In his report to the 19th National Congress, President Xi Jinping clearly pointed out that socialism with Chinese characteristics has entered a new era, and made a groundbreaking assertion that “the principal social contradiction in our country has evolved into one between the people’s ever-growing need for a better life and unbalanced and inadequate development.” This new judgment provides the fundamental framework for understanding the new era. As stated in the report to the 19th National Congress, to provide the people with richer spiritual nourishment, we must further promote the development of China’s cultural undertakings and industries. In these areas, the asset valuation industry can also play its part.

I. Definition and Core of the Cultural and Creative Industries

The definitions of the cultural industry differ between the business and academic communities, both domestically and internationally. However, as technology continues to advance, an increasing number of experts and scholars have reached a consensus: the cultural industry is a “cultural and creative industry” whose core lies in creativity. In other words, at the heart of the cultural and creative industry are human creativity and the maximization of individuals’ creative potential.

“Creativity” is the ability to generate new ideas—ideas that must be unique, original, and meaningful. In an era where “content is king,” whether it’s traditional cultural products and services such as newspapers, magazines, movies, and television, or digital animation and its derivative products, the foundation of their operation lies in outstanding content and innovative distribution channels. And it’s precisely the rich creativity of human beings that gives rise to the exceptional content and innovative distribution channels that stand out in a fiercely competitive environment.

II. Several Observations on How the M&A Process Unveils the Value of the Cultural and Creative Industries

PwC publishes a semiannual report on the development of China’s technology, media, and telecommunications (TMT) industry. Based on investment data for the first two quarters of 2017 involving the TMT sector, we have made the following key observations: (1) In the first half of 2017, both the amount and number of investments in the TMT sector saw significant increases compared to the second half of 2016. The number of investments reached a new semiannual high since 2014—totaling 1,582 deals—further confirming that investors continue to view the TMT sector as the most promising segment among China’s various sub-sectors; (2) In the first half of 2017, the number of investments exceeding 100 million yuan reached 49, with the amount of large-scale investments increasing by nearly 50% quarter-on-quarter. This reflects that leading companies in specific sub-sectors remain the primary focus of capital investment and continue to attract substantial new capital inflows; (3) From a sub-sector perspective, in the first half of 2017, the internet and mobile internet sectors emerged as the sub-sectors with the strongest fundraising capabilities in the TMT industry, accounting for far more than other sub-sectors in terms of both the number of deals and the total investment amount, with large-scale investments continuously emerging; (4) IPOs on the A-share market remained the primary exit route for capital in the first half of 2017. Despite an accelerated review process, the stringent regulatory and verification measures currently in place in the domestic market, coupled with the profitability challenges faced by many emerging business models that have sprung up in the TMT sector in recent years, pose significant hurdles for these companies seeking to go public and exit via IPOs.

From the phenomena described above, we have the following three observations:

(1) Who are the participants in M&A deals in the cultural and creative industries?

From the perspective of the acquiring companies’ corporate nature, one group consists of internet giants represented by BAT—Baidu, Alibaba, and Tencent—while the other group comprises traditional industries represented by publicly listed companies.

Internet giants, endowed with the triple strengths of platforms, capital, and talent, are actively vying for traffic by acquiring cultural and creative enterprises in the internet sector through mergers and acquisitions. Moreover, in recent years, cross-border international acquisitions involving the BAT trio—Baidu, Alibaba, and Tencent—have become increasingly frequent. A prime example is the cultural and creative gaming companies: in recent years, Tencent has spent US$8.6 billion to acquire Finland’s mobile gaming company Supercell and US$1.4 billion to take a 6% stake in Blizzard; Giant Network, meanwhile, spent US$4.4 billion to acquire Israel’s gaming company Playtika. Beyond gaming-related cultural and creative firms, video platform companies have also attracted considerable attention—for instance, Youku Tudou, which was acquired by Alibaba, and iQIYI, acquired by Baidu.

Capital from traditional industries is also actively involved in M&A activities within the cultural sector. For example, recently, Jinke Culture acquired a 56% stake in Outfit7, the company behind the Tom Cat IP, for nearly 4 billion RMB; Poly Pictures spent 700 million RMB to acquire Xingxing Cinemas; and earlier, Wanda Pictures purchased the U.S.-based Legendary Entertainment for 23 billion RMB. M&A deals in the cultural and creative industries encompass both intra-industry acquisitions and cross-sector mergers. While cross-sector M&As serve as a legitimate transformation strategy for traditional enterprises, blindly chasing market hotspots and catering to investment trends can inadvertently expose companies unfamiliar with the business models of the cultural and creative industry to potential investment risks.

