Manatt Digital - June 2016

Manatt, Phelps & Phillips, LLP

[co-author: Jordan Pritchett]

  • Virtual Reality Heats up in China
  • China's Push Into Hollywood
  • China Shifts to Digital

In this newsletter, we examine what's new in media as it relates to the Chinese market with specific emphasis on VR, Hollywood, and the ongoing digital transition.

Virtual Reality Heats up in China

By Mary Ermitanio

The virtual reality (VR) market in China is expected to reach $860M in 2016 and accelerate to $8.5B by 2020. In the last six months alone, the Chinese VR market has seen a flurry of investments, partnerships and new ventures involving both local and international players. With capabilities in low cost, mass scale manufacturing, a hot investment climate and international support, China can become the epicenter of the global VR market's growth.

While the country has been seen as a copier of Western technology, VR is a new medium that could foster innovation and drive China's future market. The limited number of U.S. head-mounted device (HMD) players and the lack of their presence in China have created a vacuum that is quickly being filled by growing entrepreneurial communities, many of which are heavily focused on mobile and standalone HMDs. E-commerce behemoths Alibaba and Taobao have reported total sales of over 300K units a month from over 100 HMD makers (this number excludes offline sales), with most of these HMDs on the lower end, comparable to Google Cardboard. Early leading HMD manufacturers include 3Glasses, Deepoon and Baofeng Mojing.

During the first quarter of 2016, Baofeng sold 1M units of its $30 headset through its network of 20,000 brick-and-mortar stores and is targeting 10M headsets by the end of the year. To put this into perspective, Google Cardboard announced shipping 5M Cardboard headsets in its first 19 months. Many Chinese device makers have gone with a first-to-market strategy. With this kind of a head start, they are more quickly iterating based on market feedback and have the potential to leapfrog the U.S. in mobile VR. Baofeng, for example, is now working on its 5th generation HMD. In the last six months, major brands ZTE, LeTV and Huawei have each entered the competitive space with their own VR headsets.

With the hardware market booming, what China needs the most is compelling content. While none of China's biggest tech companies—Baidu, Alibaba and Tencent—have released a HMD yet, they each have ambitious plans for VR. Taking almost a "wait and see" approach, they have opened their platforms and are providing seed funding for China's VR startup space, especially for content creators. Subsidiary video services of all three are working with content partners and investing in VR film, TV and game content. International efforts are also fueling the content market. 500 startups will be investing in 20 early stage companies in China. Shanghai Media Group partnered with U.S.-based Jaunt to formed Jaunt China and has plans to develop 500 VR productions in the next 2 years.

Another area of growth in VR, and one that offers immediate monetization opportunities, is out-of-home and location-based entertainment. "VR stores," such as an in-mall roller coaster VR experience priced at $6, have existed across the country since last year. Because the high-end, PC-based VR experiences are not accessible to most of China, out-of-home experiences provide the average consumer with curated, high quality VR content, accessible through internet cafés, malls, other commercial venues and theme parks. China's Suning Commerce Group plans to open 300 VR experiences within the next three months across its chain stores. LA-based SPACES and Songcheng Performance Development Co, one of the world's largest theme park operators, have recently formed a joint venture to bring VR to its theme parks and also develop standalone parks in China.

These are just two of many ventures and partnerships contributing to the burgeoning VR out-of-home market and promoting overall consumer awareness. With both the proliferation of VR platforms and out-of-home experiences, there has never been a better time for great content creators to dive in.

China's Push Into Hollywood

By Jordan Pritchett

As the archetype for entertainment production, Hollywood possesses a distinctive allure that has traditionally attracted investment from a multitude of sources. This effect has been further compounded in recent years given the increasingly globalized nature of business in 2016. As a result, international players now benefit more than ever from the opportunity to cultivate their domestic capabilities within the sphere of entertainment by investing in, strategically partnering with, or acquiring mainstay American organizations. A significant story that is emerging from the confluence of these factors is the marked increase of dealmaking between Chinese entities and Hollywood.

Admittedly, there has been a great deal of talk that has occurred throughout much of the past decade between the US and China within this particular context. However, recent years have offered a perceptible shift in tone and witnessed a veritable surge in high profile deals that seemingly indicate a new level of comfort and faith related to the benefits of mutual cooperation between east and west.

Without question there are economic incentives that exist on both sides of the table. And while these deals come in many forms, at the core they essentially amount to the same quid pro quo exchange. In simple terms, Chinese capital buys American expertise, technology, business models, and a stake in Hollywood's success, while the American side gets a new source of capital and increased access to the world's fastest growing entertainment market. This might be construed as an oversimplification, but it is nonetheless a useful characterization from a conceptual standpoint.

