How Did China's Entertainment Moguls Hand Their Booming Film Market to the Small Companies?

Call it a textbook case of Schumpeter's theory of "creative destruction."

On the surface, it was China's tightened rules on outbound investment that crippled the "entertainment moguls" who had gone abroad. What really dragged them down was misreading where the film market was headed. Behind the gap between their glory days and today's retreat, the thing that should really make them beat their chests is the new market they handed away — a market that made the fortunes of a group of "small companies," everything the moguls are not.

On January 8, Wanda Film held an investor briefing on its asset restructuring. The announcement said plainly that Legendary Entertainment, which Wanda had bought two years earlier for $3.5 billion in cash, would not be part of this round.

In 2017, Chinese capital's investment in Hollywood fell from $4.78 billion the year before to $489 million. The Wall Street Journal reported that the China Banking Regulatory Commission had tightened its watch on Wanda's overseas assets, barring the companies Wanda bought abroad from being injected into its domestically listed entity.

But Wang Jianlin gave a different account: "Legendary made a profit last year, but it didn't meet our expectations, so we're now stripping it out of the listing plan."

Wanda was not the only one whose returns came up short. Studio 8, which Fosun Group funded in 2014, originally said it would invest in and produce 24 films within five years; by the end of 2017 it had released exactly one, Billy Lynn's Long Halftime Walk. Its $30 million worldwide box office did not even cover the $40 million investment. Bloomberg reported that Fosun was talking to potential buyers about selling its stake.

China Media Capital, Shanghai Media Group and DreamWorks Animation launched their joint venture, Oriental DreamWorks, with great fanfare in 2012. After Universal Pictures bought DreamWorks Animation, Oriental DreamWorks went looking for someone new to step in, and nothing came of it. Flagship Entertainment, another joint venture, this one between China Media Capital and Warner Bros., announced in March 2016 that it would put out 12 films within two years. Not one film with Flagship in control ever reached theaters.

The stalled projects stand in sharp contrast to the frenzy of a few years earlier, when Chinese capital was scrambling for Hollywood assets.

Oriental DreamWorks was founded in 2012. That same year, Bona Film Group partnered with 20th Century Fox. In 2014, Fosun Group and Alpha Group struck deals with Studio 8 and New Regency Productions, respectively. In 2015, Huayi Brothers, Dianguang Media, Alibaba Pictures and Wanda Group joined the rush. In 2016, Tencent and Perfect World were added to the list. From 2012 to 2017, one investment after another shook Hollywood.

Chinese companies teamed up with Hollywood in roughly three ways. The simplest, with Perfect World as the model, was to put money into a studio's slate of films. A step deeper was to set up a joint venture, as China Media Capital did. And for those with deep pockets, there was Wanda's route: buying Hollywood film assets outright.

After all that spending, Wanda held the AMC theater chain and the Hollywood marketing firm Propaganda GEM; China Media Capital had a stake in the talent agency CAA; the visual-effects house Digital Domain had already become a Hong Kong company...

The moves looked a lot like what Japanese companies, flush with bubble-economy money, did when they pushed into Hollywood in the 1980s. Sony bought Columbia Pictures for $3.4 billion; Panasonic bought Universal for $6.6 billion. Later, Toshiba and Warner Bros. even set up a film production company together, Tuowani.

Most of those Japanese companies wanted to use content to sell their electronics. The Chinese companies buying into Hollywood came from messier backgrounds: Wanda, which reached movie theaters through real estate; Fosun, which said it was doing Warren Buffett-style diversified investing; Alpha Group, a toy maker turned entertainment company; state money in the form of Shanghai Film Group; and China Media Capital, an investment firm.

What they shared was a belief that Hollywood-style blockbusters could take the whole world — or at least conquer the United States and China, the two biggest box-office markets on earth.

