Friday, August 11, 2006

Sequels in Bollywood

These days most of the comedy hits are coming out with sequels to cash in on the increasing popularity of the first movie. In Hollywood people have used sequels as a way of reducing the cost of the budget in a very innovative way. Let's say a producer produces a movie like "Munna Bhai MBBS" and sell its sequel right to another movie producing company. The second company will have the exclusive right to produce the sequel and he will do so only if the first movie is a success.

This is actually a call option and while selling the right to produce a sequel, one can price the right appropriately by valuing it as an option. I found that a producer can reduce the cost of production by approximately 12 - 20 percent by selling the right to another producer. Given that the probability of creating a movie hit is very low, this definitely reduces the risk associated with producing big-budget movies.

Let's say the cost of producing a sequel is Rs.40 crores and it is expected to generate cash flow (including distribution rights, music, etc.) of Rs.50 crores. I have also assumed that the life of the sequel is four years in the sense, if one does not produce a sequel within 4 years of the release of the first movie, then the option expires (that it makes no more sense to produce a sequel after four years). This may not be a valid assumption for all-time successful movies like Sholay. I have also used a dividend yield of 25 percent. This is effectively the loss to the sequel-right holder of any loss in value of the project if he delays in releasing the sequel.

The value of the option comes to about Rs.5 crores. It is as if the first prodcer recovers 12% of the cost of the movie before releasing the first movie itself. One can also look at it this way: The second producer finances part of the cost of the original movie production.

It is actually not necessary to sell the sequel right to another producer. In this case, the fact that this is a call option can make an otherwise negative NPV project a lucrative project.

And if the dividend yield is assumed to be zero, then even under very mild assumptions the value of the sequel right comes to about 50 percent of the cost of the movie.

It is time Bollywood recruits MBA students for its financial planning!!!!

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