Viacom: Entry Into Chinese Movie Market Could Bode Well For Paramount

Alibaba Group’s entertainment unit – Alibaba Pictures – is reportedly eyeing a stake in Viacom’s (NASDAQ:VIA) Paramount Pictures. ^[1] One of Viacom’s major shareholders has urged Viacom to sell a stake in Paramount studios to Alibaba Group and invest the proceeds to produce more movies in Mainland China. Alibaba Pictures already has a relationship with Paramount, having financed Paramount’s Mission Impossible – Rogue Nation. Other media houses such as Fox (NASDAQ:FOX) and Disney (NYSE:DIS) have already set up joint ventures in international markets, including Europe and India. On that note, we discuss below why China is an important market for U.S. studios and what it means for Viacom’s studio business.

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China Offers Tremendous Growth Opportunity For Studios

There is massive demand for movies in China, as evidenced by the region’s box-office grossing, which grew from a little under $1 billion in 2009 to around $5 billion in 2014. Domestic Chinese films accounted for 55% of this total grossing in 2014, reflecting high demand for regional cinema, which various international studios are eyeing. ^[2] Furthermore, China shares only 25% of the box-office sales with U.S. media companies, and a relationship with Alibaba could help Viacom grab a bigger piece of this fast growing movie market. Viacom could choose to sell a stake in Paramount and use the proceeds to invest in movies in Mainland China by partnering with a local studio. Another reason that international studios are eyeing China is the limited exposure of international movies to the China market, which currently allows only 34 foreign films to be released in a year. Now, the U.S. box-office market declined 5% in 2014 while China grew a whopping 34%. China is expected to overtake the U.S. as the world’s biggest film market by 2020, according to a research report by Entgroup Consulting. ^[3] Given these factors, China could provide a massive growth opportunity and accordingly, U.S. based studios are eyeing a share of this market.

Movie Business Holds Little Value For Viacom

We estimate that Viacom’s movie business contributes less than 5% to Viacom’s value. The primary reason for such a low value contribution is the low margins associated with this business. While the segment accounted for 21% of overall revenues in fiscal 2015, it contributed a mere 3.5% of operating income. ^[4] We estimate EBITDA margins of around 6% associated with this business, which are the result of high production and distribution costs. Additionally, not all movies perform well at the box-office. In fact, Paramount’s global box-office market share has declined from over 10% in 2009 to around 5% in 2014. During this period, the studio sold rights to some of its popular titles to other studios. Given the low value contribution, any efforts in China will be of little value to shareholders, but could still bode well for the studio operations.

If Viacom does sell a stake in Paramount and forms a joint venture in China, and manages to grab a 10% market share in the next five years while the overall market grows in high-single-digits, it will translate into revenues of around $500 million, which will be split between the partners. Here we assume a similar market share of regional movies (55%). It will be difficult for any international studio to grab a significant market share given the presence of other international studios, along with the local Chinese studios. Still, it makes sense to have a presence in China’s movie market given the massive growth opportunity it can provide.

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1. Alibaba eyed as buyer of stake in Paramount Pictures, the studio behind Jack Ma’s favourite movies, South China Morning Post, Dec 7, 2015 [↩]
2. China’s box office revenues surge 36% in 2014, Los Angles Times, Jan 5, 2015 [↩]
3. China forecast to lead film market by 2020, China Daily, June 5, 2014 [↩]
4. Viacom’s SEC Filings [↩]