Kings of content: Investors target China media

CMC Capital Partners has closed two funds - one renminbi-denominated and the other in US dollars - and deployed around $650 million over the past five years, leveraging its status as the first private equity firm to focus exclusively on China's media and entertainment industry. A new fund is understood to be in the market, targeting around $1 billion across US dollar and reminbi tranches.

But to capture the whole gamut of opportunities presented by a fast-evolving industry, CMC wanted a level of flexibility not offered by traditional private equity fund structures. This led to the establishment last November of CMC Holdings, a vehicle designed to remain invested in assets - typically greenfield project that require deep operational involvement - beyond a 10-year horizon.

The holding company received RMB10 billion ($1.6 billion) in seed capital from Alibaba Group, Tencent Holdings and fund-of-funds Oriza Holdings. While CMC Capital Partners will continue to make shorter-term investments, CMC Holdings is the vehicle of choice for the likes of smart TV manufacturer Whaley Technology and DreamCenter, a Shanghai-based entertainment complex developed by CMC in conjunction with Hong Kong's Lan Kwai Fong Group and DreamWorks Animation.

No one believed that the Chinese population would pay for content, but now we are starting to see the subscription model being putting in place – Deborah Mei

"Today investing in media and entertainment sector, it's no longer mainly about traditional movie and TV businesses. We have to look at the entire media value chain from content creation to distribution platforms, and there are so many new models coming out from each segment, especially driven by the disruption from internet and mobile," Ruigang Li, the media mogul who founded CMC, told AVCJ in an interview last November.

CMC's approach is unique within Chinese private equity but it closely resembles the investment strategies of the country's internet giants, Baidu, Alibaba and Tencent (BAT), as well as strategic players such as Dalian Wanda Group and Huayi Brothers. These companies are trying to monetize changes in media consumption - driven by rising disposable incomes and rapid adoption of handheld devices - by creating their own industry value chains that run all the way from origination to distribution. For PE and VC investors that pick the right points in this ecosystem, the rewards could be substantial.

"The Chinese media industry is generally maturing, so we will see more high-profile outbound and inbound deals - actually you could argue this trend is long overdue," says Marcel Fenez, president at Hong Kong-based advisory firm Fenez Media. "But it is important to consider what these deals are about; obviously many of them are around films and sports."

History lessons

The idea of controlling a media value chain is not new. Right up until they were taken apart at the end of the 1940s by antitrust legislation, the US movie studios took this approach: they held actors under strict contracts; they employed the film makers; they were directly responsible for distribution. Regulators separated them from the movie theaters, but to this day the industry remains highly consolidated. A handful of companies generate the bulk of the revenue, distributing content through multiple channels.

Nevertheless, in recent years the internet has shaken up traditional business models. For example, Netflix started out in 1998 as a DVD mailing service but has since developed an online TV and movie streaming platform that doesn't rely on cable networks for distribution. It had more than 74 million subscribers, most of them in the US, at the end of last year and is expanding globally. Netflix has also moved upstream, developing content itself or in partnership with different production studios.

"Amazon and Netflix do not yet control the media business, but they are rapidly gaining in influence because they control highly valuable distribution channels and are able to spend more on production than the traditional studios," says Rob Caine, a partner in film co-production company Pacific Bridge Pictures. "More and more of the top talent and writers are working for these internet companies. TV and movie production will eventually be dominated by the internet players."

In contrast, China is much more fragmented than the US, and this is almost entirely the result of strict regulation. The major television broadcasters, like most of the media distribution apparatus, are all state-owned, which means they have never been fully commercialized.

Foreign investment therefore squeezed into the spaces beyond these red lines, and on occasion edging over them. In this sense, the internet has also been a change agent in China. Venture capitalists got direct exposure to the nascent online advertising industry through investments in web portals and then supported internet-enabled business models as they evolved, moving into e-commerce, online video, social networking and online-to-offline services.

According to PwC, China's entertainment and media market - a broad classification that ranges from book publishing to out-of-home advertising to online gaming - was worth $164.8 billion in 2015, with internet access and internet advertising accounting for 45% of the total. This share is projected to exceed 50% as the overall market reaches $242.2 billion by 2019, but segments such as filmed entertainment and TV subscriptions and license fees are also likely to see rapid growth.

