April 29, 2015

Chinese investment in Hollywood: Where is the money coming from? Who is it going to?

The following is an analysis originally written for my MA in International Film Business from the London Film School:

With a 40 percent rise in the first quarter of 2015, China’s box office is, for the first time, larger than North America’s, making it the largest market for cinema in the world. Although China is home to more than 1.3 billion citizens, almost four times the population of the US and Canada combined, it remained the world’s second largest cinema market due to a lack of infrastructure in the form of cinemas. Since early 2014, construction of cinemas in China has been as high as 13 per day, which has massively increased the opportunity for Chinese audiences to see films.
Innovative Chinese companies, such as the Dailan Wanda Group, noticed the gap in the market and invested massive sums of money building cinemas to serve what was previously a highly under-screened country relative to population. The purpose of this essay however, is to examine the innovative actions these Chinese companies are performing on the other end of the film value chain, in the development and production areas, and how they’ve invested in foreign, mostly US-based, companies to fill their new cinemas with content. Several case studies following Chinese investment in individual films, specialty services firms, other forms of media, and foreign companies are examined below, but first a short analysis of the history regarding Chinese/western business.
Doing business with China was mostly impossible in the mid-twentieth century until the foreign policy of the Nixon White House successfully opened relations. Since then a large amount of trade has taken place between China and the west, reaching never-before-seen levels in the late 1990’s when it seemed as though everything had a “made in China” label on it. This was due to cheap Chinese labor and China’s access to many natural resources necessary for materials production.
By the early 2000’s China was completing its journey from a developing nation to a fully industrialized one, eventually outpacing Japan as the world’s second largest economy. With new economic power and the rise of e-commerce, many western businesses, including Hollywood, looked to move into China to find new customers. There was one small problem however; the Chinese government wouldn’t allow it.
Despite being a highly successful, modern economy, China was and still is a communist country and not a free market. Therefore many of the proposals for western company’s expansion into China were met with refusal. This was unfathomable to many westerners who never considered that a communist government could be so economically successful. Instead they chose to remember the communists of the Eastern Bloc who, in the late 1980’s, failed so spectacularly that all of those countries no longer exist.
Western businesses failed to see the challenge of the Chinese market both politically and culturally and assumed they could operate there just the same as they had been operating everywhere else. The west was operating in a “push economy,” where a company itself can push into a new market. China however, was operating in a “pull economy,” only pulling in the business it wanted.
One of these businesses pulled into the Chinese market was Hollywood, the global leader in terms of cinema content quality and marketability. China had a weak film industry compared to neighboring Hong Kong, and required screen content to show in its slowly expanding network of cinemas. As a result, the Chinese government instituted a quota system for films, in which only a certain amount of films would be allowed in each year, as well as strict content guidelines making films subject to censorship. Because the Chinese quota was far below the number of films being produced by Hollywood and other western film producing countries, China could be very picky on which films were selected to play. Only the films deemed suitable were “pulled” through to Chinese cinemas.
The Chinese quota system is inherently limiting to foreign produced films but there is another way into the Chinese market that circumvents it: co-production. Instead of making a film with foreign funds and selling it to a Chinese distributor, as is often done in other territories, foreign films funded with a substantial upfront investment from Chinese distributors can be released in China under the same rules as local Chinese films. Therefore, rather than a foreign producer “pushing” his or her film to a Chinese distributor, the distributor has the power to “pull” the films it wants to make into the Chinese market.
This mostly occurs with large-scale action pictures such as Iron Man 3, Transformers: Age of Extinction, and Furious 7, because that’s what selling best to local Chinese audiences. Following the success of these films, several new Chinese/Hollywood co-productions have been announced including a sequel to DreamWorks’ Need for Speed, itself a major hit in China and an import under the quota system. The sequel will feature China as it’s primary location as well as several Chinese actors in prominent roles.
The first Need for Speed film was typical of a Hollywood mini-major, financed by DreamWorks, produced entirely in the US and featured American stars Aaron Paul and Michael Keaton with British actress Imogen Poots. The film played moderately well in the US but found its largest audience in China, grossing the equivalent of $66 million. That number has enticed three prominent Chinese companies: Jiaflix, China Movie Program Channel and 1905 Pictures to enter into a co-production with DreamWorks for the sequel. These are the same three companies that co-produced Transformers: Age of Extinction with Paramount in 2014, which grossed $330 million worldwide, $220 million from China alone. The promise of a more Sino-Centric sequel to the first Need for Speed film demonstrates the faith these companies have in the franchise and clearly demonstrates the evolution of Hollywood films as they become increasingly less American and more international to meet the demands of a global audience and sources of global finance.
China’s co-production activities are not limited to Hollywood alone. 2015’s European Film Market saw the debut of Jean-Jacques Annaud’s Wolf Totem, a Chinese/French co-production based on the 2004 Chinese novel of the same name. Such a production shows how the nature of Chinese co-productions are moving further away from the styles of their co-producing partners and closer to that of native Chinese cinema. Whereas Transformers: Age of Extinction was a Chinese co-production of a Hollywood film, Wolf Totem is a French co-production of a Chinese film. This is likely to be the case with the Need for Speed sequel as well, where the final product is closer to that of a native Chinese film rather than a Hollywood film. Therefore, China is moving toward a business model that pulls in outside finance for the funding of native content rather than one that pulls in outside content for local distribution.
With the Chinese film industry transitioning from an import economy to an export economy, it requires access to resources that work on a global scale and the best place to find those resources is Hollywood, the most established and mature industry in the world. Therefore, Chinese companies such as the aforementioned Jiaflix, China Movie Program Channel, and 1905 Pictures, as well as large entertainment conglomerates like Alibaba, Hunan TV, Huayi Bros. Media Group, Wanda Cinema and Tencent Media are finding Hollywood firms to partner with. These partnerships started with co-financing individual films but are now evolving to include direct investment by Chinese companies in Hollywood firms.
Q3 and Q4 of 2014, and Q1 of 2015 saw a huge amount of press announcing various deals between Chinese companies and Hollywood producers but very few of them actually happened. In his article in The Hollywood Reporter Michael Wolff writes about how the large amount of Chinese interest in Hollywood does not translate to a similar amount of money being invested in the industry. He attributes this to a cultural disconnect between Chinese and American business practice. He writes:
“The Chinese approach often is to show up and say: "We'd like to buy your company. Show us your books." The native response is, "Make me an offer, and no, you can't see my books." The result often is a nondeal deal, a willingness to begin a relationship but a resistance to make the first move — producing a term sheet that hardly commits anyone to anything.” (Wolff, 1)

