Why Did a Chinese Peroxide Company Pay $1 Billion for a Talking Cat?

Inside the strange courtship between industrial behemoths and Western video game studios.

Photo illustration by Justin Metz; Hazmat: Timothy Archibald/Getty Images; Cat: Outfit7

Samo and Iza Login were Slovenian high school sweethearts who studied computer science in college and then decided, in 2009, to get into the business of apps. Steve Jobs had introduced the Apple App Store the year before, and it was easy to believe that an overnight fortune was just an eccentric idea away. With $250,000 they’d saved while working for local IT companies, the Logins—who legally changed their surname to sound techy—started a company called Outfit7. Alongside six friends, they set up an office in the capital, Ljubljana. Their first few attempts bombed: a soccer app, a travel guide to Iceland, a “wealth affirmation” tool that shared financial mantras. They tried apps about healing crystals and ones that sent digital hugs. “Obviously,” says Samo, whose close-cropped graying hair contrasts with Iza’s red, “this is not what the majority of users are looking for.”

Then, after six months of misfires, the Logins built a children’s game in which an animated cat, Talking Tom, repeats in a high-pitched helium squeak whatever is spoken into an iPhone’s microphone. If a user feeds Tom hot peppers, pets him under his chin, or flicks his stomach, he responds with belches, purrs, and groans. Samo says he was optimistic that kids would love it, but acknowledges that “the whole team had some doubts.” One feature, added later, requires Tom to make regular stops in the bathroom, where he ceremoniously relieves himself into the toilet.

This, apparently, was what users were looking for. Talking Tom Cat was an instant hit, launching a franchise whose titles have reached No. 1 in more than 100 countries on the App Store. Today, almost 350 million monthly active users support the apps, and Tom’s YouTube channel has more than 2 billion views. Unlike many mobile app creators, the Logins have proved adept at turning popularity into profit. Playing Talking Tom triggers an onslaught of advertising and in-game purchase offers, and Outfit7 earns more than $100 million a year. In early 2016 the Logins decided to cash out, hiring Goldman Sachs Group Inc. to find the most lucrative deal.

A few months later, Samo flew to Shanghai to meet the buyer. It wasn’t a big game studio or a media corporation. Instead, as Login sat in a hotel conference room drinking a cappuccino, he was introduced to people working on behalf of a large Chinese chemical maker, founded in 2007 as Zhejiang Jinke Peroxide Co. He’d never heard of Zhejiang Jinke, but the offer was generous. The industrialists were willing to match the Logins’ asking price of $1 billion and let their team maintain autonomy. Samo and Iza signed away their company—having never taken money from outside investors, their stake was worth about $600 million.

Even by the opaque standards of Chinese mergers and acquisitions, the deal was a head-scratcher. It’s hard to see the synergies between a maker of chemical solvents and a digital cat perched over a toilet. And curiously, the buyer, which had recently been renamed Zhejiang Jinke Entertainment Culture Co., had revenue of only $133 million in 2016, according to Bloomberg data pulled from regulatory filings, and its gross profit was $55 million. Jinke won’t say where the money to buy Outfit7 came from.

Talking Tom is not alone. There’s been a recent flurry of oddball pairings between Chinese industrial interests and Western entertainment companies. A real estate magnate in Beijing bought Legendary Entertainment, the movie studio that made the Dark Knight trilogy, for $3.5 billion. A maker of construction materials bought Framestore, the company behind the special effects in the Harry Potter films. Zhejiang Dragon Pipe Manufacturing Co. acquired app developer Entertainment Game Labs. And perhaps strangest of all, Digital Extremes Ltd., which created an alien battle game, and the studio Splash Damage Ltd., which made an offshoot of the Xbox hit Gears of War, were bought by an enormous Chinese poultry processor.

According to CODE Advisors LLC, an investment bank that specializes in media and technology deals, 70 percent of all acquisitions of game companies since 2015 have been by Chinese buyers. Samo, for one, isn’t stopping to ask questions. A vegan, he’s using his windfall to start a food-sustainability foundation. “It’s not easy,” he says, “to find buyers for a $1 billion company.”

An artist draws a character with an electronic pen at Jagex Ltd.’s offices in Cambridge, U.K.
Photographer: Chris Ratcliffe/Bloomberg

“I used to race those,” says Lisa Pan, spotting a cherry-red Ferrari 458 parked in front of the London Four Seasons. “Want to see a picture?” She pulls out her phone, scrolls through old Facebook posts, and pulls up a shot of herself behind the wheel of a Spider convertible at a Beijing track. In the picture, she has dyed hair and wears a short-sleeved shirt and jeans. “That was a long time ago,” she says, laughing.

