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Eros International (EROS)
Media
Understanding Eros India-Plc Relationship Agreement. We attempt to ease
concerns about the relationship agreement between Eros India-Plc through the example
of two recent successful movies overseas, ZNMD and RA.One. These will be cash
profitable for Eros Plc despite the argued stiff cost benchmark (30% of total cost of
production plus 30% gross margin for Eros India). Eros Plc’s overall profitability will be
dragged down by smaller movies (average performers) but supported by a large library
and a strong ancillary rights market (C&S TV, Home Video, VoD and Digital). We
upgrade Eros India to BUY (REDUCE previously) with FY2013E FV of Rs270.
Eros India-Plc Relationship Agreement: Understanding the concerns better
The Relationship Agreement between Eros India and Eros Plc (parent company), which defines and
formalizes the terms of engagement between them, has been a subject of concern. Eros India is
the exclusive agent for production and acquisition of movie content for Eros Plc. The key clause
states that Eros Plc, absolutely and unconditionally, will acquire all overseas rights associated with
a movie at 30% of the cost of production/acquisition at a 30% commission. We note the
quantum of commission (30%) is moot given transfer pricing rules mandated by Indian tax
authorities. The concerns largely pertain to attribution of 30% of cost of production/acquisition to
overseas rights, which arguably sets a steep benchmark for Eros Plc profitability.
A stiff benchmark but not insurmountable: ZNMD, RA.One beat it handily
The 30% cost attributable to overseas rights is indeed high now but not insurmountable. Exhibits
1-2 present overseas gross theatrical revenues from Zindagi Na Milegi Dobara (ZNMD) and
RA.One; the Middle-East (UAE et al) is a key territory in the first cycle and RA.One’s release in
South Korea and China in the second cycle is likely to drive revenues. Exhibit 3 presents potential
overseas markets for an Indian movie with the example of My Name Is Khan. The Eros Group has
wide reach in overseas markets, given its legacy, resulting in better monetization. Besides, gross
theatrical revenues do not present the complete picture given the existence of E-tax in India;
Exhibit 4 shows Eros’ share of overseas theatrical revenues beat the 30% benchmark.
More important, overseas markets have a well-developed ancillary revenue market (C&S TV, Home
Video, Video on Demand and Digital New Media). Exhibit 5 presents the robust profitability of
ZNMD and RA.One including the potential revenue from ancillary streams; P&A costs (print and
advertising) are additional but likely small, given digital focus, co-promotion and word-of-mouth.
The only issue is the long-tail of overseas revenues (12-18 months) versus domestic (3-6 months),
resulting in a weaker cash profile of Eros Plc. Nonetheless, FY2012E should be good for Eros Plc
with two movies in its top-10 overseas grosser list, three more in the top-30 (Desi Boyz, Rockstar
and Ready) and two more A-movies still in the pipeline (Agneepath and Agent Vinod).
Digital initiatives and movie mix to decide the future course of action
However, successful overseas Indian movies are also interspersed with successful domestic
movies that do not meet the benchmark. Murder2 is an example of a movie in FY2012 that
did well in the domestic market but likely missed the benchmark in overseas markets. This is
also one of the likely reasons for Eros Group to shift the movie mix to more A-movies (focus
area in FY2012E-13E) with a star cast that is well-known in overseas markets. Additionally,
the general trend of declining DVD/Home Video revenues in Hollywood is likely hurting Eros
also. Video on Demand and Digital New Media services are replacing DVD/Home Video
demand, but at slower-than-expected pace. Eros will launch its own subscription/pay
internet video service, in the coming months, to capitalize on the VoD trend.
The underlying growth in India, led by (1) a rising number of multiplex screens,
(2) digitization of single screens and (3) rising C&S TV revenues, will outpace overseas
markets in the long term. The key territories of North America (US/Canada), the UK, Middle-
East (UAE et al), South-East Asia (HK, SG and Malaysia) and the Pacific (Australia, NZ) are
mature, with growth led by an emerging market in East Asia (South Korea, Japan and China)
and Europe (Germany, Russia), Africa (South Africa, Egypt) as well as South Asia (Sri Lanka).
The future course of action on 30% cost attributable to overseas rights would be driven by
(1) a shift of the movie mix to more A-movies and (2) success of Eros’ internet VoD platform.
Eros India-Plc RA became effective in October 2009, valid for an initial period of five years
(reviewed annually); we model shift to 25% cost benchmark attributable to overseas rights
in October 2014 from 30% currently.
Film-making subsidy helps to keep costs in check and profitability alive
The profitability of Eros India and Eros Plc is also helped by film-making subsidies provided
by various overseas governments such as those of the UK and Spain, which helps to keep a
lid on the cost of production. In FY2012E, several Eros movies such as ZNMD, Mausam,
RA.One and Desi Boyz benefitted. The cost of shooting in these locations is only moderately
higher, resulting in net benefit when including the subsidy. The UK provides 25% cash
rebate on UK film production expenditure (defined as expenditure of filming activities within
the UK, irrespective of the nationality of the persons carrying it out) and Spain provides 18%
deductions on the cost of the film. Eros Plc’s wide reach and understanding in these markets
is of course critical in deriving the best value of the offer. This helps to keep the net cost of
production of movies in check and profitability high.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Eros International (EROS)
Media
Understanding Eros India-Plc Relationship Agreement. We attempt to ease
concerns about the relationship agreement between Eros India-Plc through the example
of two recent successful movies overseas, ZNMD and RA.One. These will be cash
profitable for Eros Plc despite the argued stiff cost benchmark (30% of total cost of
production plus 30% gross margin for Eros India). Eros Plc’s overall profitability will be
dragged down by smaller movies (average performers) but supported by a large library
and a strong ancillary rights market (C&S TV, Home Video, VoD and Digital). We
upgrade Eros India to BUY (REDUCE previously) with FY2013E FV of Rs270.
