By Yelin Mo, Max A. Cherney and Stephen Nellis

The upcoming listing of semiconductor technology firm Arm Holdings Ltd is supposed to be strong medicine for what has been ailing the U.S. IPO market, as well as provide a shot in the arm for Arm owner Softbank Group Corp.

There is one complication, however. Almost a quarter of Arm's revenue comes from an entity it does not control but nonetheless relies on to access China's massive smartphone market.

Scattered throughout the hundreds of pages of Arm's prospectus are details of the company's labyrinthine relationship with China, its second-largest market. Sales in China contributed 24.5% of its $2.68 billion revenue in fiscal 2023, according to filings published on Monday ahead of its initial public offering.

Virtually all of that revenue comes from Arm China, an independent entity that has the exclusive rights to distribute Arm's technology in the country. That makes Arm China, not better-known names like Apple or Qualcomm, Arm's largest customer. And this customer has a history of late payments and presents "significant risks" to Arm's business, according to its filing.

Arm's public offering, which could happen as soon as next month, would help revive a U.S. IPO market that so far this year has raised only about one-tenth the amount of capital it did in 2021. Arm was earlier planning to raise between $8 billion and $10 billion from the IPO, but is now expected to raise less capital.

Arm China, in which Arm itself is in effect only a minority shareholder, underwent a nearly two-year boardroom battle between its local chief and shareholders that ended last year. A group of Chinese investors and a private equity firm control a majority stake.

Beyond these internal issues, U.S. sanctions limiting sales to China along with rising competition in the Chinese market cast doubt on Arm China's long-term trajectory.

An Arm spokesperson declined to comment.

WHO'S IN CONTROL?

Arm China has posed ongoing challenges for SoftBank despite its strong early growth. The entity was established in 2018 when SoftBank sold a 51% stake in Arm Ltd’s Chinese subsidiary, Arm Technology (China) Co Ltd, to a group of Chinese investors led by private equity firm Hopu Investments.

Arm China was first overseen by Chief Executive Allen Wu, a longtime Arm executive, but SoftBank ousted him last year after alleging conflicts of interest. Wu denied the allegations and filed several lawsuits against Arm, some of which were resolved in Arm's favor while others are ongoing.

Which shareholders control Arm China remains unclear.

Arm itself holds an effective interest of only 4.8% in Arm China, obtained through a 10% stake in an intermediate entity called Acetone, which owns 48% of the Chinese subsidiary. Hopu Investment indirectly owns 35% of Arm China, and various other Chinese parties control the remaining 17% directly or indirectly, according to the IPO filing.

WHAT ARE ARM CHINA'S MAJOR BUSINESSES?

Arm China was formed by SoftBank and Arm to drive growth in China's massive smartphone market. Originally, it had the right to sell technology from Arm headquarters to customers in China. Under Wu, Arm China also developed its own intellectual property.

This led to two business segments: a distribution business licensing Arm's IP, and a design business selling Arm China's own lower-end IP. Arm's filings did not disclose details on Arm China's business breakdown.

However, analysts believe distribution of Arm's IP generates the majority of revenue. That business faces challenges from U.S. sanctions restricting sales of advanced technology to China, which Arm said had cost it at least $63 million in royalty revenue in its most recent fiscal year.

Stewart Randall, a Shanghai-based chip analyst, said Arm is still the leader in supplying technology to Chinese firms developing processor chips.

"But sanctions have meant it can't be used everywhere (in China). I'm unsure Arm can substantially grow revenue here," he added.

HISTORY OF LATE PAYMENTS

Arm said in its filings that "in the past, we have received late payments from Arm China and have had to expend company resources to obtain payments from Arm China."

Those delays still show up in Arm's finances as a discrepancy between China revenue and accounts receivable - 24% of revenue came from Arm China in the fiscal year ended March 31, but 40% of accounts receivable were attributed to China, meaning Arm has still not been paid for all products sold in China.

Arm appears to be closing some of that gap. In its filing, it said cash from operating activities increased by $281 million in its most recent fiscal year, driven mostly by $713 million in collections from Arm China, though that was partly offset by cash owed to Arm China.

(Reporting by Yelin Mo in Beijing and Max A. Cherney and Stephen Nellis in San Francisco; Editing by Matthew Lewis)