The Magic Kingdom meets the Middle Kingdom, as Disney sets its sights on China. But for new chief Robert Iger, who has been leading the charge, wishing on a red star could be a risky strategy.

(FORTUNE Magazine) – Last October, on the eve of the National Basketball Association's first exhibition game in China, Walt Disney president Robert Iger stepped before a battery of television cameras flanked by NBA commissioner David Stern, Houston Rockets center Yao Ming, and a cadre of other NBA stars. A press conference to announce some blockbuster marketing deal between the NBA and China? Not quite. The venue for the high-profile gathering was a cramped classroom at Yao's alma mater, Gaoan Road Primary School in Shanghai. As cameras whirred and flashbulbs popped, Iger, Yao, and the other NBA luminaries joined a chorus of Chinese children in red neckerchiefs reciting from the pages of a Yao-sized book at the front of the room: "It's a gray, gray rainy day, but Piglet and Roo are ready to play."

Piglet and Roo are characters from A.A. Milne's popular children's stories about a stuffed bear named Winnie-the-Pooh, and Disney billed the storytelling session as part of a worldwide public-service initiative to encourage kids to read. But to properly connect the dots between the beloved bear, the world's second-largest media and entertainment conglomerate, the NBA's tallest player, and the world's fastest-growing economy, it helps to know that Disney owns the rights to Milne's characters; that Disney is the parent company of ESPN sports network; that ESPN secured rights to broadcast the Shanghai exhibition game; and that Iger wants a piece of the China market as badly as Pooh craves honey.

That last also explains why Iger, just anointed successor to CEO Michael Eisner, visited China four times last year. In October, while Eisner was slugging it out with former president Michael Ovitz in a Delaware courtroom, Iger was in Hong Kong inspecting progress on the theme park Disney is building there, in Shanghai catching the NBA game, and in Beijing chatting with China's vice president. Get Disney's new chief talking about China's potential, and he'll rattle off a list of statistics: income levels, Internet penetration figures, mobile-phone and cable-television subscription rates. The way Iger sees it, China, with 290 million people under the age of 14--more potential Mouseketeers than the entire U.S. population--isn't just a growth opportunity, "it's a needle mover."

Iger has taken to goading executives at Disney's Burbank, Calif., headquarters to prove their China savvy: "If I come back from a China trip and I know more than the guy running the business back in Burbank, he's got a problem." Indeed, so keen is Disney's new chief to bring the Magic Kingdom to the Middle Kingdom that he describes himself as the company's China country manager. "On any given day, I may talk to the person who's running Baby Einstein to see what he's up to [in China] or call the head of television there. It's constant, constant attention."

That's the sort of relentless focus championed by management experts as the secret to cracking the Chinese market. But with apologies to the Disney song, when you wish upon a red star, it makes a big difference who you are. If you're a large foreign multinational selling autos, mobile phones, or fried chicken, have at it: China waits with open arms to take in every dollar you care to invest. But if you happen to be a giant media and entertainment conglomerate--a Disney, say--be prepared for China's mandarins to wrap you in red tape.

Governments the world over restrict foreign media ownership, but China has raised regulation of the industry to a fine and excruciating art. In the developed world and in many other fast-growing economies in Asia, foreign content providers are at least allowed to purchase airtime for their programming over domestically owned networks. Not in China, where regulators limit the ability of non-Chinese companies to sell, distribute, market, and identify the programs they produce. Even cartoons are tightly controlled. Disney's most significant encroachment into China's airwaves is a half-hour kids' show that mixes Disney programming with short segments produced in China. Yet Disney can't call it Mickey Mouse Club lest its signature rodent get too well known, so the program airs as Dragon Club. The myriad prohibitions are meant to prevent criticism of China's communist rulers and to shield the Chinese from the evils of Western cultural imperialism. They're also driven, says Lehman Brothers Asia media analyst Stephen McKeever, by "good old-fashioned mercantilism" to make sure Chinese players get their share of a burgeoning market.

That's bad news for Iger, who has identified international expansion as a cornerstone of Disney strategy. Though Disney's animated menagerie includes some of the most widely recognized characters on the planet, the financial statements of the company that spawned them remain surprisingly provincial. Last year overseas revenue accounted for $6.7 billion, or 22%, of Disney's $30.7 billion in sales, and generated $1.5 billion, or 35%, of operating profit. Sure, that's enough to keep Dumbo in peanuts. But Iger has long argued that given the brand's global reach, the composition of Disney's revenue should look more like that of Coca-Cola or McDonald's, truly multinational giants that count on non-U.S. markets for more than 65% of sales. Iger is pushing for double-digit growth in foreign sales and a more diversified revenue stream. Foreign markets, he vows, must generate at least half of Disney's profits "within the next five years."

