The entertainment and media industry is in the early stages of a dramatic transformation that will create significant opportunities for buyers, sellers, investors, and other participants in the sector. The following are our partners’ perspectives on the major trends for dealmakers to follow during this time of change.
What are the key trends impacting the entertainment and media landscape?
The entertainment industry is undergoing massive transformation that, until very recently, few industry incumbents have been willing to acknowledge despite ample evidence that change is afoot. Several trends impacting the industry have accelerated in the last few years and will become even more pronounced going forward:
- Ever-expanding number of platforms: Consumers can now access and consume content via theatrical, broadcast television, cable television, pay television, advertising video on demand, subscription video on demand, transactional video on demand, free content streaming services, live streaming services, gaming consoles, social media platforms and services, and short form content services of all shapes and sizes, viewed on screens of every size. As a result, the audience for entertainment content has never been so fragmented, while overall demand for content only increases. Moreover, the alternative platforms enable content creators – large and small – to go directly to consumers by bypassing traditional distribution channels. Increased competition among content distribution channels and changing consumer preferences among younger content consumers invariably put pressure on owners of traditional distribution platforms – with broadcast and cable television channels likely to feel the most heat. The same factors also create opportunities for large communications platforms – namely mobile phone carriers – to become preferred platforms for distributing and consuming entertainment content. The increased competition in developed markets also is driving large traditional content creators and distributors to look for growth in developing markets internationally.
- High prices for high-quality content: Distributors of content, eager to attract audience, have increased their appetite and willingness to pay a premium for exclusive, high-quality content – leading many to describe this period as the golden age of content. Distributors have been on a buying spree for premium content, with new well-financed entrants jumping in regularly. This is a wonderful development for consumers, who face the difficult dilemma of having to choose among too much good programming, and is great for content creators for the moment, but may result in a glut or oversupply of premium content. At least for now, an increase in content creators around the world has not put significant downward pressure on pricing for Hollywood-style premium content.
- New content creators: Increased avenues for content distribution and lower content creation costs have facilitated and attracted an entirely new crop of content creators – ranging from the multiplatform networks operated by a mix of traditional entertainment industry veterans and new media entrants to the multitude of YouTube, Vine, and other app and social media content creators. Content creation has become a global phenomenon, and increased competition among content creators coming from all angles poses a challenge for traditional content creators, processes and cost structures. Cheap digital cameras, including those in every smartphone, turn every individual into a content creator, and dramatically lower costs for those wanting to create content as a profession. Look for the largest Hollywood studios to continue focusing their efforts on the premium and super-premium segment of content creation – particularly the blockbuster films and television that require large capital and production infrastructure, and other content creation to move away from traditional Hollywood players and geographies. Look for new live-streaming platforms like Twitch (for live-streaming videogame play) and Periscope (for live-streaming live action) to further the trend of turning individuals worldwide into citizen journalists, talk show hosts and sports commentators.
- Technology’s transformative role: Technology is becoming more and more important to how entertainment and media content is created, distributed, and consumed and ultimately will transform much of the way the entertainment and media industries operate. In the same way that “technology” (innovative new business models using software to automate processes, driven by data) has upended many other industries and disintermediated established industry incumbents, technology already is and will continue to do the same to entertainment and media. We already are seeing technology change the way content is created and who is creating it, how business processes in Hollywood are being automated and outsourced, the manner in which content is distributed and consumed, how data is driving more and more content-related decisions, and, importantly, how equity value is shifting to those embracing the new paradigm. This trend is inevitable and its importance only will grow over time.
What is driving cross-border entertainment deals with Chinese investors and companies?
Over the past year we have seen a substantial pickup in U.S. entertainment and media companies’ interest in accessing the Chinese market, as well as increased interest of Chinese investors and companies in acquiring U.S. media and entertainment assets. Both trends are driven by the rise of the Chinese consumer class and its increased demand for entertainment and media products, as well as the desire of Chinese investors and companies to move capital into Western markets. Some key points to keep in mind:
- Land of opportunity: U.S. movie studios, games companies and other content creators view China, and to a lesser extent other developing countries, as a huge untapped market for their premium content. China represents a massive and growing market of consumers who have more money to spend on entertainment and media products than ever before and seem to crave Western brands and culture. In addition, Chinese government-imposed controls on the importation of non-Chinese motion pictures have been relaxed in recent years and are expected to loosen more. Some U.S. studios, such as DreamWorks Animation and Warner Brothers, have formed joint ventures with leading Chinese media firms as a means of penetrating the China market, while others like Disney and Universal have made substantial theme park investments in China while also pursuing broader Chinese releases of large “tent pole” motion pictures. China has begun a process of relaxing its restrictions on foreign investment, which is spurring substantial interest from Western capital and companies.
- Chinese interest in U.S. assets: Chinese investors and companies meanwhile have shown increased interest in Western entertainment and media assets, frequently as a means of gaining access to intellectual property and assets that can be further exploited in China and/or from which the Chinese can learn about how U.S. and other Western entertainment companies produce and distribute premium content. This strategy likely explains Fosun’s interest in partnering with Texas Pacific Group to acquire Cirque du Soleil and Wanda Group’s interest in acquiring Legendary Pictures. Other Chinese technology companies, such as Alibaba and Tencent, seek to use U.S. entertainment and media assets to bolster their reach and penetration among Chinese and pan-Asian consumers.
- Flight of Chinese capital into Western assets: Facing a market downturn and currency devaluations in China, many Chinese investors seek to increase their investments outside of China. This comes at a time when the Chinese government is loosening capital controls on foreign investment in connection with seeking official reserve currency status for the Renminbi. While Chinese investors continue to invest massive sums around the world in energy and natural resources, Chinese investors now seek higher rates of return associated with industries like entertainment, media and technology.
