SELL Zee Entertainment: TP: INR 165.00 :: Religare research

Too much optimism all around; downgrade to SELL
We downgrade Zee Entertainment (Zee) from Hold to SELL. Even though Zee will benefit from compulsory digitisation and hence higher subscription revenue, we are negative on the stock given (a) the muted outlook on advertising revenue due to poor macro conditions and limited pricing power, (b) rising content costs which more than offset gains from better ad ratings, (c) growing regional competition and (d) continued underperformance in the sports business. We expect EBITDA margin compression in coming quarters

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 GRPs volatile – difficult to quantify or time the impact on earnings: Our study of ratings market share swings over the last 13 quarters for Zee’s flagship Hindi channel reveals that: (a) growth in advertising revenue is more a function of macro fundamentals rather than ratings, (b) advertisers decide ad rates based on the overall performance of a broadcaster across genres, and (c) the success of reality shows/sports tournaments can skew short-term ad growth numbers. Hence, over-optimism on Zee’s earnings led by the recent improvement in ratings is unwarranted.
 Increasing content costs to strain EBITDA margins: Zee’s “original” programming hours have begun to increase (up 3hrs this quarter to ~27.5hrs), in line with management’s guidance of reaching 33-34 hours by the year end. This will result in an increase in content costs and hence put pressure on margins.
 Sports business still in investment phase; regional businesses facing competition: In the sports segment, we think Zee is likely to notch up losses higher than the management’s full-year guidance of Rs 650mn‒700mn due to continued investments in the business. Further, Zee is facing higher competition in key regional markets (Bengali and Marathi) and this could worsen once the TV18-ETV deal is closed.
 Downgrade to SELL with TP of Rs 165/sh: Factoring in fundamental risks to earnings in FY13/FY14, we downgrade the stock to SELL. Valuations (25x FY13E and 21x FY14E EPS) too appear rich in the light of weak growth outlook.