Eros India-Plc Relationship Agreement: Understanding the concerns better
The Relationship Agreement between Eros India and Eros Plc (parent company), which defines and
formalizes the terms of engagement between them, has been a subject of concern. Eros India is
the exclusive agent for production and acquisition of movie content for Eros Plc. The key clause
states that Eros Plc, absolutely and unconditionally, will acquire all overseas rights associated with
a movie at 30% of the cost of production/acquisition at a 30% commission. We note the
quantum of commission (30%) is moot given transfer pricing rules mandated by Indian tax
authorities. The concerns largely pertain to attribution of 30% of cost of production/acquisition to
overseas rights, which arguably sets a steep benchmark for Eros Plc profitability.
A stiff benchmark but not insurmountable: ZNMD, RA.One beat it handily
The 30% cost attributable to overseas rights is indeed high now but not insurmountable. Exhibits
1-2 present overseas gross theatrical revenues from Zindagi Na Milegi Dobara (ZNMD) and
RA.One; the Middle-East (UAE et al) is a key territory in the first cycle and RA.One’s release in
South Korea and China in the second cycle is likely to drive revenues. Exhibit 3 presents potential
overseas markets for an Indian movie with the example of My Name Is Khan. The Eros Group has
wide reach in overseas markets, given its legacy, resulting in better monetization. Besides, gross
theatrical revenues do not present the complete picture given the existence of E-tax in India;
Exhibit 4 shows Eros’ share of overseas theatrical revenues beat the 30% benchmark.
More important, overseas markets have a well-developed ancillary revenue market (C&S TV, Home
Video, Video on Demand and Digital New Media). Exhibit 5 presents the robust profitability of
ZNMD and RA.One including the potential revenue from ancillary streams; P&A costs (print and
advertising) are additional but likely small, given digital focus, co-promotion and word-of-mouth.
The only issue is the long-tail of overseas revenues (12-18 months) versus domestic (3-6 months),
resulting in a weaker cash profile of Eros Plc. Nonetheless, FY2012E should be good for Eros Plc
with two movies in its top-10 overseas grosser list, three more in the top-30 (Desi Boyz, Rockstar
and Ready) and two more A-movies still in the pipeline (Agneepath and Agent Vinod).
Digital initiatives and movie mix to decide the future course of action
However, successful overseas Indian movies are also interspersed with successful domestic
movies that do not meet the benchmark. Murder2 is an example of a movie in FY2012 that
did well in the domestic market but likely missed the benchmark in overseas markets. This is
also one of the likely reasons for Eros Group to shift the movie mix to more A-movies (focus
area in FY2012E-13E) with a star cast that is well-known in overseas markets. Additionally,
the general trend of declining DVD/Home Video revenues in Hollywood is likely hurting Eros
also. Video on Demand and Digital New Media services are replacing DVD/Home Video
demand, but at slower-than-expected pace. Eros will launch its own subscription/pay
internet video service, in the coming months, to capitalize on the VoD trend.
The underlying growth in India, led by (1) a rising number of multiplex screens,
(2) digitization of single screens and (3) rising C&S TV revenues, will outpace overseas
markets in the long term. The key territories of North America (US/Canada), the UK, Middle-
East (UAE et al), South-East Asia (HK, SG and Malaysia) and the Pacific (Australia, NZ) are
mature, with growth led by an emerging market in East Asia (South Korea, Japan and China)
and Europe (Germany, Russia), Africa (South Africa, Egypt) as well as South Asia (Sri Lanka).
The future course of action on 30% cost attributable to overseas rights would be driven by
(1) a shift of the movie mix to more A-movies and (2) success of Eros’ internet VoD platform.
Eros India-Plc RA became effective in October 2009, valid for an initial period of five years
(reviewed annually); we model shift to 25% cost benchmark attributable to overseas rights
in October 2014 from 30% currently.
Film-making subsidy helps to keep costs in check and profitability alive
The profitability of Eros India and Eros Plc is also helped by film-making subsidies provided
by various overseas governments such as those of the UK and Spain, which helps to keep a
lid on the cost of production. In FY2012E, several Eros movies such as ZNMD, Mausam,
RA.One and Desi Boyz benefitted. The cost of shooting in these locations is only moderately
higher, resulting in net benefit when including the subsidy. The UK provides 25% cash
rebate on UK film production expenditure (defined as expenditure of filming activities within
the UK, irrespective of the nationality of the persons carrying it out) and Spain provides 18%
deductions on the cost of the film. Eros Plc’s wide reach and understanding in these markets
is of course critical in deriving the best value of the offer. This helps to keep the net cost of
production of movies in check and profitability high.
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