China's Cinema-Chain Merger Wave Has Begun. Where Will It Take the Film Industry?

When an industry hits bottom, that is when consolidation starts.

It now looks almost certain that China's red-hot box-office growth will not last. But another trend has surfaced: cinema chains are merging.

In August, Alibaba Pictures announced it had taken a controlling stake in the cinema operator Hangzhou Xingji, and said it would invest at least 1 billion yuan more to build up Xingji's theater business. Soon after, Perfect World bought 217 theaters from Jindian. In mid-October, China Film took control of Dalian Huachen. Then Bona Film Group signed an agreement with Xinhualian, under which Xinhualian would put up 150 million yuan and the two would work together on films and cinema chains.

Perfect World CEO Xiao Hong says consolidation in the exhibition business is inevitable.

The run of deals shows that China's once-scattered cinema chains are pulling together. Given that theaters were for a while one of the main engines of box-office growth, it may mean something larger: that in this bleak autumn, the whole Chinese film industry has entered a new round of adjustment.

The slump at the box office set it off. Since the second quarter, box-office revenue has fallen year-on-year for several months running. The much-touted target of 60 billion yuan is already out of reach, and some people now worry that this year's total could come in below last year's.

For theaters, falling revenue has made day-to-day operations harder. Beijing Daily visited several cinemas, and the managers all said this year's targets would go unmet. Even Wanda, the "world's largest cinema chain," cannot guarantee its theaters' revenue. Even counting chains like AMC in the US and Hoyts in Australia, Wanda Cinema Line took in 540 million yuan at the box office in April, down 9.5% from a year earlier. July, traditionally a golden season, was down 4.4% year-on-year. And in July, Wanda Cinema Line's box office per screen fell 42.5%.

Data from Fanying shows that new theaters bring in less and less. Theaters built before 2011 averaged 7.9 million yuan in box office in 2015; theaters built in 2014 averaged only 5.28 million yuan. Most new theaters are opening in third- and fourth-tier cities, where the population is thinner, so the growth they add is small. The economist Chen Qin ran an economic model and found that if theaters keep going up regardless of cost, and the pace of migration into cities holds steady, the market's remaining box-office growth is only 26%.

Faced with all this, theaters are at something of a loss. For years they had it easy — the business ran with the wind, and all they had to do was expand along with the market.

Fast box-office growth and the theaters' land grab fed each other. When the market was growing fast, running theaters was a good business, which pushed operators to keep drawing up ever more ambitious building plans. Cinemas looked like the most profitable link in the whole chain. That was the basis for Wanda Cinema Line's valuation of nearly 100 billion yuan, and Wanda's biggest asset when it moved into the film business.

As late as June, Wanda Cinema Line president Zeng Maojun still thought it was too early to talk about a bubble: "Once the total number of screens in China passes 70,000, the rapid growth of Chinese cinemas will start to decline." But in today's market, new theaters struggle to earn enough at the box office to keep the lights on, and those expansion plans have become a drag instead. Perhaps the growth in China's screen count over the past few years had some blindness in it. China's current 31,000 screens may look small against Zeng's forecast of 70,000, but when Ng See-yuen, president of UME Cinemas, got into the exhibition business in 2001, the number was barely 2,000.

Ng See-yuen says plainly what he thinks of the building spree: "Cinemas should be built according to where the people are. I often say that good things turn bad once they reach Chinese hands. People used to speculate in stocks; now that movies are doing well, everyone wants to get into the cinema business — even foot-massage-parlor owners want to run theaters. There's no barrier to entry, so box-office skimming and inflated numbers have appeared. It's a phenomenon you don't see anywhere else in the world."

Theaters built by "foot-massage-parlor owners" can damage the whole industry. Ng See-yuen gave an example: "I have a theater in Chongqing. We can't compete with them — they sell tickets for 15 yuan and don't even print a ticket from the machine, while we do things by the book and pay our taxes and rent."

The internet is a bigger challenge still. It has remade the film market fast, and not necessarily to the theaters' benefit.

Streaming sites keep shortening a film's life in theaters. Normally a film runs for about a month, then turns up a few months later on home video and streaming. But streaming sites now carry more weight in the industry, and the window keeps narrowing — often a film is available online less than a month after it leaves theaters. Some films now open in theaters and online on the same day. In the US, Netflix has signed deals with some chains to release certain films simultaneously. In China, companies like LeEco have started similar experiments. They don't always work, but the balance of power between streaming sites and theaters is shifting.