In addition, there are macro-political aims in play for the Chinese in the long term. China wants to be able to use these new collective proficiencies within the entertainment space as a foothold to generate a form of 'soft power'—which they view now as a monopoly of the West—to bolster China's global influence and entertain China's rapidly growing middle class.

While this trend can be thought of as a relatively recent development, there are many examples one can point to that exemplify this theme. The Wanda Group has been notably prolific and has served as a trendsetter of sorts in demonstrating the viability of these strategic initiatives. Its most recent move was undoubtedly the most headline grabbing, acquiring Legendary Pictures for $3.5 billion in January of this year.

Another example is Perfect World Pictures which engaged Manatt to help reach a deal with Universal Studios for a significant stake in a slate of 50 films. The deal, reportedly worth $500 million, is the largest direct investment ever by a Chinese company in the films of one of the six major studios. For Perfect World, the deal was strategic as well as financial. The partnership with Universal enhanced its global profile and additionally provided important insight into the workings of the global film industry.

Jack Ma's Alibaba has also been notably active. Most recently, it invested in two Paramount films: "Teenage Mutant Ninja Turtles: Out of the Shadows" and "Star Trek Beyond,"marking the second time that the e-commerce giant has invested in a Paramount title. The company plans to eventually import these films to China and release them through state-owned distributors.

Indeed, for a time it appeared a Chinese company might purchase a minority stake in Paramount itself. While that prospect has become more remote as the Redstone family re-asserts control over Viacom, the next few years could well see a Chinese entity acquire a significant stake in a major U.S. film studio. Only time will tell, but given the current climate there is no reason to suspect otherwise.

Taken collectively, these developments indicate that the frequency of these strategic alliances will not dissipate anytime soon. China's proactive effort to integrate within Hollywood is an important dynamic that will continue to evolve in the years to come and will undoubtedly play a significant role in shaping the entertainment industry at large.

China Shifts to Digital

By Jacob Carlson

The shift to digital is not a new topic in the United States, with mobile devices, cord cutting, and OTT usage changing the way consumers interact with content. However, China has also quietly been working through a massive digital transformation, creating the largest digital content consumption economy in the world.

China has more than 400 million TV households, which makes it the largest market for traditional TV viewership in the world. From a raw numbers standpoint, China still dwarfs other countries, with over 250 million pay-TV subscription households (for context, the United States has fewer than 100 million pay-TV subscription households). However, Chinese video consumption habits are rapidly changing, dramatically shifting the ecosystem away from live linear programming and towards mobile and digital devices at an unmatched scale.

The Chinese government has invested considerable resources to bring broadband internet access to the masses. Most urban areas have extensive coverage, but China's digital infrastructure is not capable of reaching much of the rural population. As a result, the rural areas still rely on traditional over the air and satellite TV for entertainment, maintaining the audience size for these platforms until the infrastructure catches up and allows for the digital transformation to reach them.

Chinese adults are projected to consume over half of their major media via digital devices this year, while TV consumption time continues to fall. As the gap in platform consumption time continues to widen, more Chinese companies will look for additional content to attract and keep users on their sites. Licensed popular shows and formats and original programming are ways digital sites are attracting audiences in an increasingly fragmented online video market. In the United States, users have a handful of major digital content sites, such as YouTube, Netflix, Hulu, and Amazon Prime. In China, there are many sites that each try to differentiate themselves in terms of quality and content, with subscription fees that are much lower than we are used to the U.S. Alibaba's recently completed acquisition of streaming site Youku Tudou for around $4 billion demonstrates the growth potential and value of the Chinese online video industry.

The gaming industry also has a big stake in the shift to digital, as the 2015 Chinese domestic mobile gaming industry was pegged around $5.5 billion and growing. Online live streaming of video games, including eSports, is an industry that has great potential. Douyu TV, China's version of Twitch, recently closed a $100 million round of funding led by Tencent, reportedly valuing the company at over $1 billion.

China's focus on media and entertainment includes investment domestically and internationally. Virtual reality and augmented reality are new areas that have seen Chinese investment, capitalizing on the future of digital consumption. As smartphone and broadband internet penetration rates continue to climb, digital platforms will continue to see high growth. China's unique opportunities for scale mean that they will have a key position of influence in content creation and distribution for the foreseeable future with its digitally savvy consumer population of over 1.3 billion people.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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