(2) Which cultural and creative enterprises in which fields are more favored?

Looking at the transformation trends in cultural and creative enterprises, traditional cultural and creative companies—whose business models have long relied on resource integration—are increasingly shifting toward disruptive entrepreneurship in order to maintain strong competitiveness in the market.

From the perspective of functional attributes, cultural and creative enterprises generally fall into several categories, including content creation, traffic platforms, and terminal solutions. Among these, content-focused cultural and creative companies have attracted the most attention. Content serves as the gateway to traffic; as new media—represented by self-media—continuously grows and evolves, the traditional role of intermediaries in connecting content with end users is becoming obsolete. Instead, content can now be monetized directly through methods such as user tipping or paid subscriptions. As a result, content is increasingly emerging as the simplest and most fundamental entry point for spiritual consumption, thereby drawing ever greater attention from investors. Since 2016, more than half of all mergers and acquisitions in the cultural and creative industry have centered on content—particularly intellectual property (IP). The notion that “content is king” has been thoroughly validated. What M&A activities in the cultural and creative sector are pursuing at their core is precisely creativity itself and the talent capable of generating it. The value of light-asset cultural companies is now being recognized and embraced by the capital market.

Analyzing the sub-sectors of M&A, we find that M&A activities are primarily concentrated in three key areas: gaming (mobile games), film and television-related industries, and new media. These sub-sectors are characterized by “three highs and one fast”—namely, high growth, high returns, high risk, and rapid updates. At the same time, these sectors offer significant room for creative business models, and their niche markets still have ample untapped potential waiting to be filled.

(3) How to Value Cultural and Creative Enterprises

As typical light-asset enterprises, cultural and creative businesses may encounter significant challenges when using traditional valuation theories to assess their value. The main issues involved include the selection of appropriate valuation methods, the understanding of value drivers, and the valuation of core intellectual property (IP).

1. Selection of valuation methods

Take the online gaming industry as an example: its core value lies in creativity, yet the true value of this creativity is often difficult to fully reflect in financial statements. Compared with tangible assets such as inventory and fixed assets, the cultural and creative industries place greater emphasis on intangible assets that are crucial—such as creative capabilities, marketing prowess, human resources, and intellectual property (IP). Consequently, the asset-based valuation approach typically falls short of capturing the full value of these off-balance-sheet intangible assets. Moreover, the asset-based method generally struggles to adequately account for the impact of a company’s future profitability on its overall enterprise value.

When using the market approach to value cultural and creative enterprises, given the uniqueness and exclusivity of each company’s intangible assets, identifying appropriate comparable companies or comparable transactions has consistently been a challenging issue in practice. The market approach also struggles to accurately assess the value of games that are still in the development or testing phase. Therefore, relying solely on the market approach to value gaming companies provides limited reference and should be used with caution.

Compared to the asset-based approach, the income approach not only fully takes into account the core value of intangible assets held by cultural and creative enterprises but also, to a certain extent, incorporates the synergies that may arise from the combination of the buyer and seller. As such, it is often the valuation method of choice when conducting valuations. However, it’s important to note that when using the income approach for valuation, one should comprehensively consider key factors such as these cultural and creative companies’ business models and their stage of development. Additionally, based on assessments of sustainability indicators like innovation capability and considering the competitive landscape within specific industry segments, it’s essential to construct an appropriate valuation model, determine a suitable earnings base, and select an appropriate discount rate, thereby enabling a reasonable estimation of the target company’s value.

2. Understanding Value Drivers

Building a valuation model requires a solid understanding of the key value drivers of the target company. Key Value Drivers (“KVD”) refer to the critical decision variables that influence or propel value creation. Taking an online gaming company as an example, key value drivers include the pricing model, customer retention, and the ability to continuously develop new game content. To identify the key value drivers of cultural and creative enterprises, the first step is to understand their operational and revenue models.

