China media: Lights, camera, regulation

The fantasy movie "Warcraft" has proved an unmitigated failure in the US, with takings of $47.1 million in the seven weeks following its June release against a budget of $160 million. China has turned out to be the producers' saving grace, generating $220.8 million of the $385.9 million in foreign ticket sales, according to Box Office Mojo. "Warcraft" is already a bigger hit with Chinese audiences than "Star Wars: The Force Awakens."

The success of the movie, which is based on a popular video game franchise, can be linked to the lead production company behind it. Legendary Entertainment was acquired by Chinese conglomerate Dalian Wanda Group for $3.5 billion earlier this year. "Warcraft" duly received one of the widest-ever releases in China, helped in part by the fact that Wanda operates the country's largest cinema chain.

But Wanda's interest in Legendary stretches beyond the fortunes of a single movie. The company has assiduously taken its cinema business global, acquiring US-based market leader AMC Entertainment and Australia's Hoyts Group, and with an agreement in place to buy Odeon & UCI Cinemas in the UK. As the first Chinese owner of a major Hollywood production house, Wanda has the infrastructure to bring movies to a truly global audience.

With China expected to surpass North America as the world's largest film market next year, Chinese strategic and financial investors are chasing Hollywood content, striking movie financing deals and buying into studios. Hollywood, meanwhile, is trying to appeal to Chinese movie-goers, resulting among other things, in co-production arrangements with local PE players. However, given the strict quota on foreign film imports into China, not all of these investments will deliver strong returns.

"There is a lot of interest and that gets a lot of money excited. Perhaps not all of that money should be getting excited, as it's not an easy industry and investors have to be smart on how to do it. In that sense, there is a lot of hype," says Deborah Mei, a partner at The Raine Group, a financial advisory firm.

"But in terms of China being an important player in the world's film and TV sector, it's not a hype. China continues to improve on the quality of what it is producing, and that can be seen in relative box office performance and what people are watching on television."

Content is king

Until 1994, China's film industry was in a funk, dominated by propaganda releases. That year the country imported its first foreign title - Warner Bros' "The Fugitive" - with a great success. More imports from the US followed, with 6-10 shown in Chinese theaters every year between 1995 and 2000, according to Stanley Rosen, a political science professor at the University of Southern California (USC), who conducts research on the Chinese entertainment industry.

It was not until 2012 that China and the US agreed to significantly increase market access for foreign films. Up to 34 releases are permitted each year, including in IMAX or 3D format, up from the previous cap of 20 on standard formats. Foreign studios are entitled to a maximum of 25% of the Chinese box office takings. Industry-wide revenue hit a record $6.8 billion in 2015, up 49% year-on-year, according to the State Administration of Press, Publication, Radio, Film and Television (SAPPRFT). Hollywood releases accounted for 38.4% of the total.

Chinese activity in the US movie industry have been led by strategic players, primarily through co-investment or providing slate financing for Hollywood studio productions. Perfect World, a local movies and video games company, agreed to invest $250 million in 50 films produced by Universal over five years. Hunan TV, China's second-largest broadcaster, signed a $1.5 billion slate deal with Lionsgate to underwrite 25% of the production costs for at least 50 movies over three years, while Bona Film Group agreed to invest $235 million in a slate of marquee movies by Twentieth Century Fox.

Certain companies have also targeted individual films. Alibaba Pictures, a subsidiary of Alibaba Group, is a typical example, having substantially invested in movies such as Paramount Pictures' "Mission: Impossible - Rogue Nation" and "Star Trek Beyond." Whether single titles or slates, these investments are intended to deliver returns from the global box office as well as promotional rights within China.

"The Chinese investments in Hollywood are not intended primarily to bring films to China; they are an effort to invest in and be part of a global film industry that is focused on Hollywood. Even if only a few films a year from any of these companies are shown in China, the investments allow Chinese companies to learn the international film business and profit from it," says Lindsay Conner, co-chair of entertainment and media practice at Manatt, Phelps & Phillips, who advised on the Perfect World deal.

The PE angle

Private equity investors are, understandably, taking a different approach to their strategic counterparts, focusing on partnering with foreign players that need help distributing and monetizing their products in China.

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

These partnerships, structured as Sino-foreign joint ventures, may also represent a way around the foreign movie quota. Provided there is a certain amount of domestically-produced content, the share of the box office that goes to the foreign party can be considerably more than 25%. "Kung Fu Panda 3," a recent co-production between DreamWorks Animation and Oriental DreamWorks, a Shanghai-based studio backed by CMC, has generated $519.7 million since its release in January; 30% of this came from China.

CMC set up another joint venture with Warner Brothers to co-produce Chinese movies, as well as forming a film fund with US theatre operator IMAX Corporation that produces Chinese language movies, either as original contents or as co-financed projects with other studios.

