Time Warner's (TWX) Warner Bros. could soon produce Chinese language films for China's domestic audiences, according to The Wall Street Journal. The studio is reportedly in talks with China Media Capital, a state-backed investment fund, to establish a joint venture for making movies. Would this move pay off for Warner Bros in the long run?

Shanghai, China. Image via Pixabay.

The business of Chinese movies
China's box office revenues rose 34% year-over-year to $4.8 billion in 2014, making it the first market outside U.S/Canada to exceed $4 billion in annual revenues. That growth boosted total revenues across the Asia Pacific region by 12% to $12.4 billion. By comparison, U.S/Canada box office revenues declined 5% to $10.4 billion last year.

Due to that stagnation, American film studios have become increasingly dependent on the Chinese market. Universal's Furious 7 has been the top-grossing film in China this year, with $391 million of its $1.51 billion worldwide generated by Chinese audiences.

Over the past year, four of the top 10 movies in China have been Hollywood imports. The other six were Chinese language films includingMonster Hunt, The Man from Macau II, and Monkey King: The Hero Is Back. The ninth highest-grossing film of the year, the Jackie Chan vehicle Dragon Blade, was a Chinese production that starred American actors John Cusack and Adrien Brody.

Dragon Blade. Source: SFC Films.

This indicates that Hollywood studios could generate more revenue from China if they produced more Chinese language films. Making Chinese films with a state-backed Chinese firm could also help Warner circumvent the strict limit of 34 films that Hollywood studios are allowed to export to China every year.

Warner's not the only one
Warner, which reportedly plans to invest $50 million in the joint venture, wouldn't be the first American company to invest in China's domestic film market.

News Corp acquired a 19.9% stake in Chinese film distributor Bona Film Group back in 2012. Last quarter, Bona's revenues rose 59% annually to $71.1 million, thanks to high-grossing domestic films like Insanity and SPL2. Unlike many other Hollywood studios, Bona Film also owns and operates movies theaters. Its movie theater business posted a 50% annual jump in revenues last quarter. Those gains now benefit 21st Century Fox, which News Corp spun off as a stand-alone media company in 2013.

Dreamworks Animation hasalso inked deals with China Media Capital, Shanghai Media Group, and Shanghai Alliance Investment to co-produce Kung Fu Panda 3 in 2016. It also established a Chinese joint venture that develops Chinese animated and live-action content for domestic and overseas audiences. It is also working with Chinese firms to build a $2.4 billion entertainment complex in Shanghai, known as Dream Center, which is expected to open in 2017.

Kung Fu Panda 3. Source: Dreamworks Animation.

What does this mean for Time Warner?
Last quarter, revenue at Warner Bros. (which includes films, TV studios, and video games) rose 15% to $3.3 billion and accounted for 45% of Time Warner's top line. However, those gains came from higher video game and TV licensing revenues, which offset a 15% decline in theatrical revenues.

Warner's theatrical revenues fell due to unfavorable comparisons against The Hobbit: The Desolation of Smaug in the prior year, which highlights an ongoing problem at Warner Bros: its loss of blockbuster franchises. The company rode high on the success of Harry Potter for a decade and the Lord of the Rings for three years, and stretched out The Hobbit into three more films over three more years.

But looking ahead, Warner faces an uncertain future with its polarizing attempt to build a "DC Cinematic Universe" with films like Batman v. Superman: Dawn of Justice and Suicide Squad. If those films fail to establish a Marvel-like following over the next few years, Warner will likely need to reboot those franchises again with new films. Therefore, expanding into China could provide its theatrical unit with stable revenues that aren't dependent on building and maintaining multiyear franchises.

The key takeaways
The American movie market is shrinking, while the Chinese movie market is booming. As long as these two markets keep diverging, American studios will spend more on marketing films to Chinese audiences. They'll also likely sign more joint ventures in China to produce Chinese language films. This could help major studios like Time Warner diversify their theatrical slates and reduce their dependence on big franchises with limited lifespans.