One thing that fed the belief was China's fast-growing market. In 2012, China's total box office was only 16.8 billion yuan. Five years later it was 52.3 billion yuan, with box office from imported films rising from 8.8 billion yuan to about 28 billion yuan. And the bulk of that imported-film money came from exactly the Hollywood blockbusters supposed to sell everywhere.

By the numbers, the American market was climbing too. From 2012 to 2016, North American box office grew from $10.8 billion to $11.3 billion. But one thing may have been missed: the rise came from higher average ticket prices, while the number of people actually walking into theaters each year kept slowly falling.

The second thing that fed the belief was the blockbuster model the big companies ran on. Where small companies seep in step by step, the big ones entered Hollywood with bigger bets, bigger plans and hopes of bigger returns. As Li Huaiyu, then China Media Capital's chief investment officer and managing director, put it: "In the long run, Oriental DreamWorks' business will cover a complete animation industry chain, and its products will aim at the global market."

What worked against them was timing: China's big companies arrived at the tail end of the blockbuster's golden age, just as audience fatigue swept in — not only in the United States, but in China too. The summer season, traditionally blockbuster territory, saw ticket sales dive two years running, down nearly 17% and 15% year on year. Pirates of the Caribbean: Dead Men Tell No Tales, Transformers: The Last Knight, The Fate of the Furious — none of them came close to their predecessors in North America, in reviews or in box office.

In other words, Chinese capital may have misjudged where the American entertainment industry was going, and moved a step too slowly.

While the film business declined, the whole American entertainment market was drifting toward the internet. The platforms run by Netflix, Amazon and Apple were taking more and more of people's time and money, and drawing more and more of the best creators.

According to its latest quarterly results, Netflix now has close to 110 million subscribers worldwide, and its subscriber growth has beaten Wall Street's forecasts quarter after quarter. In October 2017, Netflix said it would put out 80 original films in 2018 and release all of them within the year. That volume alone would make it the largest studio in the world.

Against the old formula of big films, big budgets, big marketing, big returns, platforms like Netflix spread their money across genres, and they move faster because production, distribution and data analysis all sit under one roof.

There is no Chinese money in this rising business, at least not yet. And in fact Hollywood's most valuable IP is not something Chinese capital can simply buy into.

In 2016 and 2017, Perfect World invested in Universal Pictures' slate in two rounds. Yet under contracts worth $500 million in total, the Fast & Furious and Despicable Me franchises were not opened to Perfect World.

The 2017 installments of those two franchises took more than $2.2 billion worldwide, over 40% of the total worldwide box office of all 16 films Universal released that year. Perfect World also takes no part in production, distribution or marketing, which makes it look like nothing more than an ordinary backer.

Seen this way, apart from Kung Fu Panda — an IP that did pass into Chinese hands, though sadly little was built on it afterward — Chinese capital acquired no intangible assets worth having. The IP that makes money most easily, and the people worth the most, stayed firmly in Hollywood's hands. That may be the biggest difference from Japan's push into Hollywood 30 years earlier.

The blockbuster model's decline seemed to happen overnight, and not even the Chinese market, with its appetite for spectacle and effects, could halt the slide. Look at 2017: Hollywood blockbusters had little to show for themselves in China.

In 2015, Furious 7 took 2.426 billion yuan. Two years later its sequel took only 2.518 billion yuan. Given how many screens had been added in between, a gain of less than 100 million yuan was plainly nothing to celebrate.

Hollywood's traditional big IP all hit a ceiling in China in 2017. Logan, War for the Planet of the Apes, Thor: Ragnarok and Spider-Man: Homecoming all stalled around the 700-million-yuan mark — not far off what such films made in the previous two years.

In fact, over the past two or three years the real growth in China's box office came from genre films, and they were usually made by small companies — "small," of course, only next to the likes of Wanda, Fosun and Alibaba.

Take Mahua FunAge. In 2015 and 2017, its two films, Goodbye Mr. Loser and Never Say Die, took 1.441 billion yuan and 2.066 billion yuan, ranking fourth and ninth among domestic films.