Cinema chains have almost never welcomed ticketing apps, even though the apps may have sold theaters more tickets. When a customer buys through an app and then spends at the theater, the theater becomes a pure point of sale. That cuts it off from its own customers — the data all goes to the app — and it also shortens the time customers spend in the building.

Ticketing apps have also wrecked the theaters' old membership programs. Members used to get two things: lower prices and reserved seats. In the group-buying era, group prices might beat the member price, but group buying came with no seat reservation. Ticketing apps give nearly every customer VIP treatment, which leaves a theater's own membership looking pointless — and leaves theaters with fewer and fewer regulars.

Still, the ticket subsidies the apps once used to grab market share did bring real business to plenty of small theaters. Those theaters cared nothing for membership or data, only for ticket revenue and popcorn revenue. They did not hold their own users; promotion happened in the cloud, and even the ticket money waited to be wired over in bulk by the e-commerce platforms. That passive arrangement caused no trouble while the market boomed. But once the market stumbled and money ran short elsewhere in the chain, the fate of small theaters lay entirely in other people's hands.

According to a report by Yiyu Guancha, in June more than 50 small and mid-size theaters from different chains in Jiangxi province formed an alliance called Fenghuo Yinglian and published a manifesto listing, one by one, the indignities small theaters have suffered in the downturn:

"The e-commerce platforms' rock-bottom prices have wrecked our membership systems; and it's because of the e-commerce platforms that our members' prepaid balances turned into receivables owed to us by the e-commerce platforms! On top of that we have to go through a long process of reconciling accounts and chasing payments, and swallow our anger while we do it. E-commerce — the thing theater investors both love and hate! We put in capital we'd built up over years to invest in one or two theaters, only to find that up against giants like Wanda, Xingmei, and Dadi, so many upstream resources are out of reach — they get promotional subsidies from distributors and e-commerce platforms, and we get nothing. Even suppliers push us around — on concession supplies, water, drinks, xenon lamps, 3D glasses — they always say our orders are too small and refuse to come down on price."

A crisis at small theaters is exactly when the big chains start buying. Speaking to QDaily and other outlets, Zeng Maojun did not mince words: "The slowdown in box-office revenue this year has given us better opportunities and acquisition valuations. As the market cools from the intense heat of the past three years, and as some players lose short-term working capital, we're going to get stronger."

In China, 31,600 screens are split among 48 cinema chains. The top ten hold about 66% of the market, the top four about 40%. In mature markets the top four chains hold 60% in North America, the top three hold 96% in South Korea, and the top two hold 50% in Australia. The room for consolidation in China is enormous.

Commercial real estate in the big cities is close to saturated, leaving less and less room for new theaters. The market has left its hyper-growth phase, and theaters' room for markup has been squeezed. Meanwhile, starting last year, China Film, Shanghai Film, and Xingfu Lanhai filed for IPOs one after another and won approval; Jinyi, Dadi, and Shidai have been working their way toward the capital markets; and Wanda and Alibaba have always spent freely. So, in this box-office winter, a wave of large cinema-chain deals has arrived.

2016 domestic cinema-chain M&A deals

Feb

Wanda Cinema Line acquires Dalian Aona Cinema

Feb

Wanda Cinema Line acquires Guangdong Houpin and Chifeng Beidouxing

May

Alibaba Pictures invests in Dadi Film, taking a 4.76% stake

May

Contemporary Oriental acquires 51% of Huacai Tiandi, gaining control of its Shanghai Honge Cinema Line

Aug

Alibaba invests in Hangzhou Xingji, taking an 80% stake

Sep

Perfect World acquires Jindian Cinema Line

Oct

China Film acquires a 70% stake in Dalian Huachen Film

When big chains buy small ones, less is wasted. As the manifesto said, big chains can get more upstream resources, they buy more cheaply, and they have more leverage with production companies and suppliers. Big companies also bring tighter, more efficient operating rules, which cuts costs.

For the more ambitious chains, all that is small change. What they really want is to build a giant that runs the length of the film industry, from one end to the other.

In this business, the link closest to the money is distribution. For a long time Bona Film Group was China's biggest distributor. Then in 2010 Huayi Brothers, freshly listed and backed by the capital markets, passed Bona to become the largest private distributor. Enlight Media and LeEco muscled in after that, and Wuzhou Film Distribution, led by Wanda, became the industry's dominant player.

