When the Chinese government barred foreign companies from holding majority ownership of exhibition companies it led to the withdrawal of Warner Bros International Cinemas.

Although it didn't come as a huge surprise, the recent decision by Warner Bros International Cinemas (WBIC) to pull out of China has taken some of the sheen off one of the world's fastest growing cinema markets.

Multiplex development has been rapid in China over the past five years with WBIC, local players and exhibitors from Hong Kong, South Korea and Japan all investing in new builds.

According to government figures, around 200 new screens opened in 2004, 272 last year and similar growth was expected in 2006. The almost immediate impact has been an increase in box office - up 30% last year to RMB2bn, according to government figures. This year box office is expected to increase by around 35%.

However, following the regulatory flip-flop that lead Warner Bros to exit the market, it's unlikely that other Western players will dive in, leaving further development to local and other Asian companies.

WBIC, which also operates cinemas in Japan and Italy [TBC], is the only Western company to have made a significant investment in Chinese exhibition.

officially opened its first Chinese joint venture cinema, the nine-screen Paradise Warner Cinema City, in Shanghai in 2003. It then set up a string of joint ventures to either part-own or manage multiplexes with partners including Shanghai Film Group (SFG), Shenzhen International Trust & Investment Co (SZITIC) and the Dalian Wanda Group.

The investment deals were based on a 2003 regulation which allowed foreign companies to hold stakes of up to 75% in cinemas in seven key cities on a trial basis. In 2004, Warner Bros became the first Western player to take advantage of the new rules when it took a 51% stake in a Nanjing multiplex, the eight-screen Shangying Warner Cinema, with SFG holding the remaining shares.

However, the 'Several Opinions on Foreign Investment in the Culture Industry' issued in late 2005 rescinded the trial by requesting that 'Chinese mainland investors must own at least 51% or 'play a leading role' in their joint ventures with foreign investors.'

The reasons for the rule change were both political and commercial, and likely prompted by fears that Warner Bros was moving too fast. 'China's government is worried about foreign control over the channels of distribution in any media and it's also a matter of commercial protectionism,' says David Wolf, president of Beijing-based consultancy Wolf Group Asia. ''They just don't believe that foreign operators have anything that special to bring to the table that justifies having control in foreign hands.'

The rule change dominated discussions at CineAsia in Beijing last December where WBIC president Millard Ochs explained why his company requires majority ownership. Apart from the way it looks on the balance sheet, the company needs management control from day one in order to shape the technical, design and marketing elements of each new multiplex.

Ochs has since made many trips to China but made no headway and the company issued a statement about its withdrawal from the market last month. WBIC currently has stakes in four operating multiplexes - two with SFG and two with SZITIC - and according to Ochs intends to sell its shares to its respective partners.

The company has already quietly withdrawn from the cinemas it was managing but hadn't invested in. Warner Bros' other businesses in China - including production joint venture, Warner China Film HG Corp, the CAV Warner Home Entertainment joint venture, consumer products and studio stores - are subject to different regulations and are not affected.

Ochs says the company would consider re-entering the market but only under the right conditions: 'I would have to recommend to my company that if we were granted majority ownership tomorrow we do not go back until we see a concerted effort by the government to allow for a holding company concept in the company structure; that film product will flow uninterrupted, except as required by normal censorship, and that strong action is taken against piracy,' says Ochs.

WBIC had hoped it would become the catalyst that would trigger growth in this potentially huge market and to some extent has succeeded. The cinemas in which it has been involved have become market leaders in their respective cities and some have opened up entirely new markets. In the northern city of Harbin, box office increased by 468% following the opening of a multiplex managed by WBIC through a joint venture with the Wanda Group.

The question now is how the market will continue to develop without Warner Bros' expertise. There is no shortage of investment in China for cinema builds - particularly as the property developers which are throwing up a multitude of new shopping malls have realised that multiplexes make the perfect anchor tenant. But Warner Bros also supplied world-class standards in the design, construction and marketing of its cinemas.

'China still doesn't have that pervasive culture of young, modern families going to the cinema together, so you need a compelling experience to get people out of their living rooms and into theatres,' says Wolf. 'The mechanical side of building a cinema is not beyond the domestic groups. But they may not have what it takes to develop the marketing and experience creation side of the business.'

That task that has now been left to the Hong Kong and other Asian companies that are investing in Chinese cinemas. Under the CEPA trade agreement, Hong Kong exhibitors operate under completely different rules in China and can open wholly-owned cinemas anywhere they choose.

Hong Kong has a proven track record in building state-of-the-art multiplexes and the four main exhibitors, along with media group Sun Wah Media, are taking advantage of CEPA and making substantial investments in the mainland. But they are all moving cautiously and at least two groups - Golden Harvest and Intercontinental Group - are only focusing on the Cantonese-speaking region across the border in Guangdong.

