Pedestrian stand in front of a Wanda Mall commercial complex covered with giant portraits of movie stars on its facade at the Dalian Wanda Group Co. Oriental Movie Metropolis film production hub at night in Qingdao, China(Photographer: Qilai Shen/Bloomberg)

China’s Epic Film Bubble Is About to Pop

(Bloomberg Opinion) -- Four of China's leading film executives recently gathered on a Shanghai stage with a bleak message. "There are 20,000 film and television companies" in China, said Wang Changtian, president of Beijing Enlight Media Co. "Many aren't making money at the moment, so why are they still here?" He predicted that thousands will go bankrupt over the next year — a full-on bubble in movie-making, ready to pop.

It's a classic Chinese tale. Bureaucrats in Beijing decide a favored industry must become globally competitive. Public and private support soon follows. Companies rush in. Investment surges. Customers never quite materialize. And eventually the whole thing falls apart. It recently happened to electric cars and solar panels. According to Wang and others at the Shanghai International Film Festival, the movie business is next.

Like any good Hollywood tale, this saga has a moral — one that should echo far beyond China's all-too-numerous film studios.

On the surface, the Chinese film business is healthy and growing. Ticket revenue was up 14 percent in 2017, aided by "Wolf Warrior 2," a patriotic shoot-'em-up that grossed a record $854 million domestically. Although China's movie market is unlikely to expand at the 35 percent rate it averaged during most of the last decade, it remains on track to surpass the U.S. in the next few years.

Beneath the surface, though, misguided policy and excessive capital have been setting the stage for disaster.

For years, the Communist Party, hoping to rival Hollywood's "soft power" in global theaters, has tried to prop up China's homegrown movie-makers. Foreign competition is strictly limited by quotas, while the local industry receives generous support, including cheap real estate for studios and subsidies for theaters that show Chinese films. On occasion, the government has even mandated attendance at screenings it is particularly enthusiastic about.

As these efforts have intensified, investors have been quick to open their pocketbooks. Between 2005 and 2015, the number of film-focused private-equity funds in China increased from five to 160. Tech companies such as Alibaba Group Holding Ltd. eagerly joined the party, investing in everything from studios to ticketing companies (as of April, Alibaba owned 48 entertainment firms). Smaller players soon followed: In the first quarter of 2016, 27,000 cultural and entertainment companies were registered in China.

Inevitably, all that capital led to a lot of content — too much, in fact. In 2015, only 372 of 686 domestically produced films ever made it into theaters. Those that did get released were helped along by rich ticket subsidies that artificially boosted their box-office hauls. Worse, far from encouraging filmmakers to produce better movies, all that investment produced a race to the bottom. By 2016, movies had gotten so bad that People's Daily, the Party's official paper, editorialized against a tide of what it characterized as vulgar, celebrity-driven junk, and blamed it squarely on too much capital.

China's discerning filmgoers clearly agreed. In 2016, second-quarter box-office revenue dropped by 5 percent over the previous year. Panicked regulators, hoping to aid ailing theaters, quietly raised the quota on foreign films, allowing four additional Hollywood imports to screen. Yet even that didn't help much: Total 2016 revenue grew a mere 3.7 percent, compared to 49 percent in 2015.

Perhaps more alarmingly, Hollywood's share of the till grew from 39 percent in 2015 to 42 percent in 2016. Last year, it hit 46 percent. If not for "Wolf Warrior 2," Hollywood might've owned half of China's box office. For Chinese film investors, that's a full-on disaster. One of the most prominent, Alibaba Pictures Group Ltd., lost $165 million last year.

And as Wang Changtian noted, the worst is yet to come. Alibaba can survive an industry restructuring; small studios, bereft of new investment, can't. A wave of production companies and studios are likely to fold and consolidate in the months ahead, while plenty of ill-timed investment will probably evaporate.

That's no great loss. Audiences probably won't miss films like "Oh My God," a 2015 comedy that played up infanticide for laughs, or last year's "Pure Hearts: Into Chinese Showbiz," featuring an amateur cast that certainly looked like it. But the coming implosion does show the peril of state-backed efforts to promote products that the market simply won't support.

The good news is that regulators have curbed some of the most irrational film-industry practices of recent years (such as ticket subsidies). They should also scrap incentives for building studios and subsidies for government-favored films, while permitting more production companies to go bankrupt.

That would allow capital to flow to the best ideas and talent, which in turn might produce films that people actually want to watch. In fact, if the government can avoid further meddling in the industry — a big if — China's epic film bubble may yet have a crowd-pleasing ending.

©2018 Bloomberg L.P.