Wuzhou's rise is tied closely to Wanda Cinema Line's strength. Wanda Cinema Line now owns more theaters than anyone else in the world, and it has led China for years running. With that hold on the exhibition end, Wuzhou has an edge no rival can match in ground-level promotion, screening schedules and more.

It resembles Hollywood seventy years ago. The major studios then controlled every stage of making a film, which cut costs and raised returns. In 1947 the average film cost just $732,000, while net profit rose to $1.6 million. The studios lived well on that for years, until Paramount was found in violation of antitrust law in 1948, after which Hollywood studios were barred from owning theaters. The rule has loosened somewhat today, and many film companies have struck deals with chains, but Hollywood has never produced another giant quite like those studios.

China has no Paramount Decree to hold it back, and one ambitious company after another has set out to become that giant. Wanda already covers every link — investment, production, distribution and exhibition — and Alibaba does not want to be left behind. Several regional theater operators in Shanghai, Zhejiang, Chongqing and elsewhere are already in talks with Alibaba Pictures about capital injections, technology integration and more. Alibaba has also signed agreements with chains like Dadi and taken control of the cinema operator Hangzhou Xingji. Theaters may not be the focus of Alibaba Pictures' future, but they are clearly a link it will not skip.

As the industry's resources concentrate, China's film business is bound to change deeply.

We may never see a company that monopolizes everything the way Paramount did seventy years ago, but giants like Wanda already use their power to shape the market. In July, When Larry Met Mary and For a Few Bullets went head to head. Their weapon was not the quality of the films but the cinema-chain resources their backers controlled. At Wanda Cinemas, For a Few Bullets got 32.57% of screenings and When Larry Met Mary got 5.24%. At Wanda's Beijing theaters, When Larry Met Mary ran just three times a day.

As cinema resources concentrate further, we are likely to see more of these duels. Chains can even take on other powers, such as their "enemy," the ticketing apps. When Warcraft opened, Wanda kept its midnight IMAX screenings off the e-commerce platforms; tickets could only be bought on Wanda's own platform. Zeng Maojun found the results excellent: "As soon as our IMAX screenings went on sale, individual theaters basically sold out instantly. Within about ten minutes, midnight IMAX screenings were sold out almost everywhere in the country. We quickly added a 2:30 a.m. showing, then a 4:30 a.m. showing, and those basically sold out too." Zeng went further: "We haven't ruled out closing off all our IMAX screens nationwide to the e-commerce platforms next."

Concentration also makes segmented distribution possible. Segmented distribution means, simply, that a film does not open nationwide but only in certain regions or on certain chains. Today's advance screenings are a variant of it. In the US, not every film opens in every theater in the country; some run only in selected regions or selected showtimes, to avoid wasting money on promotion and distribution.

But while chains are weak, theaters cannot control segmented distribution themselves; the strategy still comes from the film's backers. Fang Bin, general manager of Dadi Cinemas, said: "If a film comes in and I decide to screen it only for non-members, or only in this hall and not that one, the distributor and producer come after me — why did you cut my screenings, why are you shortchanging me?"

If chains gain enough leverage, or if the companies behind them hold the production and distribution power themselves, offering different content in different places becomes possible. At the Changchun Film Festival not long ago, China's first art-house cinema alliance was formed, with a hundred auditoriums nationwide joining in the first batch — another attempt at segmented distribution.

Big companies also have the capital to fix details like technology and service. The same film in two different theaters can be two different experiences. Most blockbusters now have 3D versions, but many theaters fall short on brightness and run outdated 3D equipment, which hurts the result on screen. Building an IMAX auditorium or brightening the lamps both cost money. By Ng See-yuen's account, China's 48 chains include some whose revenue runs to only a few million yuan — less than a single UME theater takes in. Chains like that plainly cannot pay for a technology upgrade. Now, with capital coming in, they might. And in this round of upgrades, brands behind high-end formats like IMAX and Dolby may find new openings.

A hot, even wildly growing market brings a force and a confidence that cover every problem, and it breeds impulse and blindness. Now that the enthusiasm is cooling, the problems under the rapids show more clearly; plenty of players are walking away, and the giants are moving in to harvest. Only in quiet times do companies sit down and think about questions like how to offer a different kind of service, or how to build a cinema-chain brand.

Seen that way, the film market's winter is not entirely a bad thing.

(Graphics: Wu Lingwei)