Iger's goal implies a radical redeployment of Disney's resources. Last year 70% of the company's overseas sales came from markets in slow-growing Europe; Asia contributed only $566 million, much of that from Japan, where Disney made more than $160 million in royalties from the consortium that runs Tokyo Disneyland. Iger stands little chance of hitting his foreign-profit mark without substantial gains in Asia's emerging dynamos, China and India. Disney won't say how much it earns in either market--like many multinationals, it doesn't disclose financial results by country. But the consensus among analysts and competitors is that Disney earns considerably less in the two countries combined than the $140 million that Ovitz's severance package was worth. That could change quickly as components of Iger's battle plan fall into place. In India, where broadcast regulations allow more leeway, Disney has made inroads with a sports television joint venture and the launch last year of two animation channels. But the big bet is China, where the company has identified theme parks and consumer products as its dominant profit engines.

On its face, counting on those businesses seems ... well, goofy. Movies and media networks, not parks and plush toys, are Disney's mainstay, accounting for more than two-thirds of worldwide revenues last year. In the U.S., Disney has sold off its stores, unable to make a go of hawking mouse ears and Piglet pencil boxes on its own. Why should it fare any better in a country famed for plunging prices, razor-thin margins, and rampant piracy? And while Disney's flagship U.S. parks are reliable cash cows, the company's record in operating theme parks overseas is spottier than 101 Dalmatians. Burbank balked in the 1980s when Japanese developers pitched the idea of bringing Disneyland to Tokyo, judging the Disneyland experience too American to export. Instead of investing, Disney opted to license rights in Japan in exchange for 10% of ticket sales and 5% of receipts on food and concessions. Big mistake: Japanese families can't get enough of Tokyo Disneyland. "The failure to take an ownership position in Tokyo Disneyland was exceptionally costly," Eisner wrote in his 1998 autobiography, Work in Progress. But his decision to retain a stake in Euro Disney, a theme park outside Paris, proved an even bigger error. The French venture, of which Disney now owns 40%, has been a financial sinkhole. In 12 years of operation, it has never come close to meeting its original target of 17 million visitors a year, despite generous capital infusions from Disney and Saudi Arabia's Prince al-Waleed.

Determined to finally get it right, Disney drove a hard bargain in Hong Kong, demanding a fat stake for a next-to-nothing investment. Desperate to bring jobs and tourists to their then-beleaguered economy, Hong Kong officials capitulated, agreeing to put up $2.9 billion in taxpayer money, donate land, and build a network of access roads and railways in exchange for a 57% share. Disney got its 43% for just $314 million, a sum it will recoup almost immediately because it also insisted on a 5% royalty fee for management and operation.

Nestled in a cove on Lantau Island, with views of the downtown skyline six miles away, Hong Kong Disneyland, which is scheduled to open Sept. 12, will look and feel like the original Disneyland, complete with Main Street, Sleeping Beauty's castle, and Tomorrowland. But there are some modifications. Architects went to great lengths to heed instructions of a feng shui master who, among other things, ordered the entire layout rotated several degrees to foster harmony with the elements. Staff will accommodate guests in English, Mandarin, and Cantonese, and food will cater to Chinese palates. Disney projects that the park will receive about six million visitors the first year, about 40% of them from China's mainland.

Hong Kong Disneyland is mostly a dress rehearsal for the main event--a theme park in Shanghai. Iger says Disney has been engaged for some time in "a cordial discussion, if not actual negotiations," with Shanghai officials about opening a park within the next six years. There, too, he is playing hardball, rebuffing demands to move faster. But the long-term success of Disney's Chinese parks will require more than good feng shui and hard bargaining. In other markets, Disney's film, TV, and publishing operations smoothed the way for new parks, ensuring that from the moment they set foot on Main Street, visitors felt at home. In China, says Jay Rasulo, president of Walt Disney Parks & Resorts, "for the first time, we'll be opening in a market where not all of our guests will know us well. The brand recognition is high, but the depth of the storytelling isn't there." That matters, executives say, because guests stay longer, spend more, and return more often when they invest emotionally in the characters.

To fill the void, Disney is mounting a grass-roots brand-building campaign--and experimenting with novel marketing techniques. In perhaps the most unlikely union of Mickey and Mao, Disney last year teamed up with the 70 million--member Communist Youth League to host a series of sessions billed as aiding reading skills and creativity. Disney performers toured half a dozen "children's palaces" in Guangdong province, telling stories using the Disney characters and encouraging children to draw pictures of Mickey Mouse. More sessions are planned this spring. Disney's alliance with the youth league doesn't raise eyebrows in a nation where few distinguish between advertising and propaganda. Sometimes it's unclear who's propagandizing whom. At Yao Ming's elementary school, a zealous 12-year-old scolded NBA veteran Bob Lanier for mispronouncing the word "ooze" while reading a Winnie-the-Pooh story. Afterward the boy explained that he knew the proper English pronunciation because his class had spent weeks practicing for the event.

