DREAM FACTORY
How new money is shaking out Bollywood and pushing it to Hollywood’s league
By Abe De Ramos

Anyone working in the Indian film industry probably knows a Ganesh Gaitonde. The antihero of Sacred Games, the new bestseller from novelist Vikram Chandra, is the head of the Mumbai mafia whose fondness for Hindi movies gets him into film financing with strings attached. Eventually, Gaitonde arm-twists a producer into casting his girlfriend in a leading role, but her lack of popularity ensures that the film is a flop. While a work of fiction, this plot was acted out in Bollywood for many years – not on the set, but behind the camera. Sacred Games recounts the uneasy relationship that once tied India’s colorful filmdom to its bloodstained underworld. “This was more true a few years ago,” says Chandra, himself a one-time scriptwriter and son of a successful director. These days, Bollywood is acting out a different plot, one that marks the beginning of a shakeout that just might take it into Hollywood’s league.

From industrial conglomerates wanting to build entertainment empires to foreign fund managers seeking to profit from individual projects, Bollywood, as the Indian film industry is widely known, is attracting new money like never before, putting behind its underworld link as if it never happened. “There’s now a proper channel of money that flows into the system,” says Venkat Devarajan, CFO of Adlabs Films, a newcomer backed by Reliance Group, India’s largest conglomerate. “Gone are the days when financing was done by dubious, unethical means.” Five years ago, it would have been hard to imagine media-and-entertainment giant Walt Disney, or international private-equity firm Blackstone Group, taking a slice of this celluloid world. But both have recently made multimillion-dollar deals in the sector with the expectation of rich dividends.

It’s easy to see why. “In India, the entire population has only two passions: Bollywood and cricket,” says RDS Bawa, CFO of Television Eighteen Group (TV18), a news-network operator that set up its own film studio last year. “Movies will never run out of fashion, and the business can only grow.” The numbers back him up. According to a PricewaterhouseCoopers (PwC) report, film revenues will reach an estimated 79 bn rupees (US$1.8 bn) in 2006, and grow 18% a year to reach 153 bn rupees by 2010 (see chart, right). Driving this is a fast-growing economy that adds 30m people to the middle class every year, and an urban population that spends up to 30% of disposable income on entertainment. At a time when global film markets are losing steam, Bollywood is becoming a dream factory to the executive set.

In fact, a new industry is emerging – one that looks at filmmaking as a business, even as it searches for the right model to capture the market potential. While India makes over a thousand movies a year – twice as many as Hollywood, making it the most prolific in the world – Bollywood has just begun to “corporatize”, a term executives use to describe how they are streamlining the chain of financing, production, distribution, and exhibition. Since India saw its first silent feature film in 1913, Bollywood has been a hodgepodge of creative spirits, wily financiers, and enterprising distributors, numbering in the thousands and all working independently. Now, they’re realizing there’s no point in sharing profits with others when they can boost their margins by venturing into the other parts of the value chain themselves, as Hollywood studios do.

Mission: consolidate

“Ultimately, what people are looking for is the consolidation of distribution,” says Andrew Heffernan, CFO of London-based Eros International, the largest distributor of Indian films overseas, which is now also seeking to become dominant in India. Currently, 90% of Eros’s revenues are generated from abroad, and the rest from India. Heffernan says the company aims to bring it to 50-50 in the next two or three years through organic growth and acquisitions. For this purpose, Eros raised a combined US$85m in an initial public offering and rights issue last year, and remains open to other forms of investment. “As the business grows, there may be potential for partnerships with not just private-equity firms but also some of the major players within the media and entertainment space,” says Heffernan.

“Being a pure play doesn’t give you the scalability beyond a certain point,” agrees Ronald D’Mello, chief operating officer and corporate-finance strategist at UTV Software Communications, a film-and-television entertainment company in which Disney bought a 14.9% stake last year. “Initially, people had apprehensions, but now everyone realizes that it’s the model of survival, growth, and risk control. The standalone models are collapsing,” D’Mello adds. For now, “co-productions” are becoming a fad among the studios as a way of sharing financial risk, even as they build their own distribution networks across the 14 major territories or “film circuits” in India – tying up only with regional sub-distributors to reach the last mile. Analysts say, however, that these relationships forebode further consolidation, partly through acquisitions, but more so by bumping smaller players out of the picture.

In the end, the game will be won by those with the widest reach. As it is, the new Bollywood players adopting the Hollywood model of integrated production and distribution have barely scratched the surface. In fact, Bollywood refers only to the Hindi-language film industry in Mumbai, which in 2005 accounted for 245 out of 1,041 films produced in India – fewer than the 298 made by Tollywood, in the Telugu-speaking southern state of Andhra Pradesh. Not surprisingly, Bollywood players are starting to make moves through tie-ups or acquisitions. In January, Adlabs bought Synergy Communications, a diversified TV network in the south. “We’re already in the Tamil market,” says Devarajan. “If a project makes sense, we won’t allow any language barriers to stop us.”

