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Zee Entertainment
Enterprise Limited
Emerging Concerns on Ad
Slack, Margin Shrinkage;
Downgrade to EW
What's Changed
Rating Overweight to Equal-weight
Price Target Rs160.00 to Rs142.00
EPS for F12,F13 By 9% and 7%
F14 EPS Introduced at Rs.8.9
ZEEL may witness margin contraction as
advertising revenue growth slows even as costs
expand in next two quarters. Our F2012-13E EPS are
now 7-9% lower than consensus estimates.
What's new: We recently met with ZEEL’s senior
management in Mumbai. Following these meetings and
industry checks, we reassessed our view of ZEEL’s
business environment and have thus curtailed our
expectations for advertising revenue growth and DTH
revenue, and adjusted our cost expectation to account
for sustained competition.
Why are we downgrading: 1) We cut our F2011-13 ad
revenue CAGR forecast for ZEEL from 12.8% to 10.7%.
2) We expect ZEEL’s programming costs to inch up in
F1H12 given new programming initiatives.
3) We see limited upside given F2013E P/E of 17.4x and
our EPS CAGR forecast of 15% in F2011-13.
While ZEEL is guiding for weak margins in F1Q12, the
weakness could continue through end-C2011.
Why not Underweight?: 1) ZEEL’s TV ratings remain
healthy; 2) DTH revenue stream continues to shape up
well; 3) ZEEL’s strong record of managing costs; and 4)
strong balance sheet and buyback plans cushion
downside, in our view.
Investment Thesis
• ZEEL remains a good way to
participate in potential gains from
digitization in India. We expect CAGR
of 15% for subs revenues for ZEEL in
F2011-13.
• However, we are lowering our
expectations for ad rev growth given
the recent macroeconomic
headwinds. We now expect ad
revenue CAGR for ZEEL of 11% in
F2011-13 and expect F1H12 to be
particularly muted.
• Near-term costs should also grow,
putting pressure on margins.
• Strong balance sheet apart from
healthy subscription revenue growth
should cushion downside.
Key Value Drivers
• Advertising revenue growth trends.
• Rising number of paying subscribers
and increasing ARPUs driving
subscription revenue growth and
margins.
• Competition in GEC, ZEEL’s costs.
Potential Catalysts
• F1Q12 results may cause downside
pressure unless the stock price
adjusts accordingly before that.
• Announcement of strong digitization
progress in F2H12 by DTH
companies can be a positive.
Risks
• Upside – Ad revenue growth revives
quickly (e.g., by F3Q12), cricketrelated
losses turn out to be lower
than company guidance in F2H12.
• Downside - Competition sustains high
spending patterns on programming;
DTH revenue growth lower than our
forecast.
Investment Case
Emerging Concerns on Advertising Revenues,
Margins; Downgrade to EW
We downgrade ZEEL to EW amid growing signs of a slowdown
in advertising industry growth and ZEEL’s programming cost
inflation. Our new price target (reduced by 11%) now indicates
upside of 9% from current levels.
Why Are We Downgrading
1) ZEEL’s advertising revenue, which we had been
expecting to grow 13.5% and 11.5% YoY in F2012 and F2013,
respectively, is now likely to be up 10% and 11%.
Some of the leading advertising sectors, like FMCG, auto, real
estate, and BFSI, have slowed their advertising spending, and
so our earlier overall advertising industry growth forecast of
15.5% for F2012 looked optimistic. We have thus cut our
forecast to 10.5% for F2012. Our growth forecast for F2013 of
15% is unchanged. We now expect F1H12 to be muted before
we start to see some improvement in F4Q12.
2) Higher content costs: To counter actions by competitors,
some of whom continue to spend heavily on high-profile
programs, ZEEL is looking to increase its fresh programming
hours from current levels of 27-28 hours per week to 32-33
hours. We believe big competitors like Colors and Star have
more than 35 hours of fresh programming per week.
Although ZEEL’s programs are not extravagant creations,
marketing of new programs does lead to cost inflation, even
though revenues flow with a lag. In the last three months, ZEEL
has launched two new shows in the prime time slot – Shobha
Somnath ki and Mrs Kaushik Ki Paanch Bahuyien – and so
cost inflation is likely to coincide with the slowdown in ad
revenue trends, resulting in margin compression in the next
two to three quarters.