BAT attack

The BAT have in recent years sought to diversify their businesses, entering new verticals in order to create more points of contact with users and gain a better understanding of consumption patterns. Leveraging rising demand for entertainment is part of this: it enables companies to engage a younger demographic that is increasingly resistant to traditional forms of advertising and content consumption.

Alibaba has launched Tmall Box Office, a subscription service along the lines of Netflix, and recently took full ownership of Youku-Tudou, an online video platform that has deals in place to stream Hollywood movies, at a valuation of $4.8 billion. It has also created movie studio Ali Pictures which has production and distribution agreements with a string of local TV stations and invested directly in the latest Mission: Impossible movie.

Meanwhile, search giant Baidu has China's largest internet video streaming business in iQiyi, which has about 10 million paid subscribers who watch more than 1.28 billion hours of content every month, and Tencent can use the powerful QQ and WeChat social networking platforms as tools for content marketing and distribution.

"Previously many distribution platforms faced challenges when it came to monetization, because they relied on advertising-driven models. No one believed that the Chinese population would pay for content, but now we are starting to see the subscription model being putting in place," says Deborah Mei, managing partner at The Raine Group, a financial advisory group that has worked on numerous media-related transactions.

More tie-ups between digital platforms and high-quality content providers at home and overseas are inevitable as monetization efforts gather pace. While it is difficult for venture capital investors to tap directly into areas like film production, they see user-generated content platforms, ranging from text format to short-term video apps, as a sweet spot. Virtual reality (VR) technology also has potential.

"Don't forget that the quality of content is also complemented by computer graphics and animation technology," explains Jixun Foo, managing partner at GGV Capital. "All the movies you're seeing right now will become more appealing, thanks to a combination of acting, story-telling and technology."

Light Chaser Animation Studios, which sees itself as "China's answer to Pixar" is an example of this. Set up by Gary Wang and Zhou Yu - who left their roles as founder and senior executive at Tudou following the merger with Youku - it wants to combine advanced computer processing technology from the US with China's cheaper operating costs. Yu says the risks are lower for animation than movie production because monetization channels are more diversified - from box office revenue, to VR platforms, to merchandising. GGV led a $20 million Series B round for Light Chaser two years ago.

Lacking the domain expertise to mitigate this risk factor in traditional movie production, some private equity investors have targeted foreign players that need local partners to assist with distribution and monetization of their products in China.

The likes of Hony Capital, CMC, FountainVest Partners and Fosun International have all participated in Sino-US media investments where the value they bring is knowledge and networks in China. For example, Hony introduced STX Entertainment - a greenfield Hollywood venture it is backing alongside other investors - to Huayi, resulting in a three-year partnership that will see Huayi co-fund, co-produce and co-distribute almost all of STX's movies through 2017.

Versions of this co-investment or slate financing model are being pursued by numerous other Chinese companies. Two weeks ago, China's Perfect World Pictures agreed to invest $250 million in 50 films produced by Universal Pictures over the next five years. It will receive 25% of the revenues from each release. Hunan TV, China's second-largest broadcaster, signed a $1.5 billion slate deal with US-based Lionsgate that will see it underwrite 25% of the production costs of at least 50 movies over the next three years in return for a share of the box office.

"The advantage of a slate is it de-risks the investment: they aren't investing in a single project but in multiple projects. And where the film slate is global in nature, there are common models on the fund flows. Chinese counterparts and investors can then easily lever production financing with debt. And then there is a brand association financing a foreign studio, as the Chinese partners are forging the strategic relationship with the whole Hollywood majors," says Raine's Mei.

The Wanda model

Wanda, on the other hand, took a more direct route. Earlier this year, the conglomerate controlled by billionaire Wang Jianlin paid $3.5 billion for Legendary Entertainment, the studio responsible for the Batman and Jurassic World franchises. It is the first Chinese acquisition of US studio, and also facilitated an exit for several private market investors.

The rationale for the deal is rooted in Wanda's origins as a commercial property developer. The company wants to complement its core business by entering three other sectors, culture, financial services and e-commerce. The Legendary purchase makes Wanda's movie production business, which was previously domestic only, truly global; the same can be said of overseas acquisitions in the cinema chain space. By essentially adding a front-end services component to its existing real estate offering, the company is approaching the media value chain from a different angle to the BAT.