And then there is the underserved market of the 25m-strong South Asian diaspora, as well as the potential for home video and non-theatrical exhibition that Bollywood players are just learning to exploit. Combined, revenues from overseas box-office receipts, DVD and VCD sales, as well as cable, satellite, and direct-to-home broadcasts will account for a third of the total film market by 2010, from 25% last year. With piracy as competition in these markets, companies are getting creative. Eros, for one, has forged a subscription-based video-on-demand service with Comcast, the largest cable-TV provider in the US. “It serves us to use new media as a way of targeting the Indian population abroad,” says Heffernan. “Because they’re so dispersed, there’s a host of them who aren’t able to go to a local cinema to watch Bollywood films.”

Meet the parents

Who will start the Bollywood shakeout? While some established directors and producers have created corporate entities and sought institutional funding to grow, many of the new players making a splash in Bollywood have in fact never been in the film business before. What they have is strong financial backing – and the promise of a steady stream of income – to rope in independent talents and distributors.

TV18, which broadcasts the Indian editions of CNN and CNBC, became the latest TV network to get into Bollywood in January by listing a holding firm that includes its film subsidiary Studio 18. “We studied the industry carefully, and we’re not approaching it with baby steps,” says Bawa. Studio 18 aims to make one film a month and 1 bn rupees in revenues by 2008. That’s a lofty goal, considering the average box-office receipts of the films released in 2005 amounted only to 55m rupees. For its initial supply of films, Studio 18 tied up with five-year-old production outfit Shree Ashtavinayak Cine Vision – led by a 24-year-old short-film hobbyist, Dhilin Mehta – which raised funds last December through an IPO. “By getting into co-production, you share the financial risk, the movie is already on the floor, and you don’t waste time,” Bawa adds.

Bollywood’s glitter also dazzles India’s largest conglomerates. The cars-to-tea Tata Group, which in January acquired British steelmaker Corus, was a trendsetter, forming Cutting Edge Entertainment in 2002 before selling it to a venture-capital firm in 2003. The cement-to-telecom Aditya Birla Group followed in 2003, setting up the production-and-distribution outfit Applause Entertainment, which has so far released six films. The airline-to-banking Sahara India Group started with two films in 2003 that quickly grew to 30 as of December. Garnet Paper Mills, meanwhile, abandoned its traditional business in 2002 to become K Sera Sera Productions. Last year, it set aside 2.5 bn rupees to produce 20 new films by 2008. That’s an average of 125m rupees per film, three times the budget of a typical Bollywood movie.

Equally ambitious is Reliance Group, which acquired Adlabs in June 2005, then transformed the film-processing outfit into an entertainment group eyeing the movie business down to the tills. In the same year, CFO Devarajan arranged for Adlabs to issue €84m (US$109m) in convertible bonds to finance its expansion not just in production, processing, and distribution, but also in film exhibition. The company is capitalizing on the growing popularity of malls, a new concept in India, to run multiplexes – an even newer concept in a country where most of the 12,900 theaters are single-screen. “In the next year or two, we should be in the number-one spot in all the spheres we are into,” says Devarajan.

Giants of the screen

Can Bollywood create Hollywood-style, Godzilla-scale studios? There’s no shortage of acquisition targets. On one hand, more than 30 media and entertainment companies are listed in the Bombay Stock Exchange. Of them, analysts consider 12 to be positioned to grow aggressively in the movie business – from Shringar Films, Bollywood’s distribution pioneers that has also entered production, to Mukta Arts, one of the first producer-driven outfits to incorporate and launch an IPO. On the other, the characters that typified the old Bollywood – families and individuals driven by creative urges and backed by private financiers – continue to exist. “They will never go away,” says Girish Swar, analyst at brokerage firm Raymond James & Associates in Mumbai. But without the financial wherewithal to deliver big-budget films that distributors are now demanding, many of the small players will eventually fold. “Three, even two, consecutive flops, and they will have difficulty moving forward,” says Swar.

Eventually, Bollywood could be dominated by only a handful of giants. “Consolidation will not happen overnight; we don’t see the industry as mature enough to do any M&A at this stage,” says D’Mello of UTV. He predicts, however, that the shakeout will happen in the next three to five years. Heffernan agrees. “The market within India is still very fragmented, but that will change over a period of time when there will be four, five, or six dominant players in the arena,” he says. That’s a vision that brings Bollywood in line with Hollywood, where the seven studio majors – Universal, Fox, Paramount, MGM, Warner Bros., Disney, and Columbia – account for 80% of box-office receipts from films they either produced or distributed.

