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China tech

How SoftBank's sale of Arm China sowed the seeds of discord

Terms of 2018 deal left UK parent Arm with little control over local unit

Arm's biggest customer in China is Huawei, the Chinese tech group that is the object of an increasing U.S. crackdown over security concerns.   © EPA/Jiji

TAIPEI -- British chip designer Arm Limited has found itself in an extraordinary public row with its own Chinese subsidiary in recent days, with the two sides at loggerheads over a decision to shake up the management of the unit.

But arguably the seeds of the dispute were sown two years ago when the company, the world's leading provider of the intellectual property behind much of the world's mobile devices, took the bold bet of selling a majority stake in the unit.

Since last Wednesday, Arm -- which since 2016 has been owned by Japan's SoftBank group -- and Arm China have been locked in a bitter clash over the appointment of the chairman and CEO of the Chinese unit. Arm insisted that it had removed CEO Allen Wu over "irregularities and conflicts of interests according to whistleblowers' evidence." But Arm China, in which the U.K. company now owns only a 49% stake, argues that the decision was illegal. In turn, it said that one of the executives that its parent company had assigned to oversee the Chinese affiliate had in fact been removed from the company weeks earlier.

Such a spat would be embarrassing at any time -- but when the tech world is being shaken by the growing tensions between the U.S. and China, it fuels debate about how successfully Arm can steer between conflicting demands.

Arm's IP dominates the world's mobile chips, and is essential to the most prominent users and manufacturers of chips, including Apple, Qualcomm, Samsung, Huawei, Taiwan Semiconductor Manufacturing Co. and MediaTek.

Arm's decision to establish a Chinese joint venture where it only held a minority stake was designed to allow Arm to do more business in the rapidly-growing Chinese market. The British company saw China replacing the U.S. as its top source of revenue in a matter of years. Arm executives told the Nikkei Asian Review in previous interviews that a more autonomous local unit would be able to tap into business opportunities closed to Western companies.

But the terms of the 2018 deal -- in which Arm sold a 51% stake in the local unit to a consortium of Chinese investors for $775 million -- have already significantly weakened the parent company's control of business operations in the country.

According to an internal document obtained by Nikkei, Arm China's boardroom consists of nine directors, including four appointed by the U.K. company and another four from the Chinese investors, with the ninth director chosen from a local "ecosystem partner" and appointed by consensus of the board.

Arm China itself argues that it is legally a Chinese entity and that its U.K. parent does not have the authority to remove its CEO.

This identity issue has become a dilemma, industry sources said. "Arm China hopes to have more autonomy. ... But whether it should still be viewed as a U.K. company or as a Chinese company under the context of geopolitical tensions has become a difficult question to answer," an industry source close to Arm said.

Arm told the Nikkei Asian Review that geopolitical tensions and export control rules played no role in the removal of Wu and its investigation of the executive. Wu did not respond to multiple email requests for comments.

Arm's biggest customer in China is Huawei, the Chinese tech group that is the object of an increasing U.S. crackdown over security concerns, and the relationship has put Arm in an awkward position. Last year, when Washington added Huawei to its trade blacklist, Arm had to suspend support to the Chinese company and later resumed services for non-U.S. origin technologies. Arm has a major R&D center in the U.S. as well as in its headquarters in Cambridge.

Industry sources say that against this backdrop, Arm China's own ambitions have unsettled its parent.

"We heard from time to time that Arm China hopes to forge closer collaborations with local partners as well as government partners, too, but its parent company is not always comfortable with those collaborations," a chip industry source with knowledge of the matter said.

The challenge of Arm China to the U.K. company escalated on Monday, when Arm China further posted on its official WeChat social platform a note co-signed by more than 10 managers to support Wu. The post described him as a great leader who had contributed a lot to build a good "ecosystem" and said Arm China's revenue and profit were growing strongly every year.

"Allen Wu has engaged in so many local collaborations, including setting up a fund together with local partners, foreign and local capitals, as well as local governments to initiate many angel venture capital, startup accelerators and incubators, as well as push chip design education events locally," the post added. "All of Allen's efforts, energy and time are set to build an ecosystem, and to unleash and enable more industry innovations and to create true industry values."

Phil Hughes, Arm spokesperson, told the Nikkei Asian Review on Monday that the company "continues to have confidence in Arm China's progress and vision operating as an independent company, as well as strong conviction in Arm's continuous commitment to the China market."

Under the terms of the original sale, Arm China not only has full access to its parent company's intellectual property, it also took over all of its existing business, assets and employees in China, and became the exclusive channel for licensing its technologies and serving customers there, according to the document obtained by Nikkei.

Even without the geopolitical backdrop, such generous terms would be unexpected, according to experts.

"It's unusual for Arm to form a unit like Arm China to be responsible for all the tech licenses and operations in the country, and then not really have full control of that unit," said Shih Po-jung, a senior geotechnology analyst at Market Intelligence & Consulting Institute. "Arm China's existence leaves Arm sandwiched in between the world's two big powers when they are competing with each other for the next supremacy. It's very challenging for Arm to walk the fine line in between, given it also has a big U.S. research and development team."

Securing a majority stake in Arm China was viewed as a major breakthrough for Beijing in its quest to secure a crucial source of semiconductor technology, and the company has been quick to set ambitious targets for itself.

Arm China planned to go public in 2021 or 2022, according to sources familiar with the matter, and it told its investors in 2018 that in a best-case scenario its revenue could match that of its U.K. parent by 2025, according to the document obtained by Nikkei. Arm posted $1.89 billion in revenue for the fiscal year ended in March, only a 3% increase from the previous year, according to accounts published by SoftBank.

Softbank, for its part, has plans to relist Arm within five years, according to company founder Masayoshi Son in a panel discussion in 2019. Softbank transferred a portion of its holding in Arm to its Vision Fund, its $100 billion vehicle for growing tech companies, in 2017. SoftBank declined to comment for this story.

Alex Capri, a research fellow at the Hinrich Foundation who tracks the U.S.-China dispute closely, said the situtation at Arm highlighted the tension between pursuing an “In-China-for-China" strategy and diversifying critical operations out of China to hedge against escalations in the trade war and the weaponization of tech supply chains.

"To operate in China, firms will increasingly become ring-fenced and embedded in local ecosystems. ... Naturally this could lead to some corporate internecine struggles."

Additional reporting by Wataru Suzuki in Tokyo

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