Is China-Hollywood Dealmaking Ready for a Rebound?

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The Hollywood-China partnership has had a bumpy ride in the first half of 2017, but insiders say things are not as dire as feared.

After a blockbuster 2016 — which included several mega deals in Hollywood — Chinese investment took a steep dive in the first half of this year. Closer examination, however, reveals the drop might not be as bad as first feared. There are even signs of a (modest) comeback.

Chinese dealmakers announced a staggering $246 billion in outbound takeovers across all sectors last year, but Beijing's regulators have since pumped the breaks. In an effort to stem capital flight, which was seen as contributing to a devaluation of China's battered currency, regulators upped scrutiny of large transactions and instituted various measures to make it more difficult for acquirers to shift capital overseas.

The actions had the desired effect: cross-border purchases plunged 67 percent during the first four months of this year, according to Bloomberg data. Yet, May and June showed signs of a reversal.

In each of those two months, Chinese companies publicly announced more than 20 new overseas M&A transactions with a value of $5 million or more, close to levels seen during the 2016 peak, a report released Tuesday by the Rhodium Group shows. Regulatory scrutiny has driven down the size of the deals, though — the value of transactions averaged less than $8 billion per month in the first half of 2017, compared with $15 billion in the first half of 2016 — and strategic sectors such as energy, materials and high tech have been the most resilient, with an increased share of deals closed by well- connected state-backed groups rather than private firms.

"However, it is important to stress that most transactions are still moving toward closing even with capital controls," says Thilo Hanemann, a director and economist at Rhodium Group, which has closely tracked outbound Chinese M&A activity in recent years.

These trends have held true in the entertainment sector, too. While there have been no massive buyouts to match Dalian Wanda Group's $3.5 billion takeover of Legendary Entertainment last year, modestly scaled film deals have continued at pace.

Chinese venture capital firm CMC Holdings made a strategic minority investment in mega agency CAA in April, while also forming the Beijing-based joint venture CAA China. Fellow Hollywood agency UTA is understood to be working on a partnership with Beijing's Joy Pictures and L.A. — and Shanghai-based Tang Media Partners to establish a $50 million-plus fund to acquire U.S. film titles for distribution in China. And various Chinese studios have made minority equity investments in high-profile American studio films, including Wanda's stake in Transformers 5, Jetsen Huashi's and Dadi Film's investments in Tom Cruise's American Made, and Weying's 10 percent stake in Ghost in the Shell, among others.

And well-placed sources say Huahua Media and Shanghai Film Group's $1 billion investment in Paramount's three-year slate, while seriously delayed by the leadership changes at the studio, is still inching toward completion (SFG's state-backed status may have helped keep it alive). "We never really had concerns about payment," Viacom CEO Bob Bakish told THR in May.

The most notable exception was Chinese billionaire Wang Jianlin's abandonment in March of Dalian Wanda Group's planned $1 billion takeover of Dick Clark Productions, producer of the Golden Globes and other TV awards shows. In the immediate aftermath of the failed transaction, some speculated that Wanda had been unable to move the necessary funds to close the deal because of the capital controls in China, along with offshore losses associated with Legendary. Few in the financial world find that story convincing, however. Given Wanda's international banking relationships and sizable overseas portfolio, including the world's largest movie theater circuit, spanning North America, Europe and Oceania, generating the necessary cash flow for DCP would not have posed a problem. More likely, Chinese regulators or Wang — or both — had second thoughts about the perceptions of the steep valuation, and stepping back from the deal was deemed the least embarrassing option.

Says Hanemann: "It had all of the aspects of the deals that the Chinese government didn't want to see at the time — a Chinese company making a lot of noise by splashing out a billion dollars for an asset that many believed to be worth less." (DCP was sold to Guggenheim Securities in 2012 for just $370 million, and later spun off to Eldridge Industries, the owner of or investor in several entertainment properties, including The Hollywood Reporter.)

Smaller deals like CMC Capital's stake in CAA, meanwhile, "don't get too much public attention and don't put the government in a difficult position by fueling market psychology," he adds.

Wanda was again the subject of investor alarm in late June when local media reports revealed that the China Banking Regulatory Commission was assessing banks' exposure to the debt raised by Wang's real estate giant and four other large firms to finance their overseas acquisitions. The news sparked a major investor sell-off, with Wanda Film Holding Co.'s stock falling 10 percent before it was suspended from trading on the Shenzhen Stock Exchange. Fosun International, one of the other conglomerates under review by the CBRC (the company is best known in Hollywood for its heavy financing of Jeff Robinov’s Studio 8, which is behind Ang Lee's previous and next film), saw its Hong Kong-listed shares fall 6.4 percent.

Various theories for the CBRC's motives swirled through Chinese investor circles in the immediate aftermath of the revelation. One narrative suggested that a broad political crackdown was getting underway, with President Xi Jinping asserting strength over private businesses related to possible political enemies ahead of the National People's Congress this fall. Another theory had it that the action was an attempt to preemptively signal that the Chinese government didn't want to see capital outflows on the rise again.

Since then, most expert observers — as well as the markets, which have stabilized — appear to have agreed that the review was motivated by something much more straightforward: a prudent attempt by the CBRC to assess systemic risks in the banking sector. Ironically, the CBRC communicated its objectives so poorly that it generated the very sort of political opacity that often sparks wild volatility in China's markets.

"The regulators have been moving very fast to identify risks," a person close to Chinese policy makers told The Financial Times. "But they sometimes move without being fully aware of the consequences of their action."

Richard Xu, an equity analyst at Morgan Stanley, told the FT that the longer-term impact of the regulators' review will depend on what action it takes, if any, after they get a grasp on the banks' dealings with the conglomerates.

One downstream possibility is that loan officers at China's state-owned banks will feel incentivized to at least temporarily pause new credit lines to private firms targeting international entertainment and media, and instead shift their lending to more risk-averse portfolios, such as overseas deals that are explicitly endorsed by Chinese investor policy or geopolitical initiatives, areas like the high-tech sector or Jinping's One Belt, One Road project, respectively.

The other uncontrollable impact will be how global sellers of assets perceive the events, as Chinese buyers were already in a problematic position: because of the perceived closing risks, they have had to pay higher premiums and submit to increasingly expensive break-up fees.

"For the remainder of 2017, expect more transactions in the mid-market, couple hundred million range," says Hanemann. "It would be a surprise to see multibillion-dollar mega deals in the entertainment sector though."

Still, the underlying incentives for the world's two largest entertainment markets to further integrate remain.

"The near-term outlook is pretty difficult," Hanemann adds, "but the secular story is still in play — China is a huge, fast-growing market for entertainment and we don't see an end to that anytime soon."