Golden Harvest's strategy for example is to aim at the very top end of this market, with luxury cinemas beyond the reach of most cinema-goers, and to be extremely selective about the shopping malls its goes into. Its seven-screen Shenzhen complex is one of the country's top-grossing sites and it plans to open a further two cinemas in Shenzhen next year.

Korean and Japanese companies are also exploring China's nascent cinema market, although they're subject to the same restrictions as WBIC. Korean exhibitors are taking a long-term approach (see sidebar), while Japan's Kadokawa is accessing the market by partnering with Hong Kong's Sun Wah and investing in Intercontinental Group.

There's a slight chance that Warner Bros' exit may discourage Hong Kong and other Asian companies from investing in the market - the US company inspired confidence and ironically was seen as a potential buyer for companies that might want an exit strategy further down the line.

But it's more likely that Chinese exhibition will suffer from the opposite problem of too much investment too soon. Although box office is growing, it's still restricted by piracy, limited film supply and the government's manipulation of the market to ensure that local product always has at least a 50% share. In fact, it's unlikely the market will be able to support all the cinemas that are being planned - particularly if they're in the wrong location. Some markets are already becoming over-crowded - it's estimated that there will be 15 multiplexes in Shenzhen by the end of next year.

Also, with rapid advances in technology and everything up for grabs, there's no guarantee that cinemas will become the dominant way to consume movies in China. Although online distribution is still mostly illegal, there have been advances in legitimate internet distribution and six US studios are poised to sign up with the IPTV unit of Shanghai Media Group.

'That's why we aim to build the best cinemas in every city, because we know that if online distribution becomes accepted, it's more likely to eat away at lower end of the market,' says Golden Harvest managing director CK Phoon.

Korean exhibitors remain unfazed by Warner Bros move, writes Jean Noh

Although subject to the same regulations which state foreign investors can hold no more than 49% of a Chinese exhibitor, Koreans are unfazed by Warner Brothers' pull-out from the market. Unlike Warners, their investment deals have come to fruition after, instead of before, the Dec 2005 regulation change. Koreans have gone in with their eyes open and are taking a wait-and-see approach.

'Of course, most Korean companies would probably want to hold a majority stake in the companies they invest in, but we're looking at the long-term potential of the China market,' says Jim H.J. Park, international business exec at leading Korean production house and new distributor MK Pictures.

'We're hoping the market will open up around the 2008 Olympics, but even if it doesn't, the market is full of potential. We are willing to do the work, and wait for the market, its structure, and its returns to stabilize.'

In December last year MK Pictures signed with China's Eastern Dragon Film and Beijing Bona Culture Media International to partner in a multiplex enterprise. The $2.5m deal had MK Pictures investing 45%, Eastern Dragon Film 46%, and Beijing Bona Culture Media International 9%.

The joint venture's first multiplex is to open next month in Zhengzhou, with two more sites possibly to follow next year in Shenzen and Chongquing.

Meanwhile, Korea's leading exhibitor CJ CGV - and affiliate of CJ Entertainment - opened its first Chinese multiplex in Shanghai in October. Partnering with Shanghai Film Group, CJ CGV has adhered to the minority stake rule as well.

'So far business has been good, but it has been less than a month since we opened, and we're waiting to see how it goes in the long-term to build upon that and see what we'll do next,' says Kim Il Jin, an analyst at CJ CGV. 'China's regulations only allow about 24 foreign films to be screened a year, but we're looking to China-Korea co-productions as well,' he says.

CJ CGV is an affiliate of CJ Entertainment and their businesses tie in nicely with an overall CJ plan to launch into the rest of Asia. CJ Entertainment's latest big budget martial arts fantasy The Restless features Korean Wave star Jung Woo-sung and was shot at China's Hengdian Studios with the participation of Chinese crew.

Early in 2004, Mediaplex, parent company of another major Korean exhibitor, Megabox, set up a China branch called Orion Beijing Consulting Co. (after confectioner parent Orion group), also adhering to the 49% rule. They are set to open an eight-screen multiplex in Beijing this coming April, and are planning two more sites before the 2008 Olympics.

'Despite its enormous population, the yearly average for theatre-going is very low in China. Shanghai is comparatively well-developed, but we opted to go into Beijing where we see more potential for growth,' says Geunha Choi, Assistant Manager of PR at Mediaplex.

Choi says Mediaplex has no plans 'as yet' for productions in China, but it is well known that affiliate and leading investor/distributor Showbox Mediaplex also has ambitions in Asian co-production and broadening its market in the region.