How can Chinese developers stay competitive in a market which continues to be flooded with new entrants? What are the major trends driving Chinese theme park M&A? Are Chinese companies leveraging the importance of original content and intellectual property? In our Q&A, Tim Mackey, Of Counsel based in our Tokyo office, addresses these questions and other critical issues impacting the China theme park space.

(Q1) What can Chinese theme park developers learn from the experience of theme park developments in other countries?

The story we hear regularly from global theme park operators is that location-based entertainment projects typically only generate the desired returns on investment if the guest experience is world-class and truly memorable. This means that operations standards need to be first-rate, regular maintenance and protection of health and safety are paramount, and new attractions, shows, and capital improvements need to be introduced on a regular basis. A properly done feasibility study is likely to provide a guide as to the number of visitors that can be expected over the short term, but if the venue does not live up to expectations then, in this information age, gate numbers can diminish dramatically over a very short period.

Some decades ago, a sustained period of growth in Japan coincided with significant increases in the number of Japanese tourists travelling around the world, and it is not too hard to imagine that the experiences of such Japanese tourists led to an increased appreciation for quality. As China keeps growing economically, we could anticipate that the expectations of increasingly wealthy Chinese tourists will naturally go up as well. Of course, culture plays a large role in consumer tastes, and there are significant differences between the Japanese and Chinese people. However, as a general notion, it would not be too surprising if the current large numbers of Chinese tourists visiting foreign destinations led to a similar increased demand domestically in China for better quality and more discerned attention to how the Chinese consumer spends his or her entertainment budget. In the battle for China’s domestic entertainment market, developers of location-based entertainment venues and theme parks that are not prepared to spend an appropriate amount of effort and funds on the offerings at their attractions are likely to lose business very quickly. Any such problems are also likely to have a flow-on effect and pose a significant risk for owners of any intellectual property that has been licensed to such developers as well, because their brands may suffer from being connected with a sub-standard venue.

(Q2) What are the major trends you see impacting Chinese telecommunications, media, and technology (TMT) M&A more broadly, and the theme park space in particular?

Looking at the theme park space, the Chinese market is obviously growing at a very fast pace. China is on track to surpass the U.S. and become the world’s largest theme park market by 2020 according to a recent South China Morning Post report. China already has approximately 300 theme parks, which attracted about 111 million visitors in 2015. Experts say that number will double by 2020. Naturally, this makes China very attractive to the major U.S. players in the industry, who are seeking opportunities to enter the Chinese market. Several of the major players such as Disney have already made substantial investments in China. In addition, Universal is expected to open its largest overseas theme park in Beijing in the next four to five years, and other operators such as Six Flags and Merlin have indicated their interest in opening theme parks in China.

This is a good example of what we are seeing in TMT M&A more broadly—a substantial increase in U.S. entertainment and media companies’ interest in accessing the Chinese market, as well as increased interest on the part of Chinese companies and investors in acquiring U.S. media and entertainment assets. The rise of the Chinese consumer class and its increased demand for entertainment and media products are driving both of these trends. China represents a massive and growing market of consumers who have more money to spend on entertainment and media products than ever before. Western brands and culture are gaining popularity alongside the growing domestic market. U.S. movie studios, gaming companies, and other content creators view China as a huge market for their premium content.

At the same time, we are also seeing increased Chinese interest in Western entertainment and media assets, frequently as a means of gaining access to IP and assets that can be further exploited in China, and from which the Chinese can learn about how U.S. and other Western entertainment companies produce and distribute premium content.

It is fair to say that Chinese media and related companies are realizing the importance of “global brands” as a means to grow their presence internationally, and their status at home. The major influence is always going to be the desire to grow domestic demand, although the slower than expected economic growth in China is almost certainly a factor in the increase we are seeing in investments abroad as well. A growing number of Chinese companies are looking to gain access to globally recognized content and make it available to Chinese consumers. As China grows more prosperous, the demand for high-quality content using foreign-owned IP is likely to continue to grow.

(Q3) What types of issues do you see facing Chinese theme park developers and licensors of theme park IP in China?

In terms of location-based entertainment venues such as theme parks, one of the key concerns during times such as this, when property developers have significant financial resources available for deployment, is that the licensors of IP might be lured by the opportunity to charge substantial fees and end up selecting a partner/developer that, while currently successful financially, is not going to provide the long-term support necessary for a project to continue to be successful for a sustained period. On the other hand, potential developers, when faced with the prospect of having to pay large upfront fees in addition to the fees that are payable throughout the life of the project, are having to make decisions with respect to such fees very early on, without having the information available to determine whether such fees will cut into the amount that should be held aside for capital expenditure and maintenance. For both sides, a proper analysis of the project, including realistic expectations of revenues and expenses, is essential.

When it comes to access to intellectual property for such projects, there are really three legal categories of “access” to IP.

First, access to brands or characters can be obtained through the acquisition of the company that owns the underlying IP. In such circumstances, the purchaser is essentially free to use the IP as it sees fit, subject to applicable laws and regulatory approvals. The challenge with this form of obtaining IP is whether the acquirer can maintain the on-going success of the brand not only in China, but also globally.

Second, access is sometimes obtained through a joint venture with the foreign IP owner. In most cases there will need to be a licensing arrangement in place, and the foreign IP owner/JV partner is likely to require a right to exercise some degree of direct control over how and when the IP is exploited. The foreign IP owner also gets to profit from not only royalties, but also dividends paid by the JV company. This has the potential to be a win-win situation for both the IP owner and the Chinese party looking to profit from its access to the brands.

Finally, the right to use the IP can be obtained through a licensing arrangement. Here, again, we would expect the foreign IP owner is likely to insist on exercising some control over how and when the IP is exploited, but in a less direct way than if they are invested in the company itself. The key consideration in this scenario is what the IP owner’s remedies are going to be if the Chinese licensee exceeds its rights under the licensing arrangements.