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Eros International (EROS)
Media
Management meeting takeaways and annual report analysis. Key takeaways of
our meeting with the management: (1) ~20 films target for FY2013E in core Hindi film
business and (2) top management focus shifting to new growth drivers (a) regional films
and (b) digital formats. Key takeaways from FY2011 annual report: (1) adjusted free
cash flows of Rs0.9 bn in FY2011 and (2) net cash balance of Rs1.0 bn at end-FY2011
denotes the strength of the balance sheet. Fine-tuned estimates based on the annual
report; reiterate BUY with FY2013E TP of Rs250 (unchanged).
FY2011 annual report analysis: balance sheet strength to scale up business
Exhibit 1 presents the financial summary of Eros; Eros reported FY2011 free cash outflows at
Rs0.5 bn. However, adjusted free cash flows at Rs0.9 bn are a better measure of current
operations. The Rs1.4 bn negative variance is largely explained by the (1) Rs0.7 bn increase in
production advances (non-earning asset, for FY2012E-13E film slate) and (2) Rs0.9 bn decline in
advances from parent, in line with the guidance of the company.
The net working capital (excl. cash) was reasonable at 130 days, despite the increase in
production advances (given by Eros to its content partners) and a decline in overseas advances
(taken by Eros from parent company in lieu of overseas rights on completion of film).
Key takeaways from meeting with management: focus on regional and digital
We met with Mr. Kishore Lulla, ED, and Mr. Sunil Lulla, MD, Eros International, to understand
current business operations and strategies: (1) The core Hindi film business is targeting ~20 films
for FY2013E, led by Mr. Sunil Lulla along with a team of professionals. The improvement in perfilm
revenue and profitability is driven by (a) a larger number of screens (multiplexes, Digital
Cinema), (b) pre-sale model for rights and (c) partnership model for content. (2) The focus of the
top management has shifted to two future growth drivers: (1) regional film markets and (2) digital
distribution of film content/library. Eros is looking at collaboration opportunities in the former and
has assembled a team of professionals to drive the latter.
Reiterate BUY with FY2013E TP of Rs240 (Rs250 previously); fine-tuned estimates
We have fine-tuned our FY2012E-13E EPS estimates based on our FY2011 annual report and
reiterate our BUY rating on Eros stock with revised FY2013E TP of Rs250 (unchanged), based on
8.5X FY2013E EV/EBIT. We highlight that Eros stock already trades at 9.0X FY2012E EV/EBIT,
potentially limiting the near-term upside; however, the Eros management highlighted in our
discussions that its FY2013E film slate (~20 films) was already ~80% committed and will soon be
made visible (likely end-1HFY12). We continue to remain positive on Eros given (1) its focused
approach to film business and (2) along with the favorable macro-environment for the industry.
The quality of earnings in FY2011 was better than expected with (1) ~81% content
amortization to capex ratio, ahead of our ~78% expectation and (2) Rs1.8 bn reported
direct cost of film rights versus our Rs1.5 bn expectation on account of trading in ancillary
rights (C&S TV, home video, airline telecast). In effect, only Rs0.6 bn out of the total Rs4.8
bn spend on content in FY2011 was left unamortized, which is reasonable given rising
catalog revenues (18% in 1QFY12) and FY2011 release slate (see Exhibit 2).
Eros’ FY2011 EBIT margin expanded ~450 bps to 22.1% from 17.6% in FY2010 despite
higher-than-expected content amortization to capex ratio. The positive variance resulted
from (1) modest advertising expenses (Rs199 mn, -41% yoy) led by aggressive brand tieups
and pre-sale of C&S TV rights, which helps spread the publicity costs and (2) lowerthan-
expected distribution costs (Rs331 mn, +24% yoy) led by Digital Cinema, which
must been seen in the context of the sharp increase in the number of released
prints/screens of movie (>2X in some cases).
Finally, we highlight the large Rs0.5 bn differential in profitability of Eros consolidated and
standalone financials. We note that the legacy Eros library is present in its subsidiary,
Copsale, which reported FY2011 profit of Rs0.2 bn. Eros VFx studio EyeQube and Tamil
subsidiary Aynagaran also reported profits (standalone Ayngaran reported losses given
90% first-year amortization versus 60% when consolidated with Eros). Ayngaran
distributed the widely successful film ‘Endhiraan’ in the overseas market.
Key takeaways from management meeting
The core Hindi film business
The most critical difference in the core Hindi film business in the past few years has been
made by the co-production/partnership model. It has helped the company reduce the
production cost of films (breakeven points). Notwithstanding the success of Eros’ films in
1HFY12, the average hit:flop ratio of the film industry implies that Eros makes better
returns in the profit sharing model. In return, Eros (1) ensures complete transparency in its
engagement with talent and distribution chain and (2) is happy to share super-sized
returns (in blockbuster movies) with the talent.
