Equity Research Report Media March 2019 By: Gary Guo (S1700517120002) and Jing Han (S1705518080001) www.research.hsbc.com China Cinema Initiate coverage: Back in the spotlight China’s big cinema chains are poised for a period of sustained growth. We forecast that box office revenue will rise at a CAGR of 11.8% over 2019-21e The market leaders that are increasing their reach across the value chain should benefit most Initiate coverage of three cinema chains – Wanda Film (Buy), Hengdian Entertainment (Buy) and Shanghai Film (Hold) – and upgrade China Film to Buy from Hold Disclosures & Disclaimer: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Equities ● Media March 2019 Why read this report China’s film industry is on the rise again, which is good news for the country’s big cinema chains; we forecast box office revenue will rise at a CAGR of 11.8% over 2019-21e Smaller cinemas are losing money, so industry consolidation is inevitable; the industry leaders are also increasing their reach across the value chain Initiate coverage of three cinema chains – Wanda Film (Buy), Hengdian Entertainment (Buy) and Shanghai Film (Hold) – and upgrade China Film to Buy from Hold; prefer Wanda Film 1 Equities ● Media March 2019 Contents A good screenplay 3 Industry outlook 13 Company Section 21 Wanda Film (002739 CH) 22 Hengdian Entertainment (603103 CH) 34 China Film (600977 CH) 44 Shanghai Film (601595 CH) 51 Disclosure appendix 60 Disclaimer 64 2 Equities ● Media March 2019 A good screenplay High-calibre films, a quality viewing experience, favourable policy initiatives and a growing audience away from the big cities…we believe the outlook for China’s big cinema chains is bright. The leaders will increase their market share as competition squeezes out smaller chains in this fragmented sector; they are also expanding into other parts of the film industry. We forecast box office takings will rise at a CAGR of 11.8% over 2019-21e. In this report, we initiate coverage of three cinema chains – Wanda Film (Buy), Hengdian Entertainment (Buy) and Shanghai Film (Hold) – and upgrade China Film to Buy (from Hold). Back in the spotlight It’s nearly a year since we published our thematic report on China’s film makers. We highlighted China’s film industry is on the rise again that box office takings had stalled in 2016 for the first time after an influx of hot money pushed up the quantity of films, but not the quality (China Media – A Hollywood moment for China’s film- makers, 18 May 2018). Audiences were not impressed. But since that brief blip, China’s film industry is on the rise again. There’s a wider range of quality big-budget domestic movies, which can now compete on level terms with the latest imported Hollywood blockbusters. This time, we focus on the big cinema chains. Box office takings rose 15.4% in 2017 and a further 8.0% in 2018, not bad in a year when growth in the domestic economy was slowing. We forecast a CAGR of 11.8% over 2019-21e and think the leading companies in the cinema industry are poised for a sustained period of growth. This should be driven by the rise in the number of cinemas and bigger audiences in smaller cities, as well as the ability to diversify into other parts of the film business and an accelerating pace of industry consolidation. In this report, we: Look at the new government policies that will help industry leaders gain market share. Explain why audiences in smaller cities will drive growth in box office takings. The percentage of box office revenue in third and fourth-tier cities grew from 36.16% in H1 2016 to 41.16% in H1 2018. Show why diversifying business across the film industry is so important. Assess the other market forces driving industry consolidation. For example, a lot of smaller cinemas are loss-making and about 300 cinemas closed in first 10 months of 2018. Discuss competition from streaming services and explain why we think the risks are being overstated. Initiate on three big cinema companies – Wanda Film (Buy), Hengdian Entertainment (Buy) and Shanghai Film (Hold). We explain why we prefer Wanda Film. Upgrade China Film to Buy from Hold and raise our target price to RMB19.90 from RMB16.50 on higher net profit forecasts. 