Disney's bid for China's hearts and minds reaches back to the 1930s, when its first animated features played at cinemas in Beijing and Shanghai. Disney films, along with most other forms of foreign entertainment, were banned after Mao swept to power in 1949. During the Cultural Revolution, the mere possession of a Mickey Mouse watch would have constituted a serious cultural crime. Mickey had to wait until 1986, a decade after Mao's death, for rehabilitation. In that year Disney signed a licensing agreement with China's national network to supply cartoons for broadcast on Sunday evenings. That remained the extent of Disney's presence in China until well into the 1990s, when ESPN struck a deal to syndicate international sports programming and Disney won permission to publish a weekly comics magazine for children. In 1994, Disney forged the partnership with Beijing TV that created Dragon Club. Now in its tenth year, Dragon Club airs on more than 40 stations across China, reaching an estimated 60 million households. Winnie-the-Pooh figures prominently in CCTV's flagship kids' show, The Big Windmill, and on CCTV's new children's channel. All told, Disney-branded segments reach more than 380 million households, making the company "the No. 1 provider of Western programming to China," according to Andy Bird, president of Disney International.

Iger's own interest in China goes back to his first Beijing visit in 1979, when he was with ABC Sports. "I stayed in a hotel--I swear, this is the complete truth--my mattress was filled with straw," he recalls. "No one spoke English. I spoke no Chinese. It was almost a joke, but a great adventure." He returned in 1994, as the president of ABC-TV, to inaugurate Dragon Club.

But Disney is hardly the only belle at the ball. In programming of all forms, Disney lags behind News Corp., whose China ambitions are no less grand. The centerpiece of News Corp.'s China strategy is its 38% stake in Phoenix Satellite, a Chinese-language network based in Hong Kong. Operated in partnership with a former People's Liberation Army officer, Phoenix owns five channels and boasts that its shows reach 200 million mainland viewers. The company's biggest success is news and current-affairs programming, which offers a livelier alternative to the official fare on state-run channels. Last year Phoenix, listed in Hong Kong, reported a profit of $21 million on ad sales of $100 million. Beijing has also allowed News Corp.'s StarTV to broadcast Chinese-language entertainment programs via cable networks in Guangdong province.

Viacom, which owns Nickelodeon, announced an agreement with Shanghai Media Group in November to produce children's TV programming. The deal was the first to follow a declaration by China's State Administration of Radio, Film, and Television that foreigners are permitted to own up to 49% of Chinese television production companies. Time Warner, the largest of the global media giants (and parent of FORTUNE's publisher), has been least active in pressing for entry into the China market. Its affiliate, Chinese Entertainment Television, has also been granted permission to broadcast in Guangdong, but Time Warner ceded majority interest in 2003 to Tom Group, a media company controlled by Hong Kong billionaire Li Ka-shing.

Each year titles from Disney and Warner dominate the list of films cleared for distribution in Chinese cinemas. Disney's The Lion King was the first foreign film released in China, and the company has distributed more than a dozen others, including Toy Story, Tarzan, Finding Nemo,and Pirates of the Caribbean. The terms of China's 2001 admission to the World Trade Organization require Beijing to allow the release of 50 foreign films this year, up from ten before accession. But those films do limited box office despite China's vast population and the popularity of Hollywood fare. Consumers would just as soon pay $1 for a counterfeit DVD than two or three times that to see a movie on a large screen in a dilapidated theater.

The breadth of Disney's offerings gives it a distinct advantage in China. Disney on Ice gave 30 performances in three Chinese cities last year and is preparing to expand the tour to 40 cities. Disney is also pushing content over the web in a partnership with Sohu.com, a Chinese Internet portal. Says Rasulo: "No company in the world is better than Disney at marshaling all its business lines for brand building."

But how to make that brand building pay? Piracy has crippled Disney's efforts to profit from DVD sales in China. Since entering the market in 1997, Disney has released nearly 500 VCR and DVD titles, more than any other foreign studio. Still, in 2003 it sold just 3.4 million disks. Finding Nemo,which Disney touts as the bestselling animated feature in China, had legal sales of only 284,000 copies. Legitimate disks sell for as much as ten times the price of a knockoff, and most Chinese consumers wouldn't know where to buy them even if they were willing to pay the difference. At the Xiangyang market in Shanghai, vendors tout pirated Disney titles alongside phony handbags. At one table a woman shows shoppers a trash bag stuffed with Disney knockoffs, including The Incredibles,Aladdin, and The Little Mermaid. Nine dollars buys an eight-disk set of Mickey Mouse in Living Color, with the forged signature of Roy E. Disney on the box. "This Disney stuff sells like crazy," she says. "I usually have 100 titles, but I can't keep them in stock."

It says a lot about Iger's battle plan that in December, when he finally hired a full-time China country manager, he picked Stanley Cheung, former head of Johnson & Johnson's consumer products business in China. Cheung's first task will be to expand Disney's retail and distribution network. Disney reported that China consumer products sales topped $128 million in 2003 and that the segment's contribution to overall sales in China is double Disney's global average of 8%. Cheung wants to double the number of Disney Corners, upscale retail outlets selling toys and branded kids' wear, to 2,200 shops by the end of the year. He also sees improved opportunities for Disney products as foreign retailers such as Wal-Mart and Carrefour expand in China. "Regulations are loosening," says Cheung. "We have the right legal structure. Suddenly everything's coming together."

That would no doubt gratify Iger, who joked before getting the nod to succeed Eisner that he could be the subject of his own reality TV show. His suggested title: The Apprentice Survivor Millionaire. Just don't look for it to be broadcast on Chinese airwaves anytime soon. âñ 

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