The second critical success factor for Eros in the past few years has been the pre-sale
model, which has further helped de-risk returns. Eros prefers to pre-sell the C&S TV,
music, overseas (to parent company) and even some distribution territories (where Eros
does not have its distribution offices), recovering 70-80% production cost in the process.
Eros is happy to share super-sized gains with its partners, while reducing the risk of
success or failure of single projects (films) on its books.
The slowdown in the C&S TV market is a successful example of the de-risking strategy of
Eros with limited impact of the same on FY2012E financials. Eros has already pre-sold
C&S TV rights of >70% of its FY2012E film slate and is largely insulated from the
economic slowdown that is translating into a C&S TV slowdown. Robust competitive
intensity in the C&S TV segment (launch of Colors Movies, for example) will likely ensure
continued demand for prime film content in FY2013E as well.
The rapid spread of Digital Cinema and multiplexes beyond the metros into the Tier II and
III towns of India will provide the next leg of improvement in per-film revenues and
profitability. Given a young population and ~400 mn strong consumption class in India,
there is potential of ~40K screens in India versus existing ~13K screen (of which only ~3K
screens command >US$1 ATP). Finally, 3D screens will provide upside to ATPs (~US$10)
given audience cannot have similar experience at home.
The focus of the company is scaling up its Hindi film content slate to ~20 films in
FY2013E, including a mix of high-budget, mid-budget and small-budget films; the mix
will be skewed towards high-budget films, since mass distribution (theatrical, overseas
and otherwise) is the USP of the company. The FY2013E film slate will again be a
combination of co-productions and acquisitions.
Future growth driver 1: regional films
The rapidly emerging regional film markets are the next growth opportunity for the
company. Of the 1,274 films certified by CBFC in India in CY2010, only 215 were in the
Hindi language. Even among the Hindi films, Eros maintains that only ~50 films were
quality high-to-mid-budget films; therefore, the company feels that working on >20 Hindi
films in any given year would be a difficult proposition and it would therefore prefer to
focus on the rapidly emerging regional film markets.
Breakdown of certified films in India by language (#)
2010
Hindi 2 15
Marathi 1 16
Telugu 1 81
Bengali 1 10
Tamil 2 02
Kannada 1 43
Malayalam 1 05
Bhojpuri 6 7
Gujarati 6 2
Oriya 2 6
Punjabi 1 5
Others 3 2
Total 1 ,274
Source: CBFC, Kotak Institutional Equities
Eros has experiment with regional films in the Punjabi, Marathi and Tamil languages in
the past with good success rate, though the investment has been very modest. Besides
scaling up its investments in these languages, Eros is also interested in entering other
markets such as Telugu (large regional film market). Eros is currently exploring coproduction
opportunities with noted South Indian talent such as Mahesh Babu,
Chiranjeevi, Surya et al post its association with Rajnikanth for Rana, Eros’ first highbudget
film in a regional language slated for release in FY2013E.
Future growth driver 2: digital platforms
The distribution strategy and philosophy of Eros has always been platform-agnostic. The
company has been acquiring all-platform rights to legacy movies (alongside worldwide
rights to co-production and acquisition of movies) for a very long time. The acquisition of
legacy film rights has accelerated with improving ancillary revenue streams such as C&S
TV, mobile and other digital distribution platforms.
The Digital Asset Management (DAM) software platform is at the heart of the digital
distribution strategy of the company. Essentially, the entire IP (film library) available with
the company will be digitized, converted into multi-format versions and meta-tagged by
the software, resulting in seamless delivery across digital platforms.
The company is exploring partnerships with multiple companies (Google, Airtel et al) and
various monetization models to maximize its content library, now available though the
versatile DAM platform. Eros will remain platform agnostic in providing customers access
to its content (internet, mobile, digital cable, DTH) but the focus would be on improving
the arguably weak monetization on these platforms. Eros has assembled a team of
professionals to drive the digital strategy with its partners.
We note that like FY2011, FY2012E would also be an investment year for the company
(scaling-up the Hindi film business to full potential with ~20 films) given the likely negative
free cash flows (though positive adjusted, for non-earnings assets, free cash flows). However,
we expect the company to be free cash flow positive in FY2013E-14E, driven by a stable film
slate in the core Hindi film business. The regional and digital strategy of the company is still
in its infancy (though the company has found initial success with both); the regional film
market will demand incremental capital in FY2013E, if successful; the digital investment is
capped at ~Rs100 mn in FY2012E-13E. We currently value Eros at significant ~25%
discount to regional print and ~30% discount to C&S TV given weaker cash flow dynamics
but (1) free cash flows on the back of core Hindi film business and (2) success in regional or
digital strategy may result in reduction in the discount.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Eros International (EROS)
Media
Management meeting takeaways and annual report analysis. Key takeaways of
our meeting with the management: (1) ~20 films target for FY2013E in core Hindi film
business and (2) top management focus shifting to new growth drivers (a) regional films
and (b) digital formats. Key takeaways from FY2011 annual report: (1) adjusted free
cash flows of Rs0.9 bn in FY2011 and (2) net cash balance of Rs1.0 bn at end-FY2011
denotes the strength of the balance sheet. Fine-tuned estimates based on the annual
report; reiterate BUY with FY2013E TP of Rs250 (unchanged).