But whether that would actually happen in India is far from certain. Emerging trends – such as film digitization, which can disrupt industry economics; feature-film animation, in which India is gaining competence; and gaming, which exploits film-related content – are creating a new breed of players. In short, the scope of the Indian film industry itself is expanding, aided by foreign money. Last September, New York-based private-equity firm D.E. Shaw invested US$40m in Crest Animations, which is producing 3-D feature films for the Indian and overseas markets. In January, London-based private-equity firm 3i pumped US$22m into Mumbai-based digital-distribution outfit UFO Moviez.

“There are plenty of opportunities in the theatrical film industry globally, and India offers tremendous potential for financing,” says Marlene Wittman, managing director of Hong Kong-based Aquitaine Investment, which recently raised US$250m for a media-and-entertainment fund aimed at China and India. Half of the amount will go to individual film projects – Aquitaine has already identified three Bollywood films aimed at international audiences a la “Bend It Like Beckham” – out of which Wittman expects a minimum 20% internal rate of return. The other half will go to new-media ventures such as digital cinema and animation, from which she expects a 30% return.

Frisky business

Wittman might not be disappointed. Studios claim that, even before hitting the screens, their films can break even, thanks to their ability to pre-sell the rights to exploit them. “Bollywood is not the risky business people portray it to be,” says Devarajan of Adlabs. “By the time we release the movie, the production cost is more or less covered, because we would have already sold the rights.” Bawa of TV18 counts 30 to 35 opportunities for a Bollywood studio to sell film rights, from local and overseas cable and satellite broadcasts, to airline in-flight entertainment, to pay-per-view TV, to mobile-phone ring tones and CD sales. (The Indian music and film industries are practically inseparable. Most films feature seven to 10 original song numbers, sung by “playback” artists, then lip-synched by the stars.)

“The film business is now totally de-risked,” says Bawa. “As long as you have a reasonably good product, you’re sitting on a goldmine.” That means box-office receipts almost immediately count as profits. And because theatrical receipts make up 70% of a typical Bollywood film’s revenues – compared with 35% for a Hollywood movie, according to a KPMG report – returns of up to 500% are not unheard of. To be sure, not every film can be a blockbuster; even then, “de-risking” them through the pre-selling of rights ensures a reasonable payback. Says Bawa: “In one year, if you have five super hits, five average movies, and five super flops, your return still comes to more than 30%.” Devarajan adds: “Most Bollywood producers will make money in one or two years, if one in three movies becomes a hit.”

This explains why Bollywood believes that integrating the “verticals” of the business – production, distribution, and exhibition – is the way to go. “We want to capture the last rupee in everything we do,” says D’Mello of UTV, which has 19 films in the pipeline. The company is eyeing revenues of 10 bn rupees by 2010 from a likely 1.8 bn rupees this year, based on estimates by brokerage firm Raymond James. UTV, which prefers to make big-budget films – anywhere from US$5m to US$20m – has distribution offices across India and one each in the United States, England, and Mauritius. It struck gold last year with “Rang De Basanti,” a film that rouses the Indian youth, amid song-and-dance sequences, to be more politically involved. It was nominated for best foreign-language film at the British Academy of Film and Television Arts awards – the British Oscars – and grossed US$27m in India and US$2m overseas out of a budget of US$5m, according to box-office tracker The Numbers.

Going one further, Adlabs, which aims to produce at least eight big-budget films a year, wants to capture a chunk of potential box-office receipts by running its own cinemas. The company now has 50 multiplex screens and plans to bring them to 200 in two years, in line with the growing number of malls in India. “We plan to penetrate further into the country,” says Devarajan. “There is no risk of the purchasing power in India coming down, and there is a huge potential to be tapped still.” Currently, a typical Bollywood film intended for wide release is first shown in 300 to 400 cinemas in big-city locations, which account for 70% of total box-office revenues. (Mumbai alone makes up 15%.) If Adlabs achieves its goal, then it will not have to split far more than half of the profits that can be made by the films it distributes.

The reason? Multiplexes have completely changed box-office economics in India. For one, they charge an average of 120 rupees per ticket, compared with 30 to 40 rupees for single-screen theaters in big cities and 10 rupees in small towns. The conveniences they offer – such as proximity to other retail areas, air conditioning, and reclining seats – attract an average occupancy of 85%, compared with 15% for single-screen cinemas. As such, while multiplexes account for fewer than 700 of 12,900 screens in India, they generate over 60% of box-office revenues, according to PwC. “We’ve identified multiplex locations that can ensure a 20% EBITDA,” Devarajan says. At this rate, he reckons Adlabs can recover its capital outlay in five years. “That’s the reason a lot of multiplex players are also pushing out,” he adds.

