- September 5, 2022
- Posted by: Ramkumar
- Category: Strategy
Valuing Brahmastra Movie Using Real Options Model
The Indian movie industry, especially Bollywood movies, is undergoing a drought in box office hits, with most of its big-budget movies not working well at the box office. Recent instances of movies like Shamshera, Lal Singh Chadda and Raksha Bandhan helmed by Superstars like Ranbir Kapoor, Aamir khan, and Akshay Kumar were Bollywood duds. In such a scenario, the entire industry is keeping their hopes on Brahmastra, positioned as an Astroverse movie coming with a trilogy. In this post, i want to determine the potential value of the Brahmastra franchise using an Option pricing model. Investors/analysts use the conventional discounted cash flow model to evaluate the firm’s value, or when they want to value any real-life scenario in a capital budgeting exercise.
Background on Real Options
A Real option is a strategic choice any firm makes in investing capital despite knowing that the investment is NPV negative. Firms decide to invest in such projects because they are confident that the future value of these projects is higher than the immediate projects. A firm’s right to make future investments, abandon a project, sell an investment and liquidate projects are strategic choices referred to as Real options.
For instance, a firm wants to enter China or invest in Cryptocurrencies. The reason is the enormous potential that China as a market brings or the potential that cryptocurrencies find utilities in multiple areas despite these currencies not replacing the paper currency as legal tender. In such investments, the first project will have a negative NPV; however, if the firm does not invest, it precludes them from investing later. Therefore, the firm invests to gain exclusivity that it can use to decide if it wishes to invest subsequently. So now we understand what Real options are; the next question is how to value these strategic options.
Bollywood and Indian Movie Industry
In India, the film industry business is risky, and the median movie loses money. Approximately 50% of the movies do not make money, but the producers still fund movie projects because successful movies make a lot of money. The new concept recently is the desire to make sequels. In India, Koi Mil Gaya started this trend which Bahubali and KGF exploited. Good movies often have sequels that make more money; a recent instance is Bhool Bhoolaiya 2.
When a producer makes a movie, the odds of its success are highly uncertain. However, if the movie becomes a blockbuster, there is a high probability that there will be a sequel. Thus, the key to investing in a sequel depends on whether the original movie is successful. Thus, funding a new project is a difficult decision for a producer. However, the decision to make a sequel is more straightforward. If the original movie is a flop, there is no sequel; however, if it is a blockbuster, there are higher chances of a sequel.
When you look at the above strategy, it has the characteristics of a real option. The producers are purchasing an option to invest in an original movie, and if the movie becomes successful, they have the exclusivity to release a sequel. This option value of the sequel increases the present value of the original movie.
This option value has other implications in the movie business. For instance, the protagonist in the KGF movie does not die because killing him reduces the probability of the sequel. In a franchise like Star wars, they do not even kill the villain. Another implication of sequels is that the audience expects the same actors as the original. For instance, Bahubali may not have become a blockbuster if Prabhas had not featured in the sequel. So, Prabhas has an option value as well. For instance, in Brahmastra, if there is a sequel, Ranbir Kapoor can demand higher remuneration. To prevent this scenario, movie studios often have the lead actors sign a contract for the original and the sequels. Thus, we have the Brahmastra trilogy produced before the first part is released. The producers expect Brahmastra to become a success, and if they are correct, they want Ranbir and Alia for the sequel without holding studios up for more money.
The next question is which movies deserve a sequel; considering the choice between making a movie on history and a political drama, a historical movie has higher odds for a sequel. Thus, the choice for a sequel is a function of artistic merits and basic finance.
Valuing a Real Option
We value options using the Black-Scholes Model, which assumes that the risk function is continuous rather than discrete.
I have assumed the following inputs:
According to the sources, the budget for the movie is Rs.400 crores.
I assume that the earnings from the movie, including OTT, Satellite, Local box office and overseas collections, is Rs.300 crores.
The Standard deviation of the Indian movies released in 2022 is 60%, meaning that there is a 60% risk that the movie will become a negative NPV investment.
If the movie succeeds, the studio has the right to release a sequel anytime in the next ten years.
The 10-year risk-free rate for India is 4.7%.
Computing the above inputs, I get the value of releasing the sequel at Rs.206.35 crores. However, please remember that the studio will release a sequel only when the original movie succeeds or if they are confident that the movie becomes a success. Then, they cap the production cost for the sequel at the original.
Despite the earnings below the budget, when we include the optionality, the earnings = Rs. 300+206.3 = Rs.506 crores. Thus, this investment becomes a positive NPV.
If the original movie yields a positive NPV, the value of the option increases, thus increasing the profitability of its sequel.
The pervasiveness and the utility of the real options model are higher. We can incorporate real options when we invest in projects with a strategic value, thus allowing investors to accept negative NPV projects with the optionality to either abandon/expand the investment in the future.