As China’s production levels and boxoffice are booming, the nascent local industry is starting to attractoutside capital and bank financing.

Given the number of privately produced costume epics released in China thesedays, it is easy to forget the local film industry is actually very young.

It was only in 2002 that the government began to grant licencesenabling private companies to produce films independently. Prior tothat, they had to work with the state-owned studios.

Last year marked another milestone - the first entry of private equityinto the film business - when Sequoia Capital China and SIG AsiaInvestments each pumped $5m into -Beijing-based Bona International FilmGroup (then called Polybona).

The producer-distributor, in the midst of restructuring ahead of aplanned overseas listing, is now set to raise $30m in a second round offunding from the two venture capital groups.

Meanwhile, competitor Huayi Brothers recently hired brokerages CITIC Securities and MerchantsSecurities to advise on a planned flotation. Orange Sky Entertainment(formerly known as Chengtian) and Enlight Media are also planning to float.

These moves underscore the mounting ambition of China’s private filmstudios - the oldest of which are only around a decade old - which areriding high on a box office that has quadrupled to $459m in five years.Now past the start-up stage, they are hungry for capital to enable them to expand.

And this being China, the state-owned studios are also embracingcapitalism. Both China Film Group and Shanghai Film Group are planning IPOs.

At the recent Shanghai film festival, China Film chairman Han Sanpingimplored investors to consider backing the booming industry: ‘Now thatmarket forces have been introduced to the Chinese film industry, it istime for the capital market to play a greater role.’

Meanwhile, China’s banks, which started lending to film companies around three years ago, have stepped up their involvement.

This summer, the Bank of Beijing granted loans to three Chinese filmcompanies, via an initiative in which the Beijing city government’sCultural and Creative Industry Centre will subsidise the interest onthe loans.

The bank loaned $14.6m (RMB100m) each to Bona Group for distributionactivities; to Huayi Brothers for TV drama production, and to Enlightfor TV programme -production and film distribution.

Local banks are also getting involved in project financing. ShenzhenDevelopment Bank loaned $7.3m (RMB50m) to Feng Xiaogang’s 2006 epic The Banquet, while China Merchants Bank contributed the same amount to Feng’s war drama Assembly last year. Regional bank Standard Chartered had previously provided financing for Zhang Yimou’s Curse Of The Golden Flower.

But while the industry is attracting more diverse sources of financing,analysts and bankers remain cautious. ‘Most of the private equitycompanies or banks have not yet made profits from these investments,while film companies are still eager for the influx of investment,’says Wang Ran, CEO of China eCapital Corporation, which is thefinancial adviser for Bona Group’s second-round financing#.’

‘However, the process, either IPOs or private equity financing,will help the overall development of the film market and help theindustry to have better financial discipline and corporate governance,’Wang continues.

‘Many companies in the industry, including the leading ones such asHuayi Brothers and Polybona, still need to improve their businessprocess management. This is the main reason many investors hesitate.’

Aside from management issues, the biggest concern for investors is thatthe Chinese film industry is still not as well regulated as theinternet and online gaming sectors, which have attracted a huge amountof private equity in the past few years.

‘There are still no proven, successful examples in investing in thebusiness, such as the success of Shanda Entertainment in the gamingindustry,’ says Gal Dymant, president of venture capital company AsiaDirect.

Asia Direct recently provided start-up financing to local film companyInfotainment, but this marks its first bet on film, after investing indozens of technology and media firms in China.

Investors are also concerned that, despite an annual box-office growthrate of more than 20%, China’s film market is overly dependent onbig-name directors. ‘Only three directors have market drawing force -Feng Xiaogang, Zhang Yimou and Ning Hao,’ says Wang. Apart from thosenames, no actors or genres are considered to have proven box-officepulling power.

‘The volatility is too high in this business,’ says one banker whoprefers not to be named. ‘Censorship, piracy and the lack of a filmrating system make it difficult to even produce or release in themarket, let alone get an accurate picture of profitability.’

For that reason, more investment is flowing into infrastructure thanfilm studios and production. As China is still hugely under-screened,cinemas are considered a good investment as they require low capitaloutlay and recoup in three to four years.

However, foreign investment is restricted to 49% and good relationswith local government and developers are necessary to secure the bestsites.
More open and equally inviting is the digital distributionsector. US-China fund group IDG has invested in two firms in thesector: Zonbo Media, a company developing short films for mobilephones, and Netmovie, an online film distributor that has created aseries of virtual cinema circuits in internet cafes across China.

Meanwhile, Chinese video-sharing sites are receiving substantialfinancing. has so far raised more than $70m in private equityfrom investors including US hedge fund -Maverick Capital, has raised $85m in four funding rounds. Both companies focuson video clips but have bought digital -distribution rights to moviesand plan to develop online film services.

In comparison, companies such as Huayi Brothers and Polybona havereceived financing of around $30m-$40m. ‘It’s not really a big sumcompared to the investment in internet and gaming companies which caneasily exceed $50m,’ says Wang. ‘Private equity investors’ interest inthe film industry has not yet gone beyond reason.’

Private investor Bob Xu, who co-invested with Asia Direct inInfotainment’s start-up fund, is also a big believer in digitaldistribution. ‘I optimistically believe the issue of DVD piracy inChina will be solved in three to five years, as the DVD business willdecline. Internet and video-on-demand will bring more income for film-companies,’ Xu says.

To attract more private equity into the film businesses, Wang believesthree factors will play a crucial role. First, an increase inmultiplexes will push forward movie-going and neighbouring retailbusinesses. Second, on the production side, there should be continuinggrowth in the supply of films. Third, film companies should work withnew-media firms to explore new -revenue models.

Meanwhile, it has recently become government policy to increase capitalflow into the film industry. A year before the start of this summer’sBeijing Olympics, the Beijing city government earmarked the culturaland creative sector as one of the pillar industries for the city’sfuture economic development. In addition to introducing film companiesto banks, and subsidising the interest on loans, the government’sCultural and Creative Industry Centre aims to establish a loanguarantee mechanism.

‘We aim to work as a mediator between the financiers and the industry,’ says the centre’s director Yang Gan.

It is also understood Chinese government units are discussing thepossibility of tax incentives or tax exemption policies for the filmindustry. But while local financiers say they welcome the introductionof tax breaks, they doubt the effectiveness of government interventionin bank loans. ‘The best way for the government to help the industry isto ease restrictions and let the market make the best evaluation,’ saysone banker.

While many investors recognise local companies are improving theirmanagement and financial discipline, they are also waiting forlong-anticipated reforms - the widening of the import quota, theintroduction of a film rating system and the establishment of thelong-gestating Film Management Law.