3) Forecasts cut on curtailed earnings growth; target
multiples lower: Having reduced our EPS forecasts for
F2012 and F2013 by 9% and 7%, respectively, we are now
forecasting EPS CAGR of 15% in F2011-13. At our price target
of Rs142, the implied P/E based on our F2013E EPS is 19x.
P/E on rolling four-quarter basis works out to 21.6x, which we
find fair in view of the moderating growth that we forecast and
given that ZEEL’s historical average of P/E multiple is 23x.
Other Factors Worth Highlighting
• Over the last few days, ZEEL has been warning about
near-term margin pressure. We believe, post our fresh
channel checks, that some of the factors may cause
downgrades in consensus numbers. However, as per
FactSet, there has been just one earnings downgrade on the
Street in the last 10 days.
• The company has also said that even though its F2012
guidance of a Rs1bn EBITDA loss from the sports business
is still valid, a big portion of the loss may come in F1Q12. A
major portion of India-West Indies cricket series was shown
in F1Q12, so costs for the period are likely to be substantially
higher than the rest of the year. We maintain our estimates of
sports business-related losses of Rs1bn for both F2012 and
F2013.
• ZEEL did a rebranding exercise in F1Q12. The company
intends to write off the entire cost of rebranding in F1Q12,
which may add to the depressed margins in F1Q12.
• The recent tie up with Star to create a JV company to
distribute a bouquet of 68 channels is the sole long-term
positive we see for ZEEL. This business can increase
collections from analog cable, which still forms the bulk of
India’s TV market. However, it may take three to four
quarters for this venture to start to bear fruit.
• ZEEL has a strong balance sheet (net cash of Rs7.7bn at
end-F2011) and it has a stated plan to buy back up to Rs7bn
worth of shares at a maximum price of Rs126/share . This
may act as a supporting factor for the stock if for some
reason the share price were to fall sharply from here.
Over the next two years, we feel it is unlikely that DTH
content providing contracts will see a lot of changes.
Accordingly, we now forecast DTH revenue growth of 36% in
F2012 and 22% in F2013 vs. our earlier forecasts of 44% and
20%, respectively. We expect ZEEL’s DTH subscriber growth
to reach 34% in F2012 and 26% in F2013, not very different
from our expectations for industry growth trends.
Even though our DTH revenue growth estimates have fallen
from earlier levels, we still consider the business to be healthy,
and this is one of the reasons why we do not rate the stock
Underweight.
Our domestic cable revenue forecasts have risen by 4%
and 8% for F2012 and F2013, respectively. For F2012, we
expect some improvement in collections as digitization
continues to pick at a fast clip, which suggests some higher
disclosure of subscriber numbers by LCOs. For F2013, we see
improvement in revenues due to the ZEE-Star JV for channel
distribution.
Valuation and Price Target
To calculate our price target, we use a DCF model with an
explicit phase of seven years and a terminal growth rate of 4%.
The key changes behind the decrease to our DCF valuation
are a reduction in advertising costs and an increase in
programming costs as explained on page 4, which implies an
EBITDA margin reduction from 29-30% to 26-27% for
F2012-13.
Exhibit 4
ZEE: DCF Calculation: Price Target: Rs142
(A) Present value of the explicit phase 37,716
Terminal value 166,190
Terminal growth rate (%) 4
(B) Present value of the terminal value 96,163
(A+B) Total present value 133,880
Net debt (5,115)
Equity Value Rs mn 138,994
Shares (m) 978
Implied DCF value per share (Rs) 142
Source: Morgan Stanley Research
Exhibit 5
ZEEL: WACC Calculation
Risk Free Return (Rf) (%) 7.9
Market Premium (Rm-Rf) () 6.5
Assumed Beta 0.93
Cost of Equity (Re) () 13.9
Equity () 80
Cost of Debt (Rd) () 10.0
Tax rate () 33.0
After-tax cost of debt (Rd [1-t]) () 6.7
Debt () 20
WACC () 12.4
Source: Morgan Stanley Research
Risks
Upside risks to our view and price target include ad revenue
growth reviving quickly (e.g., by F3Q12), and cricket-related
losses turning out to be lower than company guidance in
F2H12.
Downside risks include competition continuing their high
spending patterns on programming and DTH revenue growth
lower than our forecast.
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