This week, ARM Holdings announced that it will sell itself to Asian investment firm SoftBank for $31.4 billion. The chip design and manufacturing giant has been at the center of the mobile phone revolution for the last decade.
But some Wall Street analysts are looking at the deal size and questioning the value of such a massive purchase.
SoftBank is paying roughly three times more than what Google paid for Motorola ($12.5 billion) in 2014. The deal is worth about four times more than what Microsoft paid for Nokia ($7.2 billion) in 2013. Unlike those deals, SoftBank isn't purchasing a manufacturer of cell phones.
It's purchasing something entirely different.
And that “something” makes this deal an absolute bargain.
Here's what you need to know.
The Google and Microsoft deals for Motorola and Nokia, respectively, have resulted in failure. Both firms aimed to create mobile device companies to tap into global growth in physical demand for phones and tablets. SoftBank has taken a far more lucrative, and secure approach.
That's because the entire mobile device market runs on ARM's intellectual property. SoftBank isn't buying a phone brand. It is purchasing a company whose most valuable product is information. This company has more than 4,500 granted or pending patents with the U.S. government.
This is important for two reasons. First, it's proof that ARM Holdings is forward-thinking. They spend massive amounts of money on research and development to produce the system cores and mobile device designs for next-generation devices.
Second, ARM parlays this information by licensing its technology to every company in the mobile industry. Walk into a Best Buy, and almost every phone, tablet, smartwatch, and other consumer devices rely on ARM's technology. Best of all, the company receives a royalty payment directly for every chip purchased.
And these chips are purchased by every major device manufacturer out there: The Apple iPhone, the Samsung Galaxy, the BlackBerry. Every single device sold pays a royalty back to ARM if it uses the company's intellectual property.
In 2016, manufacturers will ship 1.6 billion smartphones alone, according to an IDC Study. That number is expected to increase to 1.92 billion by 2020. This represents a 6% Compound Annual Growth Rate.
This is important: Demand will continue to rise, but it's unclear which smartphone manufacturer will win the ongoing global battle for marketshare. These companies rise and fall all the time. Back in 2006, Motorola and BlackBerry were the world's most popular brands.
Today, they're lagging in the markets behind Samsung and Apple.
But ARM has dominated the infrastructure and architecture race. The biggest takeaway from this deal and from its ongoing rise is the importance and rising value of intellectual property. ;
A Musical Comparison
The intellectual property race is also on the verge of breaking out in the music industry. The last two decades has seen a steady decline in revenues as physical album sales declined.
But a reversal is coming, ensuring that owners of intellectual property are paid royalties every time that a song is played.
The royalty business in music is similar to the one we describe above in the semiconductor industry. Whenever a chip is bought, used, and integrated into a phone, a royalty is paid to ARM, which owns the intellectual property.
In music, whenever a song is played, used, downloaded, or streamed, a royalty is paid.
Looking forward, we expect new methods of music consumption to emerge — it's hard to imagine what will replace streaming — but something might.
In addition, we will see new technology platforms emerge that integrate music and pay royalties. This includes virtual reality devices and augmented reality.
However, it doesn't matter if Facebook, Apple, Google, Spotify, SoundCloud or Pandora emerge as the victors in the race to gain music subscriptions or virtual reality buyers.
What matters is the underlying intellectual property — the music played across these platforms. Every play, download, stream, and purchase generates consistent cash returns.
That presents significant value over the long term.