Capitulation or Calculation: Dreamworks and Disney Taking Minority Stakes in Chinese SOE Tie-ups

Americans negotiating in China are starting to learn that 40% of a fortune is better than 100% of nothing.

DreamWorks is following in Disney’s footsteps and cutting a deal that gives a couple of Shanghai based SOE’s (State Owned Enterprises) a majority stake in a venture that is really just a gateway to sell its wares in the lucrative Chinese market. In both cases, the US entertainment giants seemed to be giving away too much for what basically amounts to market access.

The DreamWorks deal was summed up in the American Law Daily :

“The new joint venture in China, to be called Oriental DreamWorks, is set to begin operations in Shanghai later this year. The enterprise will be capitalized with $330 million in cash and intellectual property, according. China Media Capital and Shanghai Media Group—a company owned by Shanghai Alliance Investment, the investment arm of Shanghai’s municipal government—will own 55 percent of Oriental DreamWorks.”

This follows the long-awaited Disney deal announced in November of 2011, as detailed in a Disney Resort press release:

The Walt Disney Company and Shanghai Shendi Group have joined together to invest in Shanghai Disney Resort. As part of the agreement, two new owner companies will be formed with Shanghai Shendi Group holding 57% of the shares and Disney holding the remaining 43% of shares.

Shanghai Shendi Group Co., Ltd. is a 100% state-owned joint venture investment holding company formed by three sponsors – Shanghai Lujiazui Group Co., Ltd., Shanghai Radio, Film and Television Development Co., Ltd., and Jinjiang International Group Holding Company. Shanghai Shendi Group Co., Ltd. is involved in project investment, construction, and operation through two full subsidiaries: Shanghai Shendi Resort Development Co., Ltd. and Shanghai Shendi Construction Co., Ltd.

Is this trend of US entertainment giants giving up controlling stakes and the majority of cash flow to the Chinese government a capitulation or calculation? Initial assessments that this is yet another example of Chinese communists bullying profit-starved American CEOs into accepting adverse terms may be misplaced. In fact, these may be better deals than they seem to be – and a harbinger of things to come in US-Chinese deal-making.

Advantage China:

China allows the US and international trade bodies to force them to do what Beijing really wanted all along – satisfy the masses and bring in thousands of high-level jobs for China’s best and brightest young grads. They also get the lion’s share of ownership and revenue.

The Party gets what it wants by putting their own cultural / political spin on the media message being broadcast. The Shanghai Disneyland will not have the iconic “Mainstreet USA” entrance, and instead will greet visitors with a typical Chinese garden landscape. It’s unlikely that the DreamWorks venture will be producing any films that Beijing will find objectionable.

In theory, they are also learning valuable management skills that can help them set up their own industries and eventually compete with their new American mentors.

Advantage US:

These entertainment titans aren’t really giving up all that much. The film & theme park businesses aren’t Intel or Roche. There is no source code or secret formulae locked away in secure vaults underground. The IP is on the screen and in the parks. Sure they’ve got great management, but anyone with deep enough pockets could walk out and buy up the best and brightest in either industry. (The film industry is not known for its high ethical standards or moral turpitude.) They’ve both been dying to access the China market for decades – getting Dis & DW to sign deals wasn’t exactly a stealth coup. 40% of a fortune is better than 100% of “we’ll keep your application on file”.

While the Chinese are getting to look under the MNC skirts, the Westerners get to do what they do best – identify the best human assets available and learn to market to the Chinese middle class.

By teaming up with SOEs, they effectively neutralize the real twin threats of China market entry – pirates nibbling away at the bottom line, and savvy entrepreneurs swiping big chunks off the top. SOEs have gotten better in recent years, but they are basically still bureaucrats in better suits. Not only do the entertainment giants not have to worry about wholesale piracy (as much), but they can trust their new partners to keep the real threats at bay. American entertainment, media and software firms have much more to fear from a copycat entrepreneur with an Ivy League education than a committee of Party stalwarts. Remember – Xinhua and Robin Li (Baidu) were both gunning for Google’s search business in China. Baidu did absolutely great – Xinhua failed fast and comprehensively. If Dis or DreamWorks could pick a long-term competitor in China, then the SOEs are the guys to beat – literally.

The Structural Trap of most Western-Sino JVs

The weakness of most joint ventures lies in the BOPS- or Balance of Power Shift. Western corporates with technology, IP, designs or know-how that the Chinese lack come to town and strike great deals when the local JV partner is in a position of weakness. But within a few months, the Chinese side has learned the entire business cycle and acquired the IP – while the Western side still can’t tell a Shanghai cabbie the address of his China corporate HQ.It gives the Chinese side a great incentive to cheat – swiping the needed technology and designs and striking out on their own, cutting out the Westerner all together. The structures that Dis and DW followed will cost a bit more in the early years, but achieve the holy grail of China deals – making them more valuable in the passenger seat than as road kill.

In China you have to choose your enemies wisely. If you are involved in mining, farming, production or anything engineering, then Chinese SOEs are tough competitors. But if you are in tourism, entertainment or media, then the party-guys are the ones you want to compete with. If you’ve ever been to the Shanghai Expo or Canton Trade Show, you probably feel like you’ve been though the Long March. You saw a lot and accomplished something you can tell the grandkids about, but you probably didn’t enjoy the experience – or pick up a lot of souvenirs. The SOEs will collect a lot of important data, but it will probably never find its way to market. Meanwhile US shareholders, corporate headhunters and marketing experts will get a windfall for years to come.


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