FY2011 annual report analysis: balance sheet strength to scale up business
Exhibit 1 presents the financial summary of Eros; Eros reported FY2011 free cash outflows at
Rs0.5 bn. However, adjusted free cash flows at Rs0.9 bn are a better measure of current
operations. The Rs1.4 bn negative variance is largely explained by the (1) Rs0.7 bn increase in
production advances (non-earning asset, for FY2012E-13E film slate) and (2) Rs0.9 bn decline in
advances from parent, in line with the guidance of the company.
The net working capital (excl. cash) was reasonable at 130 days, despite the increase in
production advances (given by Eros to its content partners) and a decline in overseas advances
(taken by Eros from parent company in lieu of overseas rights on completion of film).
Key takeaways from meeting with management: focus on regional and digital
We met with Mr. Kishore Lulla, ED, and Mr. Sunil Lulla, MD, Eros International, to understand
current business operations and strategies: (1) The core Hindi film business is targeting ~20 films
for FY2013E, led by Mr. Sunil Lulla along with a team of professionals. The improvement in perfilm
revenue and profitability is driven by (a) a larger number of screens (multiplexes, Digital
Cinema), (b) pre-sale model for rights and (c) partnership model for content. (2) The focus of the
top management has shifted to two future growth drivers: (1) regional film markets and (2) digital
distribution of film content/library. Eros is looking at collaboration opportunities in the former and
has assembled a team of professionals to drive the latter.
Reiterate BUY with FY2013E TP of Rs240 (Rs250 previously); fine-tuned estimates
We have fine-tuned our FY2012E-13E EPS estimates based on our FY2011 annual report and
reiterate our BUY rating on Eros stock with revised FY2013E TP of Rs250 (unchanged), based on
8.5X FY2013E EV/EBIT. We highlight that Eros stock already trades at 9.0X FY2012E EV/EBIT,
potentially limiting the near-term upside; however, the Eros management highlighted in our
discussions that its FY2013E film slate (~20 films) was already ~80% committed and will soon be
made visible (likely end-1HFY12). We continue to remain positive on Eros given (1) its focused
approach to film business and (2) along with the favorable macro-environment for the industry.
The quality of earnings in FY2011 was better than expected with (1) ~81% content
amortization to capex ratio, ahead of our ~78% expectation and (2) Rs1.8 bn reported
direct cost of film rights versus our Rs1.5 bn expectation on account of trading in ancillary
rights (C&S TV, home video, airline telecast). In effect, only Rs0.6 bn out of the total Rs4.8
bn spend on content in FY2011 was left unamortized, which is reasonable given rising
catalog revenues (18% in 1QFY12) and FY2011 release slate (see Exhibit 2).
Eros’ FY2011 EBIT margin expanded ~450 bps to 22.1% from 17.6% in FY2010 despite
higher-than-expected content amortization to capex ratio. The positive variance resulted
from (1) modest advertising expenses (Rs199 mn, -41% yoy) led by aggressive brand tieups
and pre-sale of C&S TV rights, which helps spread the publicity costs and (2) lowerthan-
expected distribution costs (Rs331 mn, +24% yoy) led by Digital Cinema, which
must been seen in the context of the sharp increase in the number of released
prints/screens of movie (>2X in some cases).
Finally, we highlight the large Rs0.5 bn differential in profitability of Eros consolidated and
standalone financials. We note that the legacy Eros library is present in its subsidiary,
Copsale, which reported FY2011 profit of Rs0.2 bn. Eros VFx studio EyeQube and Tamil
subsidiary Aynagaran also reported profits (standalone Ayngaran reported losses given
90% first-year amortization versus 60% when consolidated with Eros). Ayngaran
distributed the widely successful film ‘Endhiraan’ in the overseas market.
Key takeaways from management meeting
The core Hindi film business
The most critical difference in the core Hindi film business in the past few years has been
made by the co-production/partnership model. It has helped the company reduce the
production cost of films (breakeven points). Notwithstanding the success of Eros’ films in
1HFY12, the average hit:flop ratio of the film industry implies that Eros makes better
returns in the profit sharing model. In return, Eros (1) ensures complete transparency in its
engagement with talent and distribution chain and (2) is happy to share super-sized
returns (in blockbuster movies) with the talent.