In London, Pan is dressed in a tan Burberry trench and tastefully matching heels, with a marble-size diamond ring on her finger. Born into a wealthy Beijing family, she’s become one of China’s most influential startup investors. She’s in the city on this cool March day on behalf of Zhongji Enterprise Group Co., a sprawling Shanghai conglomerate with a history in construction, real estate, iron ore mining, and other industries. Two years ago, the company, whose chairman is a family friend, hired her to help orchestrate a transformation. A slowdown in China’s economy meant Zhongji could no longer count on the building boom to keep its business growing. Pan urged it to buy video game production houses.

Last year she oversaw Zhongji’s £315 million ($400 million) acquisition of Jagex Ltd., a U.K. studio that created the popular multiplayer fantasy game RuneScape. In 2016, the last year for which public filings are available, Jagex had sales of £74.4 million and after-tax profit of £28.8 million. “It’s a cash cow,” Pan says. Other deals are in the works. Her March visit to London is for negotiations with another game studio, which she won’t name.

The deal activity can best be understood as a consequence of quirks in the Chinese stock market. In China, industrial companies trade at valuations they’d never receive elsewhere in the world. Affan Butt, an investment banker who helped facilitate the sale of Jagex, says some may trade at as much as 100 times their annual earnings—more than four times the multiple of General Electric Co. This means they can acquire companies at what is effectively a discount. A target like Jagex is worth more once it’s part of a Chinese-listed company, allowing the acquirer to pay prices that appear bafflingly high to the rest of the world. Zhongji “saw that arbitrage opportunity,” Butt says.

There’s no small amount of financial engineering at play, say bankers and lawyers involved in the purchases. Chinese companies are betting that by adding game studios that have better margins than a stodgy industrial business, their stock price will rise. Regulators and investors in China focus almost exclusively on a company’s bottom line. In Shanghai, a company must show three years of profitable operations before listing. And once a stock is trading, it suffers if a company doesn’t have new sources of profit. With games, Butt says, “you can buy profit.”

There’s evidence the gambit works. Since Pan oversaw the purchase of Jagex last June, Zhongji has watched its shares surge almost 30 percent. (Trading was halted last month while a new acquisition is being negotiated, a common practice in China.) The stock of Leyou Technologies Holdings Ltd., the poultry company, has more than doubled since 2016, although it still trades for just HK$1.62, or about 21¢. The shares of another company, Chongqing New Century Cruise Co., a riverboat operator that did a reverse merger with the game company Giant Interactive, have jumped more than 600 percent since that 2015 deal. “Obviously there is little industrial logic in combining a Western mobile games company with a Chinese industrial firm,” says Thijs Hagoort, a co-founder of Newzoo, a research company that tracks the games business. “But people see how much money can be made, so it’s not so strange.”

On the other hand, it’s not so easy. In China, a mining company, for example, can’t just take the yuan from its balance sheet, exchange them for euros or dollars, and write a check for a video game company. The government tightly restricts the flow of money out of the country. To get a deal done, the miner has to set up a shell company and organize a group of investors who have access to yuan and foreign capital and will front the money. The mining company may agree to pay an interest rate of as much as 20 percent, Pan says, or give the lenders shares in its company at a discount, allowing them to profit when the stock rises after the acquisition is completed. Once the Chinese regulators sign off—no sure thing—the industrial company takes control of the game company and pays off the lender. If all goes according to plan, the stock rises and everybody makes money.

In these transactions, it’s hard to unpack where the money is coming from. The Logins’ Outfit7 was initially acquired by United Luck Group Holdings Ltd., a Virgin Islands-based company controlled by a publicity-shy Chinese real estate mogul, Ou Yaping. But four days after United Luck purchased Outfit7, it sent out another press release saying it was selling the game company to Zhejiang Jinke, the chemicals company. Forbes dug up a regulatory filing showing that Jinke had acquired a 10 percent stake in United Luck a few days earlier for the seemingly low price of $5,000.

A new twist has come in a recent pair of additional Jinke filings. In one, Jinke says the Outfit7 deal is still being finalized with the United Luck consortium, a sign it may not yet have government approval. (Possibly as a result, Jinke shares are down more than 27 percent since January.) In the second, Jinke says that, even though a deal hasn’t been completed, it created a subsidiary called Zhejiang Jinke Tom Cat Network Technology Co. that will share revenue and profit from Outfit7 with United Luck. A person involved in the transaction says the Outfit7 acquisition is being bankrolled by a group of Chinese individuals, banks, pension funds, and other investors, who may seek to sell the Talking Tom maker yet again after getting the business to grow in China.

