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Zee Entertainment Enterprises (Z)
Media
Sports business plays spoilsport. Zee reported weak 2QFY11 EBITDA at Rs1.9 bn
(+25% yoy; +1% qoq) versus our expectation of Rs2.1 bn; the negative variance
resulted primarily from sports business operating losses increasing to Rs542 mn versus
Rs354 mn in 1QFY11, above our expectations and those of the Street. Core business
operations were on track with 41% EBITDA margins but (1) ratings decline in flagship
Zee TV channel and (2) content investments (programs, movies) will likely result in
normalized core EBITDA margins at ~35%. Retain REDUCE with near-term challenges
of (1) Zee TV ratings decline, (2) strong cricket calendar impacting GE advertising and
(3) launch of new channels in key Zee genres post IPL Season 4 (1QFY12E).
Weak 2QFY11 results on account of operating losses in sports business
We highlight that yoy comparison of 2QFY11 financials is not possible due to (1) merger of RGECs
channels effective 4QFY10, (2) complete acquisition of Ten Sports business effective
4QFY10-1QFY11 (and thus, even EPS is not comparable on a yoy basis) and (3) other small
mergers and acquisitions (9X, ETC Networks).
ZEEL’s 2QFY11 EBITDA of Rs1.9 bn (+25% yoy, +1% qoq) was below our expectation of Rs2.1
bn. The variance primarily resulted from sports business operating losses increasing to Rs542
mn from Rs354 mn in 1QFY11, ahead of our expectations and those of the Street. The
company noted incremental launch expenses (including higher content investment) on account
of Ten Cricket and re-branding of Zee Sports as Ten Action. The complete acquisition of Ten
Sports (versus 50% stake previously) exacerbated the pressure on financials.
However, core business was on track with EBITDA margin of 41% given (1) robust ratings
performance (sharp improvement in Zee Bangla), (2) continued strong advertising environment
and (3) pullback from large content investment due to weak operating environment in the past.
However, normalized core EBITDA margins of ~35% are likely as a result of(1) ratings decline in
flagship Zee TV channel and (2) renewed content investments.
ZEEL 2QFY11 advertising revenues of Rs4.1 bn were in line with expectations, also supported by
sports business revenues of Rs1.2 bn. International subscription revenues of Rs989 mn (-7% yoy,
-2% qoq) were also in line with Rupee appreciation in 2QFY11.
2QFY11 domestic subscription revenues at Rs1.75 bn (+27% yoy, +9% qoq) were the positive
highlight with expectations exceeded with(1) DTH revenues at Rs787 mn (+53% yoy, +11%
qoq) and (2) cable revenues at Rs961 mn (+11% yoy, +7% qoq).
2QFY11 direct costs at Rs3.46 bn were above our estimates due to launch and content
expenses of the sports business. 2QFY11 SG&A expenses at Rs1.13 bn (-8% yoy, -10%
qoq) were a tad surprising given the significant amount of activity (sports business, relaunch
of Zee Bangla) during the quarter. Nonetheless, expenses will likely rise on account
of events in the coming quarters (Zee Rishtay Awards).
2QFY11 tax provisions at Rs801 mn (38.8%) were much above normal tax rate levels (33-
34%) on account of sports business losses. Exhibit 2 presents the consolidated and
standalone (as well as ZEEL “other” sports and overseas businesses) financials. Zee paid
the complete 33% tax rate for its profitable business standalone GE business but setoffs
against the loss-making sports business were not allowed due to sports and overseas
businesses being part of subsidiaries.
Zee reported 2QFY11 EPS at Rs2.6/share (-1% yoy, +1% yoy). As discussed previously,
even comparison of EPS across time periods is not possible due to remaining 45-50%
stake in Ten Sports in 4QFY10-1QFY11 that Zee did not hold previously.
However, Zee will have to bear the double impact of (1) opportunity loss of interest
income on account of payments made for acquisition of Ten Sports and (2) losses in the
sports business till it turns around and start contributing positively. We believe Zee is on
the right track with the launch of Ten Cricket and re-branding of Ten Action though a
sustainable turnaround may still be 12-18 months away. In the meantime, overall
financials will likely remain under pressure
Too many challenges for Zee in the near term
We have reduced our FY2011E and FY2012E earnings estimates for Zee to Rs11.3 (Rs12.3
previously) and Rs14.2 (Rs15.3 previously) on account of 2QFY11 results. We are back to
square one with our 12-month DCF-based valuation revised to Rs270 (Rs300 previously). We
discuss the key drivers behind our earnings and valuations drivers.
We have reduced our FY2011E and FY2012E advertising revenues to Rs15.5 bn (Rs15.7
bn previously) and Rs18.1 bn (Rs18.6 bn). Besides the decline in ratings of flagship
channel Zee TV (see Exhibits 4-9), which will likely have limited near-term impact given
GRP-neutral long-term contracts (6-12 months) with large advertisers, the cricket calendar
will also hurt in 4QFY11 (ICC ODI WC) and 1QFY12 (IPL Season 4).
We have increased our FY2011E and FY2012E estimates of the EBITDA losses from the
sports business to Rs1.1 bn and Rs624 mn. As discussed previously (also see our note
“Ten Cricket: Smart move but sports business turnaround could take a while” dated
August 20, 2010), Zee has made all the right moves with its sports business but the
impact will be visible only over the long term.
As discussed previously, we believe the core business margins of Zee (~39% in 1HFY11)
are high (versus historic average), also on account of continued benefits of cost
rationalization during the downturn. Zee has rightly renewed its investments in content
(programs, movies) for the long term; this would likely help achieve steady-state ratings of
~250 GRPs in flagship Zee TV channel and support the network (Zee Cinema movie
channel) with steady-state ~35% margins.
In our view, Zee faces too many challenges in the near term and valuations (implied)
continue to remain full at 20X FY2012E revised EPS estimates, leaving little room for upside
(potential downside on account of risks/valuations). We like some of the measures Zee has
taken for the long-term turnaround of its underperforming sports business as well as
content investments (will likely provide more stability to its ratings as well). However, we
believe we have built enough slack in our financials with 23% EPS CAGR over FY2011E-13E,
assuming a pick-up in ratings and turnaround in sports.
As clearly visible from the 2QFY11 results, the pressure points remain. We also remain wary
of long-term risks (potential success of new entrants/channels); our discussion with players in
the market reveals that most large channel launches are on hold (IBN18 movie channel) in
anticipation of the cricket calendar in 4QFY10-1QFY12 given the significant commonality in
target audiences; the competitive dynamics can potentially change for the worse post-
1QFY12E and we await better entry points into Zee stock building in some margin of safety.
We retain our REDUCE rating for the time being.
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