            Wolff sites an anonymous executive who has had many business dealings with Chinese investors and describes how in China it is common practice to meet, discuss deal terms, take press photos, issue a press release and then decide whether or not to move forward with the deal. “They call it caution, we call it reneging.” (Anonymous, Quoted in: Wolff, 1) This has resulted in many supposed Chinese/Hollywood partnerships, few of which ever came to fruition.
            Former Warner Bros. President Jeff Robinov announced a partnership with China’s Huayi Bros. Media Group and his newly formed production company Studio 8. Huayi and Studio 8 released a term sheet along with major press coverage, which seemed to cement the partnership. Later however, Huayi announced that instead of providing Studio 8 with the $120 million in capital it had outlined in the term sheet, they would instead open a Los Angeles office of their own to evaluate films for investment on a per-film basis.
            This would have been a much different type of investment in the Hollywood infrastructure than the one previously outlined. It could have proven more advantageous for Huayi Bros, as having a Los Angeles office without any direct ties to US companies theoretically gives them the freedom of choice in which American films to invest. However, not making a direct investment in Studio 8 would have limited Huayi Bros. access to projects as well, as they have no established network in Hollywood.
            Although Studio 8 is a new venture, seasoned Hollywood professionals whose job it is to know exactly which films are being bought and sold worldwide run the company. The largest advantage of direct investment in a Hollywood company is the access to that company’s network. Huayi’s announcement suggested they were taking the risk of finding their own way in Hollywood.
            This is actually the second time Huayi has announced plans to partner with a Hollywood company and failed to deliver. In 2011 the Hollywood Reporter announced that Legendary Entertainment, the financing and production entity behind The Dark Knight and Inception, was opening an office in Hong Kong and would develop “global films” with Huayi. Warner Bros. would distribute the films worldwide except for China, where Huayi would serve as distributor. It was in effect a co-production agreement between Huayi and Legendary, albeit with a condition for Huayi to become a major shareholder in Legendary’s Hong Kong subsidiary: Legendary East.
            Huayi’s deal with Legendary was never finalized and Huayi then turned to Studio 8 for a second attempt at a Hollywood partnership. Now, after a whirlwind of press coverage, speculation and doubt, Huayi has finally succeeded in investing in a Hollywood company: STX Entertainment, owned by Bob Simonds.
            Huayi is actually STX’s second major investor from China. In 2014, a Chinese private equity firm called Hony Capital invested $65 million in the startup company. Michael Wolff highlights this event as one of the key moments in the history of Chinese/Hollywood collaboration in his article for The Hollywood Reporter, but disclaims that it’s lacking in significance because Hony Capital is not a media company. Therefore the transaction was purely financial and it’s very unlikely that Hony will have any creative influence over the team at STX.
            Because STX was already sufficiently bankrolled by an outside investor, Huayi Bros. was not responsible for committing upfront capital to the company itself and instead invested in STX’s slate of 18 films. This changes the arrangement that Huayi had negotiated with both Legendary and Studio 8, where the deal was for Huayi to invest directly in the respective companies. This would have meant a significantly higher risk to Huayi as it would have been a large shareholder in Legendary, and later Studio 8. Therefore, when Hony took on the risk of owning shares of STX, a relatively low risk for that type of company as it has holdings in many industries, Huayi was free to enter into a lower risk agreement that accomplished the same goals as the previous two deals, minus the risk.
            Investing in a slate of films rather than a single company helps manage the risk associated with film production and distribution. Just like real-estate investments or those in the stock market, investment in films works best when the investor holds a diverse portfolio. Therefore, spreading out a large investment across 18 films rather than investing it all in a single company helps maximize the investor’s chance of a good return.
            This change in risk holding could explain why the previous deals with Huayi, and others that failed to materialize with other companies, were never completed. It seems that the film industry is a risky business on both sides of the Pacific and although companies on both sides need what the other side has to offer, it’s not worth adding a significant amount of risk for. Better to let the bankers handle those commitments.
            That was the exact sentiment of Studio 8’s owner Jeff Robinov after his deal with Huayi fell apart. After ceasing discussion with Huayi, Robinov turned to Chinese conglomerate Fosun International, a firm similar to Hony Capital that has diversified investments in many areas. Fosun had invested in a film company before: China’s Bona Film Group, but had not made any overseas investments in that business. The result was a $200 million investment from Fosun into Studio 8, a number that allows them to control nearly two thirds of the company’s shares.
            Both Fosun and Hony were able to invest where the Chinese media companies were not because of their diversified investments in other businesses. Therefore, it seems as though Chinese investment in Hollywood is poised to come from financial companies rather than the media companies. This makes sense given the way the different types of companies are able to handle risk. The more risk a company takes on, the more diverse their investments need to be.