"If you're investing in 15 movies, statistically you have a greater chance of getting one huge hit than if you invest in one movie at the time. So the greater number of assets you have, the more it trends towards a certain norm, which I don't think is really true in the movie industry. But that's one reason why people in China want to invest in film funds and finance a slate of Chinese language movies," says Stephen Scharf, co-chair of the entertainment, sports and media practice at O'Melveny & Myers (OMM).

The high level of risk and capital-intensive nature of the film industry should not be underestimated, and investors have adopted a range of mitigation tactics. Seeking to open up the Universal slate to a broader base of investors, Perfect World launched a film fund in conjunction with domestic fund-of-funds Shengjing. If the early films perform well, the slate can become self-financing as revenues cover the cost of later productions. Investors would also be able to take out their equity capital early on, with additional upside to come should the later films enjoy similar success.

Fosun is taking much the same approach with Studio 8, another greenfield Hollywood venture. The Chinese group committed $200 million to the project, but industry sources say it made a down payment of just $30 million, with the rest to be raised through syndication to local and international investors. On one hand, there are concerns that capital constraints might lead to production delays and failure to tie down the best actors. On the other, it is a meaningful way to protect the lead investor.

"Syndication is an efficient way of deploying capital - you can lead a deal and determine the terms, but not use all of your own capital on one property. In many cases they charge a fee to other investors," says Raine's Mei. "There are many investors who want to participate in film deals but they may not have access to the right projects, may not want to deploy too much capital in one deal, or may prefer to follow a more knowledgeable partner. There is a lot of money available and syndication is one way to access it."

Financing a production also gives the investor a small portion of the intellectual property rights to one or more films. In purchasing Legendary, Wanda got a company that typically holds the majority position in these projects, but its quest for content hasn't stopped there: the Chinese conglomerate is reportedly looking to acquire a 49% stake in Paramount Pictures, a studio and production house. This represents a move to control a larger portion of the value chain, and it has a strategic relevance beyond movies.

"If Wanda wants to build a theme park bigger than Disney's, from where do they get the IP for all the characters and attractions? With an over saturation of theme parks already in China, one will require strong and recognizable IP to stand out and it takes years to create or acquire it," says Rick Ambros, a partner at consultancy Lightsource Asia Media Group.

CMC is also looking for additional ways to monetize media content. Having secured agreements to develop projects such as Shanghai's entertainment complex and Legopark, it took a minority stake in Imagine Entertainment, the production house behind "The Da Vinci Code" and "Apollo 13." CMC also backed Tang Media Partners - a Sino-US media investment firm headed by industry veteran Donald Tang - which in turn bought Hollywood film and TV studio IM Global. One of the other investors, Tencent Holdings, formed a joint venture with Tang and IM Global to produce and distribute TV content.

"You will see more companies that combine the best Hollywood and the best of China. It doesn't matter if a Chinese company owns the studio, or if the film is made substantially in Hollywood with American actors. They're making content for the US and Chinese markets, and for the international markets," says USC's Rosen. "In the past, leading directors or stars would make films in Hollywood because that's where the money is. That's not changing."

And relax?

The success of these Sino-foreign arrangements, including monetization of content outside of movie theaters, ultimately hinges on regulation. Legendary is an interesting test case: Is it a Chinese company and therefore not subject to the quota system or a US-incorporated subsidiary that produces are Hollywood movies? If the former, it would provide a strong incentive for other Chinese takeovers of film studios overseas.

"There are a lot of negotiations going on over non-Chinese companies doing business in China and Chinese companies doing business overseas. Many deals have closed but some have not. It is often complex because the parties haven't dealt with each other before, or because of government regulation. But it's an active market and I think it will stay that way for the next couple of years at least," says OMM's Scharf.

He notes that some investors don't expect the movies to be released in brick-and-mortar theaters, but are targeting online distribution. While a larger number of foreign films are expected to be released online, those materials still have to go through SAPPRFT, and there is little evidence that the government will loosen the criteria for "qualified movies." Content deemed to be offensive or inappropriate for general audiences will therefore still be blocked.

However, there is cautious optimism of leeway in other areas. Industry participants expect a relaxation in the revenue-sharing model, with foreign studios' share of Chinese box office receipts rising as high as 50%, while the revenue split for co-productions also set to increase as these are considered to be more favorable than straight imports. But the policy environment remains opaque.

"There will be a lot of pressure from Chinese companies - not only from US companies - to open up the Chinese market, because they're investing a significant amount of money into these movies. If they can't be released in China, that will be very awkward," says Lightsource's Ambros. "But in China you never really know. There have been instances where foreign players have seen the release of their movies delayed or even cancelled last minute due to government regulation. That's the frustrating part for US companies."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Media
• Performance
• China
• Dalian Wanda Group