Huayi Brothers Keeps Straying From Its Day Job. Is It a Film Company, or Something Else?

None of these options is better than the other. The problem is that Huayi has to choose one.

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Mr. Six was one of the Chinese-language films most worth watching in 2015. In its final scene, Lord Six, played by Feng Xiaogang, struggles to hold himself up on a military sabre on a frozen lake. The camera looks up at him, and the moment feels heroic and doomed at once.

The "left-behind" Lord Six also looks like a portrait of Huayi Brothers, the studio that produced Mr. Six. As China's box office grew at a frantic pace, Huayi fell behind. In 2014 it lost its long-held place as the top-grossing private film company, and in 2015 its market share slid further, to about 4.5%. Huayi Brothers' golden age seemed to be over.

Huayi may not see it that way. Its financial statements, which matter just as much to a company, show a completely different Huayi. In the first three quarters of 2015, Huayi Brothers' revenue doubled. Leaving out income from its various investments, net profit came to 128 million yuan, up 148% on the same period of 2014.

Most of the growth came from Yinhan Technology, a game company Huayi Brothers bought. Yinhan's results were folded into Huayi's accounts in May 2014. Huayi's half-year report then showed that in little more than a month, Yinhan had contributed nearly 75 million yuan in revenue.

In Huayi's 2015 interim report, gross profit from internet entertainment, the segment that houses the game business, exceeded 400 million yuan. That beat the 330 million yuan from film and TV and made it Huayi Brothers' most important source of profit.

In fact, the biggest source of profit in Huayi Brothers' accounts was neither film nor games but so-called investment income. Selling shares in Ourpalm, an earlier investment, and in Jiangsu Yaolai Cinemas, along with the Hong Kong listing of Chaofan Network, another company it had invested in, brought Huayi nearly 500 million yuan in gains.

Strictly speaking, it no longer quite fits to call Huayi Brothers a film production company.

A strategy launched in 2009 seems to have paid off. That year Huayi Brothers first announced what it called "de-filmification."

"If all we did in future was chase box office, I think the company would have lost its way. When we listed in 2009, the first thing I said to my executives was: from today, Huayi Brothers is de-filmifying. Had I really thought it through? I had and I hadn't. But I sensed, somehow, that Huayi must never make only films," Wang Zhongjun said in an exclusive interview with Phoenix Finance.

Wang may insist he hadn't thought it through, but he knew exactly what he was doing. Film is a very risky business. In China especially, a studio lives or dies by the box office, and nobody can say whether people will want to go to the cinema, let alone whether they will want to see Huayi's films.

By then the Chinese film market had already taken off, growing more than 30% a year. But Huayi's in-house model, in which star talent drove its whole film production, was being eaten away.

Feng Xiaogang is the best example. From Big Shot's Funeral in 2002 to If You Are the One in 2008, Huayi and Feng together claimed the year's box-office crown several times.

In recent years, though, Feng has grown older and his creative powers have faded. In February 2012 he posted on Weibo that his love of film was fading, and seemed to hint that he would quit the business. Huayi's share price began falling that same day, until Feng was pushed into posting an apology: "I will honor my contract with Huayi and fulfill it to a high standard, as far as I am able." Even so, Feng had lost his absolute hold on the market.

Huayi's talent-management business, once its pride, was shrinking too. First the agent Wang Jinghua walked out; then Zhou Xun, Huang Xiaoming, Li Bingbing, Fan Bingbing and others left the Huayi system to set up their own studios.

Meanwhile, rivals were rising. Enlight Media used its strong on-the-ground distribution network to move into production. Bona Film Group relied on Hong Kong filmmakers who had come north to seek their fortune. Wanda had deep pockets. And internet companies watched from the sidelines, eager to use the internet to overturn the traditional film industry. All this made the big-budget Feng Xiaogang film look unwieldy and its risks hard to gauge.

This was the background to de-filmification. For Huayi, the point was to find sources of profit outside film. In Wang Zhongjun's words: "I don't think a film company can ever become a great company... I might just end up as the boss of a Playboy. It puts out a magazine that's all show and beauty, but it can't make money consistently, or make big money."

The Wang brothers said many times that "de-filmification" did not mean Huayi would stop making films, only that it would not make films alone. But once Huayi poured its resources and energy into other businesses, film was bound to be pushed to the margins.

And so, over the next five years, a different Huayi came into view.

In 2010, Huayi Brothers paid 148 million yuan for 22% of the mobile game maker Ourpalm. After Ourpalm went public, Huayi sold down its stake, cashing out nearly 1 billion yuan in total. The Ourpalm shares it still holds are worth more than 1.7 billion yuan.

In 2013, Huayi Brothers bought Yinhan Technology, whose results entered Huayi's accounts a year later. In 2015, Huayi also invested in the game publisher Xianyu Games and in Hero Entertainment, the developer of Crisis Action.

Huayi's entertainment real-estate projects (which Huayi calls its brand-licensing and location-based entertainment business) may also bring in a fair amount. After 1942 Street opened at the Feng Xiaogang Film Commune in Hainan, Huayi Brothers went on to sign 14 similar projects by the third quarter of 2015.

Yet next to the dominance Huayi once enjoyed in film, it is still a small player in games and entertainment real estate. In 2015 China's game industry took in more than 140 billion yuan. Tencent earned more than 40 billion of that and NetEase more than 15 billion. Huayi earned less than 1 billion.

In entertainment real estate, the Feng Xiaogang Film Commune officially claims more than 1 million visitors a year. Even taking that figure at face value, it is far behind Disney, the model it aims at. The Shanghai government's official forecast is that Shanghai Disneyland will draw more than 7 million visitors in its first year.