3 Equities ● Media March 2019 The industry outlook China is world number one in many industries, but it will have to wait a little longer until it is crowned king of the world’s box office. There were signs that revenue from ticket sales would overtake North America in 2018 but a bumper year in the US cinema industry and the slowdown in growth of China’s domestic economy meant that it was not to be. But we believe it’s really only a matter of time. China’s box office revenue rose 8.0% in 2018 to RMB56.6bn (about USD8.41bn). Domestic There are now around 60,000 cinemas across the country films accounted for 62% of the total, up from 54% in 2017, reflecting higher production standards. One of the main factors driving this growth is the rapid increase in the number of cinemas. There are now around 60,000 screens across the country, with 9,000 being added in 2017. Between 2015 and 2018, the number of film screens in China has risen at a CAGR of 22.7%. All this means that competition is now at a whole new level and we believe that industry consolidation is inevitable in this fragmented market for the following reasons We believe China cinema industry will enter a period of consolidation. Intense competition would force small and medium-sized cinemas to phase out of the market and enhance the market share of top players. Our view is based on the following reasons: Increasing saturation: The rise in the number of cinema screens has resulted in a sharp decrease in revenue per screen, from RMB1.39m in 2015 to RMB1.01m in 2018. The squeeze is on: According to Top Thinktank, 84% of the cinemas in China pulled in box office revenue of less than RMB10m and 63% less than RMB5m. This means a lot of smaller cinemas are loss-making and, according to a report by 36Kr, about 300 cinemas closed in first 10 months of 2018. Out with the old: New cinemas, normally run by the big chains, have advanced facilities and can provide a better consumer experience. We believe old cinemas can’t compete. Policy incentives: In December 2018, the State Film Administration stated that to build a cinema chain a company should have “no less than 50 cinemas with a controlling stake or no less than 300 screens” and “box office of no less than RMB500m from its cinemas with controlling stake”. Out of the 48 cinema chains in China, only about 20 can fully meet these requirements, in our view. International comps: The top five cinema chains in China accounted for 46.1% of box office takings in 2018. It’s a different story in developed markets. For example, in the US, AMC, Regal and Cinemark control 59% of the market in terms of the number of screens. 4 Equities ● Media March 2019 Exhibit 1. Number of screens in China Exhibit 2. Per screen box office revenue (RMBm) 70000 40% 1.60 60079 1.39 60000 1.40 1.26 50776 1.18 1.20 50000 30% 1.10 41179 1.20 1.01 40000 32487 1.00 20% 30000 24304 0.80 18398 20000 10% 0.60 10000 0.40 0 0% 0.20 2013 2014 2015 2016 2017 2018 0.00 Screen YoY 2013 2014 2015 2016 2017 2018 Source: EntGroup, HSBC Qianhai Securities Source: EntGroup, HSBC Qianhai Securities Number of screens: lower-tier cities are the main growth engines We use the number of cinema screens per 100,000 population to measure screen density in different countries. In developed markets like the US, France and Australia, screen density is between 9.2 and 12.5. In China, the average is 7.2 but it varies by city tier. Using a weighted average, it is 10.6 in first-tier cities (Beijing, Shanghai, Shenzhen and Guangzhou), 9.6 in second-tier cities, and 6.4 in other lower-tier cities. First and second-tier cities in China have almost reached the level of developed countries, while lower-tier cities are still catching up. According to guidelines released by the State Film Administration in December 2018, “the We estimate 10,000 new screens will be installed number of screens in urban cinemas is set to total over 80,000 by 2020”. Based on this target, annually in 2019-20 we estimate 10,000 new screens will be installed annually in 2019-20, a CAGR of c15%. The main drivers are rising urban populations in some second-tier cities due to migrant inflows and urbanization, and increasing “screen density” in lower-tier cities. China’s urbanisation rate was 59.58% in 2018. According to National Plan on Population Development 2016-2030 published by the State Council, China’s population is expected to reach 1.42bn by 2020, with 60% of the population classified as urban. We have done a sensitivity analysis based on an urbanization rate of between 59% and 62% in 2020. If the number of screens rises to 80,000 in 2020, the number of cinema screens would be in the range of 9.5-9.1 per 100,000 population, on par with the current level in developed countries.