STOCKS: Huayi Fits the Bill as China Hit Maker

Bottom line: Huayi has the potential to become one of China’s leading makers of Hollywood-style film and video, with a strong track record that has helped to attract major partners for a growing string of well-conceived production deals. 

Huayi destined for China stardom?

Two savvy new deals this week are casting a spotlight on fast-rising rising film star Huayi Bros (Shenzhen: 300027), which is fast emerging as China’s most promising independent film-maker that could someday attain Hollywood-level status. Huayi is the lone company in my “favorite Chinese stock” series from China’s Nasdaq-style ChiNext board, which is typically quite volatile and often looks more like a casino than a serious stock exchange.

But despite any volatility in its share price, Huayi has shown an ability to consistently make movies and other entertainment products that get strong audience reception, laying the foundation for strong future growth. The company has become a regular fixture in the headlines, including the 2 new production deals this week that both look quite promising.

One of those has Huayi partnering with leading Chinese Internet company Tencent (HKEx: 700), in a bid to bring films from South  Korea and the US to China, and possibly also sell into those markets as part of its fledgling move abroad. The other has Huayi forming a new animation joint venture led by a major US industry veteran, again looking to tap both markets both at home and abroad.

Huayi is a household name in the Chinese film industry, and its hit movies include the 2012 film “Painted Skin: The Resurrection” and the 2013 film “Journey to the West: Conquering the Demons”, which both earned well over $100 million at the Chinese box office. Lately the company has joined a fledgling movement by Chinese companies looking abroad, many to Hollywood, in a wide range of production deals aimed at tapping China’s booming market for movies and other video products.

Each of its latest deals is a bit different, but both are also quite focused on promising growth areas and reflect Huayi’s ability to attract major partners to its endeavors. The first has Huayi and Tencent buying Hong Kong-traded China Jiuhao Health (HKEx: 419), with plans to transform the shell company into a financing vehicle for acquiring films from Korea and Hollywood. (English article)

The pair said the company will be renamed as Huayi Tencent Entertainment Co Ltd, and will become a vehicle for acquisitions outside China. Huayi will hold 18.2  percent of the company, while Tencent will hold 15.7 percent. A unit of e-commerce giant Alibaba (NYSE: BABA), which its own big film production aspirations, will also be a small stakeholder.

The actual deal is quite small, involving the subscription of HK$527 ($68 million) in new shares by the buyers. But it reflects Huayi’s careful and focused approach to expansion, which typically sees it enter very specific alliances targeted at particular areas.

Animation Studio

The company’s other major news this week saw it announce the formation of a new animation studio to be based in Shanghai, which is already home to another major animation joint venture between US giant DreamWorks Animation (NYSE: DWA) and local heavyweight Shanghai Media Group (SMG). (Chinese article)

While the new venture is in China, it will be headed by Hollywood veteran Joe Aguilar, who has more than 20 years of experience at names like DreamWorks and Twenty-First Century Fox (Nasdaq: FOX). In fact, Aguilar is actually coming to the Huayi venture from Oriental DreamWorks, the DreamWorks-SMG joint venture. The new Huayi studio will make films for China, with its first productions set to hit the market as soon as next year.

These latest 2 deals come just a half year after Huayi announced another major tie-up with Ping An Bank last year in a massive partnership reportedly worth 30 billion yuan ($4.7 billion), presumably to make films for both the China and global markets. (previous post) The ability to attract that kind of funds from such A-list investors testifies to Huayi’s attractiveness to investors both large and small as a savvy bet on China’s booming film market.

From an investment standpoint, Huayi’s valuation current valuation looks slightly rich at about 37, which is about double the level for US giant Disney (NYSE: DIS). But let’s not forget that Huayi is traded on the ChiNext, where stocks regularly rise and fall by double-digit percents in very short periods based on heavy short-term speculation.

Huayi’s stock was actually much higher at the start of this year, and has lost nearly half of its value since mid-December in a broader sell-off on China’s domestic stock markets. But at a more fundamental level, its revenue and profits are both posting very healthy growth, rising at a current rate of about 100 percent and 50 percent, respectively.

From a short-term perspective, I would caution investors about buying any Chinese stock, and especially ones on the highly volatile ChiNext. But from a longer-term perspective, Huayi certainly looks like a shrewd play on the future of China’s rising role as a major producer of movies and video for not only its booming home market, but also potentially eventually for overseas markets as well.

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