In truth, 1942 Street is just a pedestrian street dressed up to look like Republican-era China and old Hong Kong, lined with shops and snack stalls. It is no different in kind from the "ancient towns" and "old streets" that have sprung up at tourist sites all over the country.

Its only selling point is its link to Feng Xiaogang's films: as the name suggests, 1942 Street was built from sets in Feng's Back to 1942. But next to its competitors, Disneyland and Universal Studios, Huayi has no richer entertainment to offer, and so little ability to compete.

What's more, in most of these real-estate projects Huayi puts in only its brand, and takes back licensing fees, free equity stakes, and a 10% cut of ticket sales. Huayi's financial reports put the gross margin of this business at 100%. As Wang Zhongjun put it: "A brand is a money-printing machine."

The biggest share of this income is still the licensing fee. It is a generous one-off payment, but it does not recur. Once the entertainment real-estate market is saturated, what these projects bring Huayi will fall sharply.

So Huayi Brothers' real-estate business depends on the fame of its past films and on a bubble in entertainment real estate. It is living off its past.

Huayi Brothers did have ambitions for its real-estate and game businesses: its model was Disney. It wanted to do what Disney does, taking a film like Iron Man and turning it into a TV series, then toys, then games, and finally an attraction in a theme park.

But Huayi has not managed it. In 2014 it announced that it would turn God and Demon, a Yinhan Technology game, into a film, with Wong Jing directing. Yet God and Demon appears nowhere in the plans Wong Jing himself has described.

The Feng Xiaogang Film Commune, too, looks more like an ordinary shopping street. Next to the 700 million yuan that Feng's Personal Tailor took at the box office, it clearly has much less pull.

Seen this way, Huayi's game and real-estate businesses do make money, but neither connects closely enough with Huayi Brothers' core film and TV business. They let Huayi grow bigger and find new revenue outside the high-risk film industry. They are not enough to make Huayi Brothers China's Disney.

What separates Huayi Brothers from Disney is not some business Huayi lacks. It is that Huayi cannot make good films. Whenever Disney sums up its business, it talks mostly about four brands: Disney, Marvel, Pixar and Star Wars. In other words, what drives all of Disney's business is still its films and shows.

Star Wars is the best example. The first Star Wars film came out in 1977 and was a worldwide sensation. Only then came the sequels, the bestselling toys, the theme-park rides, the mobile games and everything else spun off from it.

Now look at what Huayi did in film and TV over the past year. Apart from Mr. Six, it made few films that won audiences over.

Huayi may already be changing strategy again.

In the second half of 2015, Huayi bought two companies for 756 million yuan and 1.05 billion yuan respectively. The first was founded by its own stars, including Li Chen, Chen He, Feng Shaofeng and Zheng Kai; the second by Feng Xiaogang.

The deals look like bonuses for the stars in disguise, and Wang Zhonglei confirmed as much to QDaily: "What Huayi Brothers values most is the worth of the artists themselves."

The bonuses now come as acquisitions, and Huayi has signed earn-out agreements with the stars that tie the price to future results. But this is essentially the same strategy as before, when Huayi held on to Feng Xiaogang, Zhou Xun, Huang Xiaoming, Li Bingbing and Fan Bingbing: both bet on stars to guarantee box office or ratings.

Wang Zhongjun may now be after more than that. Huayi wants a piece of the fan economy that grows up around celebrities. In 2014 and 2015 it teamed up with Tencent and BesTV respectively to launch two fan products, Xingying Alliance on mobile and Yulejia on TV.

Huayi also set up a company devoted to the fan economy, Huayi Chuangxing, run by Hu Ming, formerly the board secretary of Huayi Brothers. The latest news is that Hu Ming has stepped down as Huayi Chuangxing's chairman and general manager, and Wang Zhonglei has taken over himself.

Clearly the fan economy is now a priority for Huayi. Stars become IP too, or at least, as part of the fan economy, they can just about count as IP, and Huayi pitches all of it to audiences in one go.

But will fans buy it? Can the artists Huayi has signed become idols, and do they carry enough weight to get the fan economy going? Huayi has to answer these questions.

Besides turning back to its stars, Huayi now also sees itself as an investment company.

At the Shanghai International Film Festival last June, Huayi borrowed from the "Internet Plus" slogan to announce an "Entertainment Plus" strategy. It set up an investment fund, Fuhui Capital, to back companies that could work alongside Huayi Brothers' entertainment businesses, among them Sutu Entertainment, which runs WeChat public accounts, and Zhihui Mofang, an online travel company.

So Huayi presents a contradictory picture. On the one hand, Wang Zhongjun wants to turn Huayi Brothers into a Chinese Disney: "Huayi keeps making films and building up influential IP. The IP carries over into games; the games keep being developed and keep producing IP of their own. Then these two kinds of IP support the third business, brand licensing."

On the other hand, film, the most important link in that IP chain, has been weakened under the slogan of "de-filmification." Huayi no longer looks like a film company, nor quite like an entertainment company. It looks more like a conglomerate that grew bloated before it ever grew up, with a little of every business.

Seen this way, the criticism that has dogged Huayi all year for straying from its core business has a point. It forces Huayi to face one question: what kind of company is it?

If Huayi's answer is an investment company, it can stop holding back and go on a buying spree, as it did with Ourpalm. If the answer is a film company, it should put more of its energy into making good films, not into entertainment real estate, games and the like.

Neither choice is better than the other. The problem is that Huayi has to choose one.

And it is not an easy choice. Like Lord Six in Mr. Six, who can either cling to his old-school ways or change to fit the world around him, whichever way Huayi chooses carries a touch of tragedy.