The second critical success factor for Eros in the past few years has been the pre-sale
model, which has further helped de-risk returns. Eros prefers to pre-sell the C&S TV,
music, overseas (to parent company) and even some distribution territories (where Eros
does not have its distribution offices), recovering 70-80% production cost in the process.
Eros is happy to share super-sized gains with its partners, while reducing the risk of
success or failure of single projects (films) on its books.
The slowdown in the C&S TV market is a successful example of the de-risking strategy of
Eros with limited impact of the same on FY2012E financials. Eros has already pre-sold
C&S TV rights of >70% of its FY2012E film slate and is largely insulated from the
economic slowdown that is translating into a C&S TV slowdown. Robust competitive
intensity in the C&S TV segment (launch of Colors Movies, for example) will likely ensure
continued demand for prime film content in FY2013E as well.
The rapid spread of Digital Cinema and multiplexes beyond the metros into the Tier II and
III towns of India will provide the next leg of improvement in per-film revenues and
profitability. Given a young population and ~400 mn strong consumption class in India,
there is potential of ~40K screens in India versus existing ~13K screen (of which only ~3K
screens command >US$1 ATP). Finally, 3D screens will provide upside to ATPs (~US$10)
given audience cannot have similar experience at home.
The focus of the company is scaling up its Hindi film content slate to ~20 films in
FY2013E, including a mix of high-budget, mid-budget and small-budget films; the mix
will be skewed towards high-budget films, since mass distribution (theatrical, overseas
and otherwise) is the USP of the company. The FY2013E film slate will again be a
combination of co-productions and acquisitions.
Future growth driver 1: regional films
The rapidly emerging regional film markets are the next growth opportunity for the
company. Of the 1,274 films certified by CBFC in India in CY2010, only 215 were in the
Hindi language. Even among the Hindi films, Eros maintains that only ~50 films were
quality high-to-mid-budget films; therefore, the company feels that working on >20 Hindi
films in any given year would be a difficult proposition and it would therefore prefer to
focus on the rapidly emerging regional film markets.
Breakdown of certified films in India by language (#)
2010
Hindi 2 15
Marathi 1 16
Telugu 1 81
Bengali 1 10
Tamil 2 02
Kannada 1 43
Malayalam 1 05
Bhojpuri 6 7
Gujarati 6 2
Oriya 2 6
Punjabi 1 5
Others 3 2
Total 1 ,274
Source: CBFC, Kotak Institutional Equities
Eros has experiment with regional films in the Punjabi, Marathi and Tamil languages in
the past with good success rate, though the investment has been very modest. Besides
scaling up its investments in these languages, Eros is also interested in entering other
markets such as Telugu (large regional film market). Eros is currently exploring coproduction
opportunities with noted South Indian talent such as Mahesh Babu,
Chiranjeevi, Surya et al post its association with Rajnikanth for Rana, Eros’ first highbudget
film in a regional language slated for release in FY2013E.
Future growth driver 2: digital platforms
The distribution strategy and philosophy of Eros has always been platform-agnostic. The
company has been acquiring all-platform rights to legacy movies (alongside worldwide
rights to co-production and acquisition of movies) for a very long time. The acquisition of
legacy film rights has accelerated with improving ancillary revenue streams such as C&S
TV, mobile and other digital distribution platforms.
The Digital Asset Management (DAM) software platform is at the heart of the digital
distribution strategy of the company. Essentially, the entire IP (film library) available with
the company will be digitized, converted into multi-format versions and meta-tagged by
the software, resulting in seamless delivery across digital platforms.
The company is exploring partnerships with multiple companies (Google, Airtel et al) and
various monetization models to maximize its content library, now available though the
versatile DAM platform. Eros will remain platform agnostic in providing customers access
to its content (internet, mobile, digital cable, DTH) but the focus would be on improving
the arguably weak monetization on these platforms. Eros has assembled a team of
professionals to drive the digital strategy with its partners.
We note that like FY2011, FY2012E would also be an investment year for the company
(scaling-up the Hindi film business to full potential with ~20 films) given the likely negative
free cash flows (though positive adjusted, for non-earnings assets, free cash flows). However,
we expect the company to be free cash flow positive in FY2013E-14E, driven by a stable film
slate in the core Hindi film business. The regional and digital strategy of the company is still
in its infancy (though the company has found initial success with both); the regional film
market will demand incremental capital in FY2013E, if successful; the digital investment is
capped at ~Rs100 mn in FY2012E-13E. We currently value Eros at significant ~25%
discount to regional print and ~30% discount to C&S TV given weaker cash flow dynamics
but (1) free cash flows on the back of core Hindi film business and (2) success in regional or
digital strategy may result in reduction in the discount.
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