Show me the money

The profitability of Bollywood studios depends on how well they manage production costs. But in a country where budgets are already low, having a steady flow of films is the most critical factor in sustaining the business. “Ultimately, as we generate more and more interest from the market, lack of content is the biggest risk for any CFO,” says Heffernan. Prior to the “corporatization” of Bollywood, when a film got started and when it finished were anything but predictable. For one, the absence of legal contracts with talents meant that actors, directors, and scriptwriters – who accepted only cash – were free to work on multiple projects at a given time. This not only resulted in production-cost overruns, but also made planning a monumental challenge, in turn creating a cycle of inefficiency.

To impose method on the madness, one of the first things emerging studios have done is to keep a stable of creative talents working for them, if not exclusively, then on a contractual basis bound by legal agreements. UTV has forged exclusive alliances with 15 directors, from top-ranked to emerging, with whom it builds a pipeline of projects. “Our model is exactly what Hollywood does,” says D’Mello. “We give them enough creative freedom; we take care of the commercial aspects.” True to its Hollywood aspirations, UTV compensates its talents variably, some for a fixed fee, others for a share of the box office. At TV18, management talent is being attracted by a new currency. “We’re all being incentivized with stock options and bonuses,” says Bawa. “You need these to retain your people as much as you can.”

More recently, Adlabs pioneered signing actors for multi-picture deals, long a norm in Hollywood and other countries. Last December, it signed a 360m-rupee, three-picture deal with Hrithik Roshan, the muscular superhero of last year’s top-grossing film “Krrish,” making him the highest-paid actor in Bollywood. This was followed in January by a 220m-rupee, three-picture deal with John Abraham, who starred in the Hindi film “Water,” produced by a Canadian outfit and nominated at the Oscars this year for best foreign-language film. Other studios are following suit, both with actors and directors. Yash Raj Films is reportedly in negotiations with Abhishek Bachchan, son of India’s most revered actor Amitabh Bachchan, for a similar deal.

What Bollywood has yet to adopt from the West is the use of completion bonds to instill cost discipline in film production. A completion bond is a guaranty subscribed to by the producer, assuring financiers that the film will be delivered on schedule and within budget, and that budget overruns are not the financier’s responsibility. So far, lenders in India don’t require them. (Only nine countries in the world make use of film-completion bonds.) Only one Bollywood studio, Kaleidoscope Entertainment, claims to use them in all its films. That’s partly because it has a joint venture with Film Finances International, the world’s largest provider of completion bonds, to introduce the instrument in India. Even film-production insurance is new, having been introduced only in the last three or four years.

That doesn’t stop studios such as Adlabs from being innovative in managing its budget. The company employs a team of auditors on-call 24 hours at shooting locations, to monitor costs as production goes along. These are people who know the market prices of line items such as props and extras. “Recently, we had to blast a car, and the production team came with a proposal of 75,000 rupees to purchase a scrap,” says Devarajan, who gives final approval on film budgets. His auditors, it turns out, knew where to find one for only 15,000 rupees. “They minimize my worry, because everybody knows we have a system of controls and there’s no way any hanky-panky can happen. We’re in the business of fun, but we take it seriously.” Now, Adlabs can produce films in six months, a quarter the time it takes most Bollywood studios.

This financial discipline is sure to help Devarajan shoulder the cost of Adlabs’ expansion. And as box-office receipts remain strong while studios follow a “de-risking” strategy through pre-selling of rights, Bollywood CFOs are understandably confident that, going forward, they will be able to fund their expansion with internal cash flows. This, in effect, gives Indian studios the confidence to push their ambitions beyond their boundaries, says Raj Pande, Hong Kong-based partner at law firm Paul Hastings, who advises clients on M&A and private-equity investments in India. “Bollywood is growing a lot faster than other industries, and certainly than the economy,” he says. “You can see them partnering with Hollywood studios on major projects.”

UTV is one of the few doing just that, having forged two co-production deals with Fox Searchlight – the arm of Fox Studios responsible for this year’s Oscar best-picture nominee “Little Miss Sunshine” – with a third in line. The first was last year’s “The Namesake,” an English-language Indian film directed by Mira Nair of “Monsoon Wedding” fame, at a cost of US$12m. The second was “I Think I Love My Wife,” a mainstream release starring comedian Chris Rock, due this month. UTV is also co-producing an animated feature with Overbrook Entertainment, owned by Hollywood A-list actor Will Smith. In all cases, UTV evenly splits the cost of production. And while no announcement has yet been made, the company is likely to enter into similar deals with Disney, whose head of international business, Andy Bird, sits on UTV’s board.

We’re working closely to explore synergies in activities like movies, animation, content, and gaming,” says D’Mello. “When you think about it, there’s no reason why, while you’re sitting here growing your India pie, you can’t be a content producer in the mainstream Hollywood scene.”

Perhaps, stealing Hollywood’s glitter will be in Bollywood’s next script.