Why Tencent Literature Stock Fell After New Classics Media $2.3Bn Acquisition

NOTE. Tencent Literature is often referred to as China Literature or China Reading. Its official IPO listed name in English is Tencent Literature but in China it is still referred to by its previous titles, especially in regards to the app portals used to access the freemium publishing platform. For simplicity Tencent Literature / China Reading / China Literature should be viewed as one entity.

NOTE II. To add even more confusion Tencent Literature has its own portal in North America, in both website and app form, called Webnovel.

Bloomberg and the FT - Financial Times - have both reported that Tencent Literature (from here on, China Literature) the freemium e-publishing spin-off of Tencent Holdings, saw the largest drop in its price on the HK Hang Seng Index since its listing in November 2017.

Why did China Literature see such a drop when it acquired a promising Chinese film studio, New Classics Media (NCM)? A studio that is behind some of the biggest Chinese box-office hits in recent years, has multiple lucrative streaming deals, and has produced a return.

This seems like an obvious move by a listed company for vertical growth of its core business, but as Bloomberg points out many analysts were unhappy with two factors of this M&A. China Literature purchasing remaining assets from another division of Tencent, and the appearance of China Literature propping up its growth through this deal.

Earlier this year, China Literature's parent company Tencent Holdings acquired shares in NCM taking over Enlight Media's 27% stake at a price of $524MMUSD. As NCM is one of the hottest mini-studios anywhere in the world, solely due to China's box-office alone. This year's surprise hit Hello Mr. Billionaire a remake of the Richard Pryor movie Brewster's Millions grossed $367MM, while its previous films of the past couple of years, Never Say Die and Goodbye Mr. Looser brought in $334MM and $226MM.

China Literature's purchasing the 27% stake Tencent Holding has in NCM is not what bothers me, of one division buying shares from another, as Wall Street analyst have expressed concerns over.

It is the price that was paid for NCM that I believe should really be the concern for those on Wall Street.

Wall Street analysts should be looking at the limited content library for post theatrical revenue streams that NCM hold. Even though NCM has been involved in some of the biggest hits ever in China, it doesn't mean they are pocketing the majority of the box-office receipts or that they own the IP of those hits themselves.

Just look at the example Wanda's purchase of film finance studio, Legendary Entertainment. Thomas Tull's Legendary Ent. was know as an incredibly successful film finance company, but the properties that they developed and own did not fair to well.

The incredibly successful comedy troupe Mahua FunAge is behind all of NCM's surprise hits, Goodbye Mr. Looser, Never Say Die, and the recent Hello Mr. Billionaire. So, does NCM own the rights to Mahua FunAge's films? This is unclear.

Beyond who owns the IP, there is another factor to consider. Most major Chinese releases are not backed by one major studio, or a studio along with its mini-studios and finance production subsidiaries, but through a host of participants. The number of participants occasionally number in the double digits when provincial and local partners, who have minority or low-minority stakes, are involved to mitigate the main studio's risk.

Another hot Chinese studio of late is Beijing Culture, a production company that in just a few years went from one no-one heard of to one of the most important. All due to a couple of massive hits, including Wolf Warrior 2, but recently they have been in the trades due to them pulling their box-office bomb Kung Food from cinemas. A move that is being compared to box-office mega-bomb Asura, though it is an unfair comparison.

Another example is Enlight, the media and film production company that Tencent Holding purchases their 27% stake for half-billion dollars earlier this year. Enlight Media has been around for years, and has Ali Ventures as one of its share holders (Alibaba), but it was not until the first true surprise hit Lost in Thailand in 2012 ($208MM) that the company became what it is today.

It is unclear if either Beijing Culture or New Classics Media will survive and remain the power player that they currently are, but even with a series of huge hits on its roster their purchase price of well-over $2Bn is still pricey and not a sure thing.

When Disney acquired Pixar, Lucasfilm, Marvel, they were purchasing sizable content libraries that had solid track records. Mainly in the merchandising realm. An aspect of Tencent's desire to be the Disney-of-China still lags in, but so does the rest of the Cultural Industries in China.

Tencent Literature acquiring NCM is to solidify their pipeline from IP creation, to animation, to live-action. This is where NCM comes into play for China Literature, as they have produced successful adaptations of China Literature's properties for Tencent Video and the box-office.

The other argument by Wall Street analyst for China Literature's drop is that they purchased NCM to prop up growth, as the number of their paid subscribers have slowed since their IPO. This is only part of their business model, as analyst discount the micro-transactions of serialized stories, of per chapter purchases. That does not require paid monthly membership.

I may appear bullish about China Literature, but that is because I do not believe Tencent Holdings views this spun-off division as a key revenue driving source. I believe China Literature's purpose for Tencent as a whole, is to be the IP Incubator for a larger pipeline to drive content up and down their overall pipeline.

A pipeline that New Classics Media now fits into, and one that does not require China Literature needing to focus of relying on paid memberships alone.

Beyond the argument that the NCM acquisition was to prop up China Literature's Hang Seng value, an argument that has merits, the broader picture of the M&A is that Tencent is following the Disney Model. Of creating a conglomeration built around multi-faceted industries built around Valued Branded IP, or as they would say in China, Pan Entertainment.

Ryan is a leading voice and speaker on China's growing ACGN markets & industries: Chinese Anime / Manhua Comics / Games / Freemium Light Novels, and how they interact with the Culture Industries of  2D Culture & Pan Entertainment in China.

Beyond ACGN (二次元) Ryan specializes in China Film & Entertainment, and their cross-pollination with Chinese Entertainment-tech industries.

Ryan has direct Executive Consulting experience with partners in a range of entertainment & media fields in; India, Norway, China, Africa; Malawi and Kenya, and the United Arab Eremites; Sharjah and Dubai.

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