Four years ago, Japanese conglomerate SoftBank (SFTB.Y 0.92%) acquired British chip designer ARM Holdings for $32 billion in a bold expansion into the semiconductor market. But SoftBank is now reportedly mulling an IPO or sale of ARM to raise cash after a streak of poor investments -- including WeWork, Uber, and OneWeb -- crushed its profits.

One of those potential suitors is reportedly NVIDIA (NVDA 0.35%), according to Bloomberg, and a takeover could strengthen the chipmaker's business and give it new ways to challenge AMD (AMD -2.94%), Intel (INTC 0.02%), Qualcomm (QCOM 0.10%), and other rivals.

Investors should always be skeptical about buyout rumors, but the long-term implications of a marriage between NVIDIA and ARM are too great to ignore. Let's see if NVIDIA could pull off this massive deal, and what it could mean for the semiconductor industry.

An illustration of a semiconductor.

Image source: Getty Images.

The key facts and figures

ARM Holdings doesn't manufacture any chips. Instead, it designs chips and licenses its designs to a wide range of chipmakers, including Qualcomm, Apple, and NVIDIA. NVIDIA currently licenses ARM designs for its Tegra CPUs.

ARM's designs, which generally emphasize power efficiency over raw processing power, are now used in over 95% of the world's smartphones. A growing number of PCs, data centers, and IoT (Internet of Things) devices also use its designs, which undermines the x86 architecture used by Intel and AMD.

ARM's revenue rose 2% to 206.7 billion yen ($1.94 billion) in fiscal 2019, which ended on March 31. But on the bottom line it posted a net loss of 42.8 billion yen ($400 million), compared to a profit of 134 billion yen ($1.26 billion) in 2018.

Excluding a one-time gain of 176.3 billion yen ($1.66 billion) in 2018 from setting up a joint venture in China, ARM would have remained unprofitable over the past three years. ARM mainly struggled with sluggish smartphone sales, trade war-related headwinds, and disruptions from COVID-19.

SoftBank claimed ARM "will continue to grow again" as "market conditions normalize" in its last annual report. However, the rumors regarding a potential sale suggest a recovery could be further off than SoftBank suggests.

Could NVIDIA buy ARM Holdings?

NVIDIA ended last quarter with $15.5 billion in cash and equivalents and $7 billion in long-term debt. Its debt more than tripled from a year ago after it issued a $5 billion debt offering prior to closing its all-cash $6.9 billion takeover of Mellanox in April.

SoftBank might sell ARM at a slight discount to its original price tag, but NVIDIA will likely need to take on more debt and fund part of the deal with its own stock. If it closes the deal, it could boost its annual revenue by over 10% -- although ARM's recent losses would weigh down its earnings.

A transparent view of a smartphone.

Image source: Getty Images.

But if we look past the near-term noise, NVIDIA could benefit from adding ARM's licensing and royalty business to its portfolio. NVIDIA can sell its own Tegra CPUs, which generated 13% of its revenue last year, at higher margins because it would no longer pay royalties to ARM.

It could also pave the way for NVIDIA's return to the smartphone market. NVIDIA previously challenged Qualcomm in the mobile chip market with Tegra and baseband modems, but Qualcomm's wireless licenses -- which entitled it a cut to every smartphone sold worldwide -- gave it a major advantage.

Qualcomm often bundled its mobile chipsets with its licenses, making it tough for chipmakers to offer competitively priced chips. As a result, Qualcomm conquered the mobile market, forcing NVIDIA to abandon baseband modems and pivot its Tegra CPUs toward cars and gaming consoles.

But if NVIDIA buys ARM, Qualcomm will need to pay NVIDIA royalties on all its Snapdragon chips. That shift could level the playing field, and allow NVIDIA to compete against Qualcomm in the mobile market again. NVIDIA would also profit from the inroads ARM chipmakers are forging in the PC and data center markets against Intel and AMD's industry-standard chips.

The key takeaways

NVIDIA's purchase of ARM would significantly reduce its dependence on GPUs, which generated 87% of its sales last year, and match Qualcomm's licensing might by taking a cut of every ARM-based chip sold worldwide.

However, it would also dent NVIDIA's margins, increase its debt, and inevitably trigger complaints from competing chipmakers and antitrust regulators. But if NVIDIA can clear all those near-term hurdles, a takeover of ARM could transform the chipmaker's business and strengthen its competitive position in the crowded semiconductor market.