A person familiar with Jinke’s strategy says the company has been expanding into tech areas like games that have better growth rates and stock valuations than the chemical industry; Outfit7 isn’t its only games acquisition. The person said Jinke partnered with United Luck on the Outfit7 deal because it’s based outside mainland China, making it easier to get a deal done. In an emailed statement, United Luck said it’s the “100 percent” owner of Outfit7 until a deal with Jinke is finalized. Samo, now serving as an adviser, said by email, “I can’t speak for our buyers. This is their business, and you should ask them.”

Butt, who didn’t work on the Outfit7 acquisition, says many Chinese deals are murky. “There are certain layers that you are just never going to 100 percent know,” he says.

Phil Mansell, acting chief executive officer of Jagex.
Photographer: Chris Ratcliffe/Bloomberg

Last June, when Jagex announced it was being acquired by a giant but obscure Chinese mining company, employees wondered if they would see dramatic changes, says Phil Mansell, the company’s acting chief executive officer. But the new owners have earned the staff’s trust by keeping their distance. A long-overdue office expansion was recently completed, including an auditorium, a bar with local beer on tap, and a “gaming cave” for employees to use at lunch. “They weren’t looking to drain the company. They weren’t looking to take it apart,” Mansell says. “They were looking to build upon what we already had.” Jagex wants to create titles for the Chinese games market, where even a modest hit can produce big profits. Butt says Chinese acquirers are likely to keep their hands off if the new division is performing well.

Nicolas Chartier, the Academy Award-winning producer of The Hurt Locker and Dallas Buyers Club, has had a worse experience. Last year, Chartier agreed to sell his company, Voltage Pictures, for about $350 million to Anhui Xinke New Materials Co., a copper processor and maker of electrical cables. Chinese companies have made several Hollywood acquisitions in recent years, so the acquisition didn’t attract much attention. But a month after it was announced, Anhui backed out. It said Voltage hadn’t provided necessary information being sought by Chinese regulators, an allegation Voltage denies.

Chartier declined to comment, but in a lawsuit filed in Los Angeles in January, Voltage alleges Anhui backed out so it could buy a stake in a Hong Kong-based movie producer. The suit describes how, to get the complicated deal completed, Voltage set up a limited partnership in Hong Kong. Chartier transferred its intellectual-property assets to that partnership. Anhui in turn set up an international media investing arm in Hong Kong, Wotaiji International Media, to make the purchase.

Chartier’s experience of being left at the altar might scare companies from entering into an agreement with a Chinese buyer, but there aren’t many alternatives. Western video game and media companies haven’t been as acquisitive in recent years, leaving those who want to sell with little choice but to look to Asia. Even that may become more challenging now that Chinese regulators are restricting overseas deals. As the economy cools, the government doesn’t want people taking money out of the country. Concerns about a declining currency and Chinese companies that are taking on more than they can manage have led regulators to be tougher on acquisitions outside a buyer’s core business.

Employees play computer games in a gaming room at Jagex.
Photographer: Chris Ratcliffe/Bloomberg

“The Chinese government realized what was happening, and they weren’t so sure this is a good thing for mining companies to suddenly become game companies,” says Paul Heydon, a general partner at the game-focused venture capital firm London Venture Partners.

The Logins have little to worry about. Asked in an email if he had to overcome any doubts about selling to a Chinese industrial company with no history in media or games, Samo responded with a smiley face. “Ultimately,” he wrote, “they offered us the right price.” The sale of Outfit7 went through without much trouble, and with the proceeds, he and Iza are realizing their philanthropic dreams.

In May the Logins came to London. Approaching a vegan restaurant, Iza is hard to miss in a bright pink coat and Dolce & Gabbana shoes decorated with yellow floral jewels. The two smile a lot, laugh at each other’s jokes, and slip into Slovene when they don’t want a reporter to understand what they’re saying.

Over spinach-coconut soup and eggplant tagine, Samo explains that Outfit7 was largely a means to an end. The two had a seven-year plan to build a business and cash out so they could focus on their concern about food scarcity. They could have put the plan on hold and continued expanding in hopes of getting an even bigger payday down the line, but they aren’t sentimental about saying goodbye to Talking Tom. “If we kept running the company, then it would have been a failure,” Samo says. “The greed would have won.”

—With David Ramli and Manuel Baigorri