By Robert Cain for China Film Biz

December 30, 2011

Legendary Pictures’ China ambitions ran into a great wall of investor resistance yesterday, as Hong Kong financing partner Paul Y Engineering (PYE) announced that it has been unable to raise sufficient investor interest to complete its $220 million investment in Legendary East, a planned three-way partnership with Legendary and Beijing-based Huayi Brothers.

Here’s the first part of the press release that was issued by PYE and its parent company, PYI:

The most revealing phrase in the press release is the statement that “some or all of the parties… may continue, in the near term, to discuss potential changes in the transaction structure…”

While PYE Chairman James Chiu blamed “the current difficult environment of the capital markets” for his failure to raise the necessary funds for the joint venture, I strongly suspect that other factors were the real reason for his quashing the deal. As I wrote in a previous post, the deal terms as originally announced were decidedly lopsided in Legendary’s favor, and in any event it made no sense for a construction firm like Paul Y to be putting shareholder money into movies, a business about which PYE’s senior executives openly admitted they know absolutely nothing.

PYE had originally explained its participation in the Legendary East joint venture as an effort to diversify its business into a more profitable industry sector with less cyclicality than its core construction operation. But as my former boss, Harvard Business School professor Michael Porter, would tell you, this is just the sort of misguided thinking that almost always leads to ruin.

In a study I conducted for Porter that led to a seminal article he wrote for the Harvard Business Review, we found that corporate diversifications like the one PYE proposed most often dissipated instead of created shareholder value. Investors are almost always better served by making their own diversification decisions within their personal stock portfolios instead of having corporate managers try to make these diversifications for them.

PYE’s and PYI’s investors no doubt took issue with their management team’s intentions and refused to go along.  PYI Chairman Tom Lau made himself an easy target for investor revolt in November when he said. “We do not understand the business of motion pictures nor do we pretend that we can contribute anything more than money.” It was one of the most candid statements I’ve ever seen from a major company Chairman, and also one of the least confidence inspiring.

I’m a big fan of Legendary, and I hope they find a way to realize their ambitions. My friends at the company tell me they’re pushing ahead with their China plans, and for their sake I hope that either PYE or other investors will provide the capital they need. But for Legendary to succeed in the long run in China they’ll have to do so on business terms that make sense for both sides. Even if the initial capital raise had succeeded, the PYE-Legendary East deal wasn’t a good one for PYE or for Huayi Brothers, and therefore looked to me like a partnership that would have been doomed from the start.

Robert Cain is a producer and entertainment industry consultant who has been doing business in China since 1987. He can be reached at rob@pacificbridgepics.com and at www.pacificbridgepics.com.