As U.S. government officials disagree about the state of a trade agreement with China, one industry has Chinese and U.S. companies becoming more entangled than ever.
China’s film industry is enjoying a boom period. Its box office overtook the U.S. in the first quarter to become the biggest on Earth, HSBC analyst Gary Guo wrote in a new report.
China took in $3.17 billion in box-office receipts in the quarter, while the U.S. drew $2.85 billion, said Guo, citing a report in Variety. The No. 1 film in March was the Chinese-produced “Operation Red Sea,” which easily beat out the Disney blockbuster “Black Panther” in a sign of how domestic films are increasingly able to compete with U.S. imports.
“The top filmmakers have started investing in U.S. productions too,” Guo wrote in the report. “At home, they have a growing presence throughout the movie industry — from production and distribution, to cinema screens. They are also using their hit movies to extend their reach into other areas of entertainment through spinoffs such as TV series, videos, and games.”
The Chinese film industry grew significantly in the period between 2009 and 2015 as the number of cinemas expanded and producers spent heavily to improve special effects, but overall quality did not keep up with quantity, and by 2016 growth had stalled.
“Since 2009 the growth in box-office takings, number of screens and audiences has soared [by a factor of about 10],” said Guo. “This growth reflects the thriving demand for entertainment by a wealthier and increasingly sophisticated audience”
‘The big difference in China is that the content producers get a worse deal than the channel operators who run the cinemas.’
The Chinese box office is structured in a different way to other markets. It is split three ways, with production accounting for 28% to 38%, promotion 5% to 15% and screening accounting for the remaining 57%, said Guo. That compares with international markets, where box office is divided 47%, 17% and 35%, respectively. In North America, the numbers vary, but production and promotion companies usually end up with at least half the total box office.
“The big difference in China is that the content producers get a worse deal than the channel operators who run the cinemas,” said Guo, who is expecting that to change as the industry grows and matures. The companies that make the films take the biggest risk, given the long run time from planning to shooting and screening, which can take one to two years and require constant investments.
“In China, there are further complications in the form of acquiring licences and meeting the demands of censors,” said Guo. “It usually takes two years for investors to see any returns. Audiences are becoming harder to please, so low-quality films tend to flop at the box office.”
The successful production companies have proven smart by moving up the value chain and into distribution and cinema chains, said the analyst.
HSBC initiated coverage on three Chinese companies that Guo believes are poised for success: Huayi Brothers Media Corp. 300027, +1.01% , one of the first private film and TV producers in China, which he started as a buy; Beijing Enlight Media Co. Ltd.300251, +1.76% , a TV and advertising company that has expanded into film distribution, investment and production, also started as a buy; and China Film Co. Ltd. 600977, -0.58% , a pioneer in the sector with credits including the international hits, “Farewell My Concubine” and “The Last Emperor,” which Guo started as a hold.
Guo is expecting Huayi Brothers to grow net profit by 28% in 2018 to 1.06 billion renminbi ($166.2 million), climbing to RMB1.48 billion in 2020, a compound annual growth rate of 18%.
“A large number of films are scheduled for release in 2018-19 and many are potential box-office hits,” he wrote. “We also expect returns on the investments in TV and web series over the next three years to increase.”
Guo set a stock price target of RMB11.43 for the stock, representing a 30% rise from its current trading level. The company has become famous in China for a genre it started called New Year’s Celebration films, which include “The Dream Factory,” “Be There or Be Square” and “Big Shot’s Funeral.” Its shareholders include AlibabaBABA, +1.35% and Tencent 0700, -0.73% .
For Enlight Media, Guo set a stock price target of RMB12.95, equal to 15% upside from its current level. The analyst is expecting the company to grow profit by 23% in 2018. Enlight was created in 1998 and has made box-office hits including “Lost in Thailand,” and “The Mermaid.”
While films and TV are core businesses, Enlight is also engaged in animation, music, literature and other fields through a series of deals. In 2016, it acquired a stake in Maoyan, an internet platform that uses big data to promote films. Maoyan has also got involved in film production and distribution and has distributed more than 40 films.
For China Film, Guo is expecting profit to grow 21% in 2018 and set his target price at RMB17.50, implying 4% upside over its current level. China Film’s strength is its role in all elements of the film value chain, including having the biggest market share in terms of cinemas and being a leading importer of foreign films.
Huayi Brothers shares have gained 1.6% in 2018, while Enlight’s stock has gained about 9% and China Film has added 13%. The S&P 500 SPX, +0.74% has risen 2.1% in the same period, while the Dow Jones Industrial Average DJIA, +1.21% has added 1.1%.