After clarifying the operational and monetization models and establishing a robust revenue framework, when conducting specific revenue forecasting, it’s essential to identify key performance indicators (KPIs) that can accurately simulate the target company’s future profitability. Taking online games as an example, some key KPIs might include average recharge amount per account, paid conversion rate, user retention rate, number of paying users, number of active users, download activation volume, and the recharge-to-spending ratio, among others. Among these indicators, the user retention rate is arguably the best metric for assessing user stickiness—literally, it measures “how many users have remained faithfully engaged.” This provides the most direct indication of the game application’s quality. The paid conversion rate, on the other hand, reflects the ratio of paying accounts to total registered accounts. The higher this ratio, the stronger the game’s ability to attract and retain paying users, making it a relatively reliable indicator of profitability. On the cash outflow side, for a game that is either preparing to enter or has already entered the market, estimating marketing and promotion expenses is critically important. The calculation of promotion costs depends on the specific promotion methods employed, such as brand advertising, performance-based promotions, payment based on ad impression duration, payment based on download volume, or revenue-sharing arrangements from recharges. Key performance metrics in this context include the proportion of newly acquired users relative to the total number of paying users, as well as the percentage of annual net recharge revenue allocated to acquiring new users.

Due to the numerous value drivers involved, in practice, online gaming companies with different operational and profit models need to identify the true underlying drivers in order to estimate the target company’s future earnings base.

3. The value of core intellectual property

Intellectual Property (“IP”), also known as intellectual property rights or intangible property rights, refers to the fruits of intellectual creation. Intellectual property is broadly defined as all rights arising from the realm of intellectual activities. Based on a single IP, there can be countless monetization opportunities—such as films and TV series, video games, variety shows, novels, merchandise, and more. The allure of IP for capital lies in the fact that once one particular form of content establishes brand value, all related derivative products will benefit accordingly, thereby generating even greater value.

The biggest difference between cultural and creative enterprises and other businesses lies in their core creativity. Innovative capability is the lifeblood of their development and, to a large extent, determines the company’s future trajectory. In recent years, the market’s enthusiasm for IP has been steadily growing. Consequently, licensing fees for top-tier IPs have also risen dramatically. The role of IP is most pronounced during the user-acquisition phase; the built-in fan base effect of IP can effectively reduce user-acquisition costs.

IP itself is inherently scalable; when forecasting a company’s revenue, it’s crucial to fully take into account its sustained innovation capability based on IP. At the same time, however, we also face the challenge of setting appropriate boundaries: Should we include in our calculations the revenues from all potential areas that could potentially be extended? Our view is that, to maximize the IP value of a product, we need to consider not only the product’s inherent characteristics but also the limitations imposed by the copyright holder and distribution channels. Moreover, we must carefully factor in the inputs and costs associated with resources that are required or consumed in the process.

III. New Trends in the Global Cultural and Creative Industries Transformation

Currently, there are diverse perspectives on the new trends in the global cultural and creative industries.

1. Business Model: In the relentless competition among companies vying for market share, emerging business models that gain share through creative partnerships, brand effects, and brand loyalty are receiving increasing recognition and adoption.

2. Value Chain: Technological advancements and profound shifts in consumer behavior are already reshaping industry revenue distribution and competitive advantages. Therefore, cultural and creative industry enterprises need to build and strengthen a direct, sustainable relationship with consumers.

3. Technological Transformation: The acceleration of technological change has brought macro-level risks to most businesses. However, in the cultural and creative industries, this also presents numerous opportunities for innovation in products, brands, and business models centered around user experience.

4. Content Strategy: In a world where consumers have greater autonomy in their content choices, businesses must develop appropriate strategies to navigate the powerful filtering mechanisms shaped by consumers themselves.

5. Transaction Perspective: The primary objectives of transaction activities are to expand global scale, diversify revenue streams, and unlock new growth drivers.

6. Regulation: Although global operations have become a trend for businesses, it remains crucial to stay informed about changes in the regulatory environment of local markets.

Thus far, this article has provided a preliminary discussion on the commercial and economic value of the cultural and creative industries. Compared with other industries, the cultural and creative sector also boasts significant social value stemming from its powerful cultural spillover effects. Measuring this social value, in turn, places higher demands on evaluators. This is precisely the great opportunity that the report of the 19th National Congress has created for evaluators—while charting a course for the development of China’s cultural and creative industries in the new era. Seizing this opportunity, all asset valuation professionals should closely align themselves with the spirit of the 19th National Congress, remain true to their original aspirations, forge ahead with determination, and collectively continue enhancing the credibility of the asset valuation industry.

(Author’s Affiliation: PwC; This article is reprinted from the 2nd issue of 2018 of the journal “China Asset Valuation”)