            It is because of this arrangement that Chinese broadcaster Hunan TV was able to come to a co-financing and distribution deal with Hollywood Mini-Major Lionsgate. A deal so large, it nearly doubles the $200M figure invested by Fosun in Studio 8. Lionsgate is already successfully bankrolled by a combination of equity investment and debt finance and has been in the film business far longer than start-ups like Studio 8 and STX. Therefore there was no need for a private equity firm to bankroll the company as it has consistently proven itself to be a going concern.
            With no need for outside investment in the company, Lionsgate was a prime candidate for a co-financing and distribution deal with a Chinese media company, an opportunity seized by Hunan TV. Hunan is generally considered to be China’s most progressive broadcaster despite being state owned and they are the second most watched channel in China. Hunan is also a parent to several other media companies, including feature film producers and distributors Leomus and TIK Films, as well as Hunan’s pay TV network, Hunan CATV.
            Under the terms of the agreement, TIK Films will front 25% of Lionsgate’s feature film production budgets, a number that could be as high as $375 million. TIK and Leomus have the option to distribute four of the co-financed films in China. Lionsgate will also co-develop and co-produce Chinese language films with TIK and Leomus with Lionsgate handling distribution of those films outside the US and China. There are also rumors that the Hunan/Lionsgate deal could evolve to include theme park entertainment as well.
            This sounds like a triumph of international capitalism but ultimately Hunan is a state-owned enterprise and some very specific deal points had to be made in order to come to an agreement. China’s strict censorship and regulatory requirements dictate strict guidelines for films. Hunan’s power may go as far as preventing certain Hollywood stars, whose political views differ from the Chinese government, from appearing in Lionsgate films for release in China. Furthermore the Renminbi is a currency with strict exchange regulations. Partnering with Lionsgate required Hunan to open a separate Delaware corporation specifically for currency exchange.
            Despite these restrictions however, both parties seem to have agreed that the partnership between the two entities is worth the trouble. To date this is the largest investment from a Chinese company into a Hollywood firm, which Lionsgate is happy to receive due to the market exploitation opportunities it opens for them. Why though, are Chinese companies so eager to invest in Hollywood? There are two possible answers.
            In recent years China has seen the emergence of a healthy middle class. No longer is China a nation of poor famers and factory workers, with its new position as the world’s second largest economy the Chinese are developing a more sophisticated consumer culture. A prime example of this trend is in the automotive industry. As few as ten years ago, cars in China were reserved for the wealthy while ordinary people made their way on motor scooters or bicycle. As the Chinese economy expanded however, the industrial complex matured enough to begin to manufacture domestic cars rather than relying exclusively on imports. The first Chinese cars were unreliable, unsafe and impractical. Now though, the manufacturers have learned from experience and the quality of Chinese cars has nearly caught up to other car-producing countries. This increase in quality has increased the demand for quality by consumers. No longer will a middle class family settle for a poorly built car when there are much better options in the market. The same is true for film.
            Film technology and technique was largely developed outside of China, meaning that the Chinese had to rely on imported technology to create screen content. With the expansion of the economy has come a surge of technology and practices developed in China. The native film industry of China was able to mature just as the automotive industry was, which has now increased consumer demand for product that is both native and of high quality. The Hollywood studio system has reigned supreme in the market for decades due to its development of the best talent and technology. Now that Chinese audience are demanding more from their films and television, it seems as though Hollywood is the obvious choice help Chinese companies bring it to them.
            China wants to be able to offer native films to its audience the same way Hollywood is able to offer them to theirs, they only want to be limited by what’s possible, not by what’s possible in their country. Despite the rise of the internet and the current information society, Hollywood’s best practices for development, production and exploitation remain a mystery to anyone working outside the system. The only way for one to learn Hollywood’s secrets is to climb the career ladder or to buy in at a higher level. Huayi Bros. and Hunan TV have chosen to buy in.
            The next reason that China wants to become a part of the Hollywood infrastructure is because of Hollywood’s success with the international market. Generally speaking, Hollywood films travel, Chinese films do not. China is looking to change that with its two new partnerships with Hollywood. As mentioned earlier, one part of the Hunan TV agreement was for Lionsgate to distribute Chinese films internationally, something that the Chinese companies haven’t been able to do on the same scale as Hollywood.
            China is looking to become a global leader in film production and distribution, they are not content with having a profitable native industry, which is why investment in Hollywood will continue until that goal is realized. An anonymous source quoted in an article by Variety Asia Bureau Chief Patrick Frater states:
“From now on [the Hollywood China connection] is going to get real, ultimately leading to the acquisition of a studio.” (Annonymous, Quoted in Frater, 1)