"Traditional investors like Wanda are building their content production capabilities, while the BAT are enhancing their online operations. It is natural for companies to focus on areas in which they are already strong, and a successful business model doesn't need to be simply content-driven or channel-driven," says Laurence IP, executive director at LKF Capital, a PE arm affiliated to Lan Kwai Fong Group. "The bottom line is monetizing resources in order to build a sustainable business model."

With this in mind, Wanda's interest in the media value chain extends beyond visual content. In the past six months, it has bought two sport-related assets from overseas PE investors: World Triathlon Corporation (WTC), the leading global operator of Ironman events, was acquired from Providence Equity Partners for $650 million; and marketing specialist Infront Sports & Media was picked up from BridgePoint Private Equity for $1.19 billion.

CMC has also been active in the segment, paying a record $1.3 billion for broadcast rights to matches in China's domestic football league and then teaming with CITIC Capital among others to buy a 13% stake in City Football Group, owner of Manchester City Football Club and other global assets.

There is a policy angle to these investments. Culture and entertainment is one of the pillar industries in China's latest five-year plan, which outlines the government's economic priorities. Support for the domestic sports was also the subject of a State Council guideline that envisaged creating an industry worth RMB5 trillion by 2025. Wanda and CMC are not the only private sector players to unveil headline-grabbing deals in this space.

And as with television and movie production, there is an element of soft power to China's efforts to bolster sports. Through its investments, CMC wants to improve the standard of domestic football, bringing more foreign professionals into a league that is still weak by global standards, while Wanda is said to be eying a potential Chinese bid for the football world cup.

"When it comes to football, there is a lot of national pride - success in the world cup would be far better than winning table tennis medals at the Olympic Games. China wants to become a leading global power, not only economically but also in knowledge terms. Its ‘soft power' has historically lagged behind developed countries such as the US and it is now trying to catch up through support for films and sport," says Mark Dreyer, a Shanghai-based sports commentator who runs Chinasportsinsider.com.

A consumer story

However, for strategic investors looking to redefine markets through landmark deals, and for private equity investors targeting investment opportunities in these markets, it is a consumption-driven game. China's disposable income per capita reached RMB21,966 in 2015, with year-on-year growth consistently in the high single digits. This increasing capacity for discretionary consumption translates into stronger demand for services and a greater willingness to pay a premium for quality.

Media and entertainment is a logical beneficiary of this trend. China box office revenues hit a record $6.8 billion last year, up 49% from 2014, according to the State Administration of Press, Publication, Radio, Film and Television. The country will soon overtake the US and become the leading global market by movie ticket sales. Wanda expects sport to follow a similar growth trajectory. On closing the WTC deal, Wang noted that the US has a population of 300 million and a sports industry worth $500 billion per year. In China, annual revenues currently stand at just $10 billion.

"As the economy matures, the pursuit of ‘spiritual consumption' will become more significant. It is similar to the US 50 years ago," says GGV's Foo. "This will drive more media-related deals over the next 5-10 years. China needs local content to fit into the taste of local consumers and domestic content creation will be benefit from learning overseas experiences and production techniques."

Establishing a grip on the media value chain - and maximizing the revenue generated by consumers subscribing to content and advertisers that pay to reach those consumers in new, engaging ways - has therefore never been more important. Private equity strategies vary and certain groups will no doubt find success by targeting specific niches in the ecosystem. For CMC, though, mobile and internet technology area the primary focus, but flexibility is the key. Much like the strategic players, the firm wants to leverage consumer activity at multiple points, from sofa to cinema to amusement park.

"The traditional model won't go away - people will still dine out and go to the cinema, instead of staying home and watching videos on their iPads. But technology is bringing new business models to every sector, everywhere, and changing consumer behavior," says LKF Capital's Ip. "As a result, the media industry will see enormous change. Thirty years from now, reading the news on an iPad might be considered old-fashioned. Who knows?"

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• Topics
• Greater China
• Media
• Technology
• Expansion
• Buyouts
• Venture
• TMT
• buyout
• Growth capital
• Venture
• Dalian Wanda Group
• Alibaba Group
• Tencent
• Baidu
• GGV Capital
• China Media Capital
• Hony Capital