Bollywood will thrive as economy dives

Hollywood thrives when the economy dives. It's a maxim that's proved consistently accurate box office revenues in America rose in five of the past seven recession years, dating back to the 1960s. Even in the Great Depression, says David Germain for the Associated Press, people managed to scrape together enough small change to visit the pictures. Marx Brothers comedies and glossy musicals provided the perfect escape from the cold reality outside the cinema doors.

But these days it's Bollywood, not Hollywood, that's stoking memories of the golden age of cinema. As Indian society has been transformed by the economic boom of the past decade, the country's burgeoning middle class has flocked to the cinema, seeking films that remind them of a more traditional India one with joyful weddings, elaborate celebrations and strict observance of Hindi mores. The Indian movie business raked in $2bn in 2006 and is forecast to outgrow $4.3bn by 2011, according to PricewaterhouseCoopers.

It's a long way from its humble and somewhat disreputable origins. Fifteen years ago, Bollywood was little more than a large cottage industry, Indian film writer Anupama Chopra tells The New York Times. "Hugely disorganised and chaotic", the business often had to rely on raising cash from shady men with mafia connections culminating in a series of killings of prominent industry figures as the mob sought to extort money from Bollywood stars. The cramped and sweltering 1,000-seater cinemas were largely avoided by the urban middle class who regarded the films as low-brow fare for the masses.

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A number of factors helped turn the industry around. With the introduction of multi-screen cinemas in the late 1990s, film makers had the chance to appeal to the better-off urban population with smaller, more high-minded films. Scores of multiplexes sprung up in the new malls dotting New Delhi and Mumbai, where the urban middle class was happy to fork out $5 for a ticket quite a mark-up on the $1 price of entry for the single-screen theatres. The "Multiplex Film" made Bollywood financially viable. Even though multiplexes make up just 2% of India's 12,000 screens today, they account for more than a third of box office revenues in the country. With success came the ability to raise cash from banks and the government, freeing Bollywood from its links with organised crime.

The second big catalyst in the turnaround was Bollywood's overseas market. Roughly 20 million Indians live outside the country. So once the new brand of Bollywood films caught on, the industry was transformed. Returns on movies increased tenfold, while the big players in the industry were able to build a solid business in distributing films both at home and abroad.

Recent hit Om Shanti Om, for example, made $3.6m at home, but turned in $36.2m in overseas revenues. That may look paltry against Hollywood takings. But with relatively tiny budgets and an industry producing twice as many films as America, Indian cinema is in rude health. "The total budgets of even the most expensive Bollywood films are equivalent to a few special-effects-loaded minutes in the $200m comic-book behemoths that Hollywood is currently producing," says Chopra. That gives them plenty of room to keep growing fast. We look at one firm set to benefit below.

The best play in the Bollywood sector

One of the leading players in the Bollywood business is Aim-listed Eros International (LSE:EROS). The £337m company commissions and produces films, but it is also a market leader in global distribution, releasing 30 to 40 films a year to more than 50 countries around the world. Rather than selling films outright to Hollywood, as the Japanese film industry has done, Bollywood has very wisely held onto its distribution rights, and companies like Eros have reaped the benefits as they've tapped into overseas markets.

In its last interim results, Eros reported a 75.9% annual increase in its pre-tax profits for the six months to 14 September 2007, with a 55.7% jump in its earnings per share.

Last year, it was responsible for five out of the top-ten grossing box-office films in India. The group has also expanded its interests in the $6bn Indian television sector, signing a number of syndication deals with partners including Sony, Sky and Viacom, to premier its films. Eros is forecast to earn pre-tax profits of £28.7m on revenues of £81m for the year ahead which would deliver 30% earnings per share growth. That values the company on a forward p/e of 13.5, but with a price to earnings growth ratio of just 0.5, that valuation looks more than reasonable.