            In all likelihood this is a real possibility as the studios both want access to the Chinese audience and have the best collection of film talent and technology in the world. A Chinese-owned Universal or Paramount could increase the value of Chinese films worldwide while simultaneously providing a reliable source of funding to their slate of films. It could be the first step toward a truly global entertainment company. It is very possible that the world is headed for an era where instead of the two film industries being the Studio and Independent industries, they are instead the Worldwide and Regional industries. Two distinct industries for screen content, one global, one local.

Works Cited
Coonan, Clifford. 'China Box Office: Theater Takings Rise 40 Percent In First Quarter (Report)'. The Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.

Coonan, Clifford. 'China's Huayi Brothers, Enlight Report Better-Than-Expected Earnings'. The Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.

Coonan, Clifford. 'Lionsgate Unveils Film Financing Deal With China's Hunan TV'. The Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.

Coonan, Clifford. ''Need For Speed' Sequel In Development As U.S.-China Co-Production'. The Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.

Coonan, Clifford. 'Slower Chinese Economic Growth May Pose Challenges For Hollywood'. The Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.

Coonan, Clifford. 'Universal Film Chief Jeff Shell: "China Is More Exciting Than It Is Difficult"'. The
Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.

Frater, Patrick. 'Inside The Lionsgate-Hunan TV Deal (EXCLUSIVE)'. Variety. N.p., 2015. Web. 25 Apr. 2015.

McClintock, Pamela. 'As Huayi Brothers Eyes STX, Questions Surround The Proposed Marriage'. The Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.

Wolff, Michael. 'Michael Wolff On Hollywood's Disappearing Chinese Money'. The Hollywood Reporter. N.p., 2015. Web. 25 Apr. 2015.


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