Mahua FunAge's success was built on years of touring stage shows around the country. Goodbye Mr. Loser was staged in 2012 as a New Year comedy and did well with ticket buyers and critics alike. Never Say Die also ran as a play, some 500 performances, before Mahua FunAge agreed to turn it into a film. Touring the country taught the company what audiences liked, and film amplified it. That is what made both comedies work.

Xu Zheng took the comedy route as well. His Lost series, about a middle-aged man's crisis, took nearly 3 billion yuan across two films, and his company, Zhenledao, became one of the most sought-after film outfits in China.

Chunqiu Shidai and Bona Film Group, meanwhile, worked out together how to make money from patriotic mainstream films. The first released Wolf Warrior in 2015 and Wolf Warrior 2 two years later; the second released The Taking of Tiger Mountain in 2014 and Operation Mekong in 2016. The four films took nearly 8 billion yuan between them. The genre wraps patriotism in an action blockbuster, and it reaches the broadest audience there is.

Then there are the fantasy films drawn from Journey to the West that arrive with great ceremony every Spring Festival. Everyone in China, young and old, knows Sun Wukong, which makes these films a perfect fit for the family outings of the New Year season.

Stephen Chow's Bingo Group and another Hong Kong company, Filmko Entertainment, have split the spoils. Chow's side released Journey to the West: Conquering the Demons in 2013 and Journey to the West: The Demons Strike Back in 2017. Filmko produced Cheang Pou-soi's The Monkey King and The Monkey King 2, released in 2014 and 2016, and its new Spring Festival film for 2018, The Monkey King 3, is also about to open.

These small companies' returns in the Chinese film market have been extraordinarily rich, far beyond anything the big companies got from investing in Hollywood.

Take China's 2017 market. Only six films grossed more than 100 million yuan with clear Chinese investment behind them: xXx: Return of Xander Cage, Transformers: The Last Knight, War for the Planet of the Apes, Valerian and the City of a Thousand Planets, The Foreigner and The Mummy. Together they took about 5.2 billion yuan, while their combined production cost came to nearly $800 million (about 5.2 billion yuan). As a return on investment, that is nowhere near Never Say Die, which cost 70 million yuan and took more than 2 billion.

The small companies' success only sharpens the big companies' anxiety, even though it was the big companies' own strategic mistakes that made room for them. And the blockbuster model cannot ease that anxiety.

Transformers: The Last Knight, which Huahua Media helped finance, set a low for the franchise: its $603 million worldwide was little more than half the previous film's $1.1 billion. Variety reported that Huahua Media complained to Paramount about it and finally pulled its money, citing China's tighter foreign-exchange controls.

Kung Fu Panda 3, from Oriental DreamWorks, also took the lowest worldwide box office of its series, less than 80% of Kung Fu Panda 2. Its cumulative take in China topped 1 billion yuan, but that was far from the 2 billion yuan expected beforehand.

After The Great Wall opened in China, Wang Jianlin said he hoped it would take $400 million to $500 million worldwide; he clearly had high hopes for North America. The film ended up taking $45 million there. Nick Carpou, head of domestic distribution at Universal Pictures, which released the film, said the United States was never The Great Wall's main market and was unlikely to do much for its box office.

Judging by these cases, the "global market" may already be a false premise. The biggest box-office surprises in North America in 2017 were two horror films, It and Get Out — one about a fear of clowns rooted deep in Western culture, the other about racial discrimination, the subject Americans most like to argue over.

China is no different. While much of Chinese capital was expanding overseas, Chinese moviegoers' tastes were slowly taking shape. That means finer divisions between types of films, different channels for promotion and marketing, and studios that have to think hard about what an audience is feeling when it sits down. Flexibility, whatever the genre, may be what every film now needs.

Next to the small companies, the Wandas of the world do have capital and the power to move resources around. Unfortunately, that same power sent them in exactly the wrong direction.

Cover image from Douban.