Is IPO in China Imagination’s Only Possible Exit Path?

Next week the U.K. government will hold a parliamentary hearing to consider establishing an instrument similar to America’s CFIUS (Committee on Foreign Investment in the U.S.) to protect UK companies from takeovers deemed against the national interest. The impetus for considering such a measure is what’s going on with Imagination Technologies.

The hearing will call upon former CEO Hossein Yassaie, one of the more prolific campaigners to “keep Imagination Technologies British” and current management team Steve Evans, chief product officer, and John Rayfield, chief technical officer, who have threatened resignation if the company’s ultimate owners, China Reform Holdings, exercise more control within the company’s governance.

Imagination’s saga is being spun at least four different ways, as those with different agendas and vested interests attempt to control the perception of what is happening with the company. Here’s the essence of each of those views:

1. China is trying to exert additional control over Imagination. That is not good for the UK’s economy. There’s an increased risk that employment and/or IP development will be moved from the U.K.
2. Imagination is already controlled by China. Little will change. Chinese financiers already own Imagination through investment company Canyon Bridge, whose key backer is China Reform. China Reform is a $30 billion venture fund controlled by the Chinese government.
3. Imagination, “for its foreseeable future,” will keep its head office in the U.K. “IP moves around the world by licensing it.” So, what’s your problem?
4. Former CEO Ron Black recently left Imagination not because of China’s growing control over the company, but because he couldn’t save the company from a deep financial trouble the company was already in.

Now here’s our latest analysis of the Imagination saga:

Based on many conversations and reports over the last couple of weeks, it’s becoming clear that this is not an ownership or political issue as is being made out in the UK media. It’s much more fundamental: that of Imagination’s survival. I was waiting for some piece of evidence before writing this article, and it came in the form of a Reuters report this week that highlighted Imagination’s precarious financial position: it was significantly loss-making with an adjusted annual operating loss of $23 million in 2019 under Black’s leadership (Black resigned earlier this month). Our own sources also suggest a similar figure, indicating that Black was running out of options for the company, and he turned the issue into a political one as his parting shot.

Underlining the nature of its financial position, current CEO Ray Bingham wrote in a letter (found in the committee’s official correspondence section) to Tom Tugendhat, the chair of the Foreign Affairs Committee within UK parliament, that Imagination spent $73 million on R&D in 2019, which represents 84% of its revenue last year.  He added, “The UK is the main beneficiary of this spending because more than 50% of our headcount is located in the UK. We expect that will continue to be the case in the foreseeable future. More than 700 of Imagination Technologies’ 850+ staff are engaged in R&D activity and the majority of those are based in the UK.”

Bingham also said Imagination filed 304 patents in 2019, putting it in the top 15 patent filers in the UK. And reinforcing earlier statements, he stressed that Imagination Technologies would remain domiciled in the UK, and the UK would remain the company’s base of operations. “Senior management will continue to operate out of the UK in the foreseeable future, and the strategic direction of the business will continue to be set from the UK. Canyon Bridge can affirm that under its ownership, the majority of Imagination’s employees will remain based in the UK.”

Bingham even said in an interview with the FT last week that that there was “no need” to transfer Imagination’s technology to China. He commented, “IP moves around the world by licensing it.”

So, one would think, what is the problem with that? Lots of reassurances, so surely Bingham and Canyon Bridge would be respected for that? Imagination, like most UK IP companies, don’t have any significant business in the UK, so the issue is not around national security. And like most UK companies, Imagination licenses its IP all around the world, with China being a key market, so surely the connections afforded by additional governance from the owners would enhance its opportunities in China?

The reality is that the short-term challenge is centered on how to turn around Imagination’s fortunes. Three years ago Imagination’s fortunes plummeted when it lost the business of its biggest customer, Apple. Earlier this year the company announced that Apple would resume buying from the company, which inspired some optimism about the company’s future.

We understand that the “winning back of Apple” played a key part in reducing the company’s loss, but our sources suggest even then it is not clear whether that was part of a payment to ensure access to some patents, or whether it involves winning new or existing design slots. As one source told us, “Regaining Apple as a customer was primarily a facade.” Another source said, “If it weren’t for the Apple settlement, the company would be in trouble. Having said that, this wasn’t something that only Ron Black could have achieved, it would have happened whoever was in that position.”

One of the options open to Imagination would have been to obtain additional investment. We understand that Black was in advanced talks to raise around $200-$300 million in investment to build a new RISC-V platform. Since the company was already losing money and had taken an additional interest-free loan of $50 million from Canyon Bridge, it would have been difficult to obtain investment from investors based in the U.S. or Europe, so the only option was China. It is very possible that Black would have turned to THG Ventures, an investor whom he worked with at Rambus in May 2018 in conjunction with GigaDevice to establish Reliance Memory for the commercialization of resistive random access memory (RRAM) technology in China.

Our sources suggested that it is not in Imagination’s interest to stir up political tensions and exploit the “China takeover” narrative. “The anti-China sentiment will turn any potential investors away,” we were told, referring to the fact that Imagination’s only path to pursuing its ambitions would likely be from Chinese investors.

Clearly that is why Bingham is quoted in the financial media as suggesting a possible IPO as a way to exit its troubled investment.  Reuters said its source indicates Shanghai was the favored location for a listing, “largely because China was likely to be the world’s pre-eminent power in semiconductors this century and so would likely provide the best valuation.” It added, “There is an enthusiasm towards semiconductor companies in China, with the Star Market. Many semiconductor companies have listed there, and valuations have been attractive.” Star Market was set up last year in Shanghai as a Chinese rival to the tech-focused U.S. Nasdaq.

One of our sources, an investor in the semiconductor market in China, said that as a standalone IP company Imagination would find it hard to obtain a decent valuation in western markets. He added, “But if they were to go start developing products and systems on chip (SoCs), then they are more likely to be highly valued in China.” However, the company needed to move away from its political maneuverings. “The home market is small for them, and the UK needs a market like China where a win-win situation can be created. We don’t care where the engineers are — they can be in the UK, but the sales opportunity is in China.” He concluded that the company needed to get back on track to give them a hope for a turnaround, which the last two CEOs haven’t been able to do.

Hence our thoughts so far on the situation are as follows: Imagination Technologies’ financial performance caused concern among its owner investors and prompted them to look at ways of stemming the losses. Part of that would mean adding better governance and control on current management, which would also help control costs. Meanwhile, the CEO needed to look at ways of re-inventing the company and was probably pursuing significant additional investment to develop new RISC-V products.

But the only way investors potentially wanting to invest in a loss-making company would probably have been Chinese investors, since there would be a demand for development of new IP locally. However, the additional governance that the owners needed worried management, believing it would mean Chinese control, without realizing Chinese funds already own the company. Hence, they make a political play of it.

The investors are probably now thinking — enough is enough, this is not worth the trouble; hence a possible route is the talk of an IPO and the only possible place that do that is likely to be in China. But that won’t be any time soon, as that is likely to be at least five years away.