What are the critical IP issues that U.S. companies need to consider when pursuing cross-border entertainment and media deals?
A savvy IP strategy is more critical than ever when negotiating cross-border deals. As noted above, many Chinese companies view investments in and partnerships with U.S. companies as opportunities to access valuable intellectual property, whether to further exploit it in China or learn more about U.S. technology platforms and production and distribution methods. As such, intellectual property is an area that offers significant opportunities for dealmakers, but in the cross-border context also can create risks. Some key issues to consider:
- Technology transfer regulations are critical: Overseas investors should carefully consider the technology transfer regulations of any country in which they invest. In China, during the term of the applicable agreement, the licensee owns the improvements to any technology that it creates. This issue arises in situations where a U.S. investor licenses technology to a Chinese company, and the Chinese company makes improvements to that technology, and different investors have addressed the issue in different ways. One common approach is for a U.S. company to set up a wholly foreign-owned enterprise (WFOE) to license technology to the Chinese company, which avoids application of the technology transfer regulations.
- The importance of navigating rules impacting joint ownership of IP: Business principals often love joint ownership because it sounds fair and equitable. For example, the business teams may want to own a joint copyright in a motion picture. Generally, however, joint ownership of intellectual property is discouraged because the joint ownership rules differ by country and by type of intellectual property asset, meaning that the parties could face different default rules in different countries for the same intellectual property asset. For example, the joint copyright rules in the United Kingdom (and in most of the rest of the world) are entirely different from such laws in the United States. In the United States, a joint copyright owner can license a joint copyright to a third party without permission of other joint owners (although each owner would have a duty to account or pay the other owners their share of profits from exploitation of the joint work), but in the United Kingdom (and most other countries), the permission of other joint owners is needed to license a joint copyright to a third party. Similarly, joint ownership of trademarks (e.g., motion picture titles) is arguably inconsistent with the function of trademarks to indicate the source of goods or services and can substantially undermine the scope or even the validity of the associated rights. The result in either case could be less value for all involved. Therefore, thorough and careful negotiation and drafting of contracts to reflect the parties’ mutual understanding regarding their respective rights and responsibilities is more likely than merely providing for joint ownership of intellectual property to maximize overall value and enhance predictability and consistency.
- The local nature of IP laws necessitates use of local counsel: Intellectual property law is inherently local, with different laws applying in each jurisdiction. This make it important to also retain local counsel to ensure IP is properly registered, maintained and enforced in accordance with local laws. For example, U.S. common law rights to a trademark arise from bona fide use of the mark in commerce. In China, on the other hand, generally uses a first to file system that requires no evidence of prior use. Therefore, if an overseas investor is thinking of setting up a joint venture in China or otherwise doing business in China, the investor should retain local counsel and conduct a trademark search for the same or similar registered marks.
- Not all IP rights are recognized the same way in all jurisdictions: Not all countries’ Intellectual property laws recognize the same intellectual property rights, which can make it challenging for investors who may assume that they can get the same protections abroad as at home. For example, while “publicity rights” exist in the United States, in China there are no provisions concerning publicity rights and instead investors must rely on privacy rights under a General Principle of Civil Law of the People’s Republic of China for which the remedies available for infringement of such rights at best include requiring the infringer to make a public apology, remedy any negative effect and pay compensation for mental anguish. In addition, IP assets are protected for different lengths of time in different countries. Therefore, while a song could be potentially in the public domain in the United States, copyright protection in other countries may be longer and would still have to be cleared in other countries.
What investment opportunities will be created by recent U.S. regulatory changes?
Changes in FCC policies will create new opportunities for U.S. and foreign investors looking to monetize entertainment assets or increase their stake in such assets. Some changes to keep in mind as we move forward:
- FCC channel sharing rules provide new opportunities for broadcasters: The FCC’s current Incentive Auction will provide television broadcasters and their investors with a unique opportunity to monetize their spectrum assets by bidding to sell all or a portion of their spectrum use rights back to the FCC. As part of the Incentive Auction, the FCC has also created a mechanism – channel sharing agreements (CSAs) – that allows a television station to relinquish its existing spectrum-use rights in the Incentive Auction and remain on the air by sharing spectrum with another existing station in the same market. While the FCC’s Incentive Auction rules created a strong incentive for stations to enter into CSAs in advance of a January 2016 deadline, the FCC has also provided a process for stations with successful Incentive Auction bids to relinquish their spectrum to enter into CSAs during a six-month period after the auction’s close. In addition to the policy goal of facilitating greater participation in the Incentive Auction, CSAs may provide broadcasters with new ways to achieve efficiencies through shared operations. As such, the FCC has also proposed (but not yet adopted) rules that would allow television stations to enter into CSAs outside of the context of the Incentive Auction. These CSAs are novel, typically long-term agreements that integrate business, regulatory, operational, tax, real estate, and future-technology issues.
- Increased opportunities for foreign investment in U.S. broadcasting: A recent change in FCC policy has opened the door to increased foreign investment in U.S. television and radio broadcast stations. Under U.S. law, the FCC must review and approve transactions involving spectrum licenses, and in the context of transactions proposing aggregate indirect foreign ownership in excess of 25%, the FCC must also make a public interest determination. Historically, the FCC has not permitted indirect foreign investment in television and radio broadcasters to exceed this 25% threshold. Last year, however, the FCC granted a request by Pandora Radio for greater flexibility under the FCC’s foreign ownership rules and allowed foreign investors, in aggregate, to hold up to 49.99% of the interests in the company, so long as actual control is held by U.S. entities or U.S. citizens. While the FCC will review future requests for increased foreign investment in television and radio properties on a case-by-case basis, the industry has viewed the Pandora Radio decision as signaling a willingness by the FCC to permit greater foreign investment in the U.S. broadcast sector.