing up its manufacturing capabilities after the U.S. placed export controls on both semiconductor foundries and companies dependent on foreign chips.

In the latest show of the geopolitical significance of semiconductors, yesterday the U.K. government initiated a national-security review of Nvidia’s $40 billion acquisition of British chip designer Arm Holdings. When the deal was announced last November, regulators raised concerns about Nvidia’s ability to restrict Arm’s chip designs from smartphone producers such as Apple and Samsung.

Arm is unique in that it licenses designs and software to all customers, be they semiconductor companies or mobile-phone makers. Arm has been termed the “Switzerland of semiconductors” because it provides an open platform that does not compete directly with its customers. Nvidia, on the other hand, runs datacenters that compete with some of the software offerings of Big Tech firms such as Microsoft and Amazon.

In February, Google, Microsoft, and Qualcomm publicly protested the acquisition, which would combine the world’s dominant mobile-chip designer with the world’s dominant graphics-chip designer. Now, the global economic disruption from a shortage of semiconductors has added national-security concerns to economic concerns.

While the chip shortage is a consequence of production constraints at foundries — and therefore does not directly involve design-only firms such as Arm — it highlights the increasing dependence of the global economy on computing power. With capital-intensive research and manufacturing processes, companies cannot easily switch semiconductor suppliers. Nor is it feasible to purchase too far ahead of time due to the pace of technological change in the industry.

While the current chip shortage is mostly limited to low-tech chips, it underscores the key role of semiconductors in global supply chains. Companies like Nvidia and Arm, which offer differentiated, high-end chips, could theoretically cut off tech businesses from irreplaceable inputs. As international competition in 5G communications and complex artificial intelligence grows more intense, chip companies are becoming geopolitical assets.

As Arm co-founder Hermann Hauser wrote in a letter to the Financial Times when the acquisition was announced:

It will make Arm a division of an American company to which the US Cfius regulations apply. This means that the American president can decide which companies Arm is allowed to sell to worldwide. This raises the vital issue of technology sovereignty which the UK and Europe have suffered from for many years.

“This has become the new colonialism,” Hauser added recently. “If you have sovereignty, you can independently run your economy without running to another country for semiconductors.” It remains to be seen whether the U.K. will block the deal, but there’s no question that governments around the world will be wary of relying on global competitors for chip R&D or fabrication.

Around the Web
Chip shortage fuels record exports for Taiwan

Global demand for semiconductors, fueled by 5G and high-performance computing, showed little sign of easing off as Taiwan’s searing pace of export orders continued for a fifth straight month.

Export orders grew 33.3% to $53.7 billion in March, Taiwan’s Ministry of Economic Affairs said on Tuesday. Economists had forecast an increase of 34.9% in a Bloomberg survey. The data for March set a record high for the month. . . . Officials see the strong growth continuing for a sixth month, with the ministry predicting orders will increase by between 29.8% and 33.7% in April.

Marshall Wace, one of the hedge-fund industry’s largest SPAC investors, is sounding the alarms

The life cycle of SPACs, or special purpose acquisition companies, is riddled with “perverse incentives” for investors, sponsors and the companies using the shortcut route to come to market, Paul Marshall, co-founder of the investment firm, told his investors in a newsletter. SPACs have delivered “awful returns” and most recent issuances will be no different, he said.

“The SPAC phenomenon will end badly and leave many casualties,” Marshall said, while disclosing that the firm has more than $1 billion of gross exposure to SPACs in its flagship $21 billion Eureka hedge fund.

A bidding war for railroad operator Kansas City Southern

Canadian National Railway Co. made a roughly $30 billion topping bid for Kansas City Southern, likely kicking off a bidding war for a railroad operator that has already agreed to a sale to another Canadian rival.

Canadian National offered $325 for each Kansas City Southern, including $200 a share in cash and 1.059 Canadian National shares. The offer represents a 21% premium to Canadian Pacific Railway Ltd.’s agreement to pay $275 a share including $90 in cash for Kansas City Southern, a roughly $25 billion deal reached last month.

Random Walk
The American Enterprise Institute’s Derek Scissors has some advice for the Biden administration’s attempt to strengthen domestic chip manufacturing:

As a good start, eliminate the possibility of taxpayers being conned. There’s no requirement to take this money. If a firm accepts it, it can’t then expand overseas semiconductor output in any way competing with US operations. During last year’s process, well-intentioned members of Congress insisted government shouldn’t tell companies what to do. Exactly right, until government hands out $50 billion. The money is to boost production here. Don’t like strings? Walking away is free.

Scissors points out that $50 billion allocated domestically could flow to international competitors down the supply chain. If a domestic fab uses international inputs, a good chunk of any subsidy would go overseas.

How to deal with supply-chain issues?

There’s again an easy and a hard part. Easy: China shouldn’t be allowed to participate in any meaningful way in supply chains connected to the semiconductor subsidies. This includes helping make equipment then used in the chains or supplying materials chain participants need. The Biden administration can’t constantly justify industrial policy as helping us compete with China, then be casual about whether the spending ends up benefiting the PRC.

That supply chains are complicated is illustrated in this case by Taiwan. With companies like ASE and MediaTek, Taiwan is vital to chip chains. While Taiwan works hard to be a reliable American partner, its largest semiconductor firm, Taiwan Semiconductor Manufacturing Corp. (TSMC), sees over 17 percent of sales from mainland China. TSMC and Taiwan as a whole can be coerced commercially and even militarily by Beijing. The US should be creating genuinely independent supply.

— D.T.

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