How Hollywood Could Catch a Break in China Box-Office Standoff

IPO can't attract foreign investors with so many unpaid bills to major partners

Last Updated: July 16, 2014 @ 3:48 PM

The Hollywood studios' underdog fight with China to recover tens of millions in box-office receipts may have a ray of hope — China Film Group wants to go public soon, but will have a hard time getting foreign investment with a mass of unpaid bills on the books, TheWrap has learned.

China wants U.S. distributors to shoulder a new 2 percent luxury tax on the studios' cut of mainland ticket sales, which Hollywood says violates its 2012 trade agreement with the country. The dispute is holding up payments going back to last year — and totaling in the tens of millions.

The Motion Picture Association of America has deployed negotiators who are working toward a resolution, two individuals with knowledge of the talks have told TheWrap. But one media executive with ties to China cautioned that the two sides remain very far apart.

Also read: Hollywood Movies Losing Out to Chinese Films in a Big Way

Studios are threatening to turn to the Office of the U.S. Trade Representative if a resolution is not reached. And it was reported Tuesday that China's State Council may get involved — though analysts say that since China Film Group carries the imprimatur of the government, any state council role would be merely cosmetic.

"It may just be to create the perception that there's really a negotiation going on," Brad Cohen, a partner at Venable who has worked on legal issues related to China, told TheWrap.

Hollywood hailed a major trade victory last year when China granted studios a healthier cut of ticket sales — up from the mid-teens to 25 percent — but Chinese officials have since insisted that the 2 percent tax, which was not part of the agreement, be taken out of their final checks.

To fight it, the studios used what little leverage they had, refusing to cash checks from China Film Group that had taxes withheld. That stall tactic may be paying off — because as it turns out, China Film Group can't wait around to make good on those debts. 

Also read: Hollywood's Trouble With China? It Has All the Leverage

China Film Group plans an IPO on the Chinese stock exchange in the next six months, which could motivate it to make a deal more favorable to the studios, one foreign film executive tells TheWrap. That's because China Film Group can't afford to have months of unpaid bills to its major partners if it wants foreign investors to buy in, the individual said.

In January, China Film Group was added to a list of IPO applicants for reviews by the China Securities Regulatory Commission, according to CNBC.

Cohen said what's going on with the studios is symptomatic of the cost of doing business in China across various industries.

"China got forced into opening markets a bit more than they would have liked and increasing the rental rates is their way of getting it back to where it was before," Cohen added. "It's a great market, but the truth is that they win pretty much all the time and you have got to find out a way that works for you where they win and you still make money."

Another factor working in Hollywood's favor: China's need to save face. The republic's reputation in the world of finance is at stake here, said Lindsay Connor, co-chair of Manatt, Phelps & Phillips entertainment and media practice.

"The leverage on the studio side — or the American side — is the potential long-term benefits to China of being recognized as a fair trading partner that honors the deals it makes," he said.

Not that China doesn't have its own set of aces that make negotiations difficult.

Chief among them is its burgeoning population of moviegoers. Last year, the country surpassed Japan to become the second biggest market for movies in the world. It contributed $2.7 billion in box-office revenue in 2012 alone — a 36 percent jump from the previous year.

Also read: Hollywood Movies Losing Out to Chinese Films in a Big Way

Studios desperate to replace falling revenue from DVD and home entertainment are increasingly looking to China and other emerging markets to boost their bottom lines. But the republic is not as desperate for American movies as it was a year ago.

The country's box office rose 36.2 percent to roughly $1.7 billion during the first half of the year, with Chinese films responsible for more than 60 percent of those receipts. At the same time last year, Chinese movies accounted for just 10 percent of the country's market share.

"What are you going to do, boycott the biggest economy in the world?" the media executive asked. "That’s a death sentence. If a company said it wasn't interested in exploiting China, its stock would tank."

The media executive theorized that investors' ardor for China will force studios to accept at least part of the tax on box office receipts.

For his part, Connor acknowledged that China has one critical advantage.

"Holding the money always gives you leverage," Connor said.