Dream Factory

New money is pushing Bollywood into Hollywood's league.
Abe De RamosMarch 28, 2007

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 onetime
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 (see
“Married to the Mob,” below). “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. 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.

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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

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
, 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 coproduction
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 coproducing
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.

Married to the Mob

Ever since the short films of the
Lumiere Brothers were shown at the
Watkins Hotel in Bombay in July 1896, India
has had an enduring love affair with cinema.
By the 1930s, the local film industry was
making 200 films a year, produced by Hollywood-
type studios with their own roster
of directors, stars, and musicians.

Bollywood’s early success quickly
drew other players, and it has been fragmented
since then, dominated by individuals
or families with a flair for the arts and an
even bigger attraction to its glamour. While
many were self-funded, most were relying
on costly moneylenders (by the 1990s, they
were charging up to 40% a year). The Indian
underworld saw an opportunity, and with
their cash influenced both the creative and
financial aspects of film-making, calling the
shots on casting and film-star salaries.

The industry took an ugly turn in 1997,
when several high-profile producers suspected
of underworld connections were brutally
murdered, some for their inability to
repay their lenders, others for resisting
extortion threats. The scandal peaked in
2000 when a popular director, Rakesh
Roshan, was shot six times outside his office,
reportedly for refusing mob pressure to cast
his heartthrob son, Hrithik Roshan, in his
film. Under the glare of the public eye, Mumbai
authorities cracked down on the mob
and, in 2001, seized reels of a high-budget
film and arrested its producer and financier
after intercepting their phone calls with a
mob leader. Both were imprisoned after a
two-year trial.

The incident was a wake-up call for
the government, which until then had treated
the film industry as a trivial pursuit. In
2001, after six yeas of lobbying by industry
veterans, it finally recognized the world of
filmmaking as an industry, an effective go-signal
for financial institutions to extend
loans to Bollywood. Since then, according to
a 2005 study by the private-sector Yes Bank,
the contribution of institutional funding
sources — from bank loans to private equity
to the equity market — ballooned from 485m
rupees in 2001 to 2.6 bn in 2004. In a report,
auditing firm KPMG projects that half of all
movies will be corporate-funded by 2010.

The “corporatization” of Bollywood
— both in terms of filmmakers establishing
business entities, and established corporations
venturing into films — has brought discipline
to studio finance. “Ten years back,
everything used to happen in a haphazard
manner — bring the car and I’ll pay you in
cash,” says Adlabs Films CFO Venkat
Devarajan. “There was no documentation of
how money flowed in and out.” With their
financiers demanding balance sheets and
cash-flow projections, Bollywood changed
the dynamics between studios and talents,
introducing contracts and insisting on timeliness,
consequently avoiding schedule and
cost overruns. “Corporatization brought
project-management skills,” says Devarajan.
“It used to take 18 to 20 months to make
a movie; now you can finish a film in five to
six months.”

What’s the future of Bollywood? Now
that organized film financing is in place, the
industry is tackling value-chain integration
— the consolidation of production, distribution,
and exhibition activities. The next challenges
for the industry, says the KPMG
report, are controlling piracy (the audit firm
estimates Bollywood loses 14% of revenues
to piracy), expanding the international market,
and Indian studios gaining technical
expertise in areas such as animation —
enough to make Bollywood an outsourcing
provider of animation services.