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Zee Entertainment: De-merger benefits

Jan 24, 2007

Performance Summary
Zee Entertainment Enterprises Ltd (Zee) announced its results for the third quarter and nine months ended December 2006. For 3QFY07, on a like to like basis, while topline has grown by 53% YoY, the bottomline growth has been a superlative 179% YoY. The comparison is after taking into account the de-merger of Zee News Limited, Wire and Wireless Ltd and the direct to home (DTH) business from Zee. Sharp declines in programming and sales expenses (as percentage of sales) have helped the company record a substantial improvement in its operating margins during the quarter.

Consolidated ZEEL financial performance*
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Total revenue 2,728 4,177 53.1% 7,566 10,568 39.7%
Total expenditure 2,255 2,820 25.0% 5,540 8,331 50.4%
Operating profit 473 1,357 187.0% 2,026 2,236 10.4%
EBITDA margin (%) 17.3% 32.5%   26.8% 21.2%  
Profit before tax 427 1,375 221.8% 2,068 2,307 11.6%
Profit after tax 344 958 178.7% 1,615 1,707 5.7%
Net profit margin (%)** 12.6% 22.9%   12.7% 9.1%  
No. of shares (m)       433.4 433.4  
Diluted earnings per share (Rs)#         5.2  
P/E ration (x)#         61.7  
* Previous year figures are adjusted for the de-merger impact
** Excluding minority interest ; # On a trailing 12 months basis

What is the company's business?
Zee is India's first privately owned TV channel covering nearly 30% of the country's television homes. It reaches an estimated over 300 m people worldwide. Though the channel did not face competition in the initial years of its launch, it has been facing tough times in recent years owing to the competition from other channels like Star and Sony. With an effort at de-risking its existing business model, Zee has been spreading its wings internationally through its wholly owned subsidiaries, which would help it in increasing its subscription-based revenues.

The company recently underwent a restructuring exercise wherein Zee Telefilms (now ZEE Entertainment) was demerged into three entities effective December 18, 2006. As per the ‘Scheme of Arrangement', the company demerged its cable distribution business into Wire & Wireless India Ltd. (WWIL) and the regional and news broadcasting business into Zee News Ltd. (ZNL). The demerger of DTH business will be effective January 18, 2007 and is likely to be listed in February 2007.

What has driven performance in 3QFY07?
Revenue momentum continues: Adjusting for the demerger, Zee reported a strong 53% YoY growth in sales for 3QFY07. Though the adjusted revenue break-up is not given, the same seems to be on the back of a strong growth in both the subscription and advertising segments. The growth in advertising revenues was a result of higher average rates on most of the network channels, especially the flagship channel - Zee TV. The growth for Zee TV was led by the continued success of Sa Re Ga Ma Pa, Kasamh Se, while some of the new launches helped the channel to bolster its share in prime time. Zee TV now has 5 programmes in top 20 and 11 programmes in top 50 (as per TAM viewership data). The advertising as well as subscription revenues were also bolstered by the acquisition of the sports channel – Ten Sports and improved performance of Zee Sports. Overall, the contribution of the sports business during 3QFY07 stood at Rs 610 m.

Operating margins - Leverage effect: The adjusted operating profits surged by 187% YoY during 3QFY07. During the same period, operating margins expanded from 17.3% to 32.5%. The strong performance at the operating level was largely due to the operating leverage effect. This is due to the fact that the operating cost of the channels is more or less fixed, irrespective of the performance in the topline (which is dependent upon the revenues and subscription). As the channel increases its viewership (which results in increased advertising and subscription income), the company is able to generate more revenues for the same level of operating expenses.

Bottomline – Mirror operating profits: Reflecting the spectacular performance witnessed at the operating level, Zee's bottomline (excluding minority interest) increased by 178% YoY during 3QFY07. The net margins during the same period stood at 22.9%, compared to 12.6% in 3QFY06.

What to expect?
At the current price of Rs 318, the stock trades at a multiple of 61.7 times its trailing 12 months earnings. Going forward, we believe that Zee is well placed to benefit from the digitisation of the Indian cable and satellite industry. The shift from conventional distribution platforms to newer platforms such as CAS and DTH will result in increased subscription billings for the company, as it will now not be at the mercy of local cable operators that have been underreporting subscriber base for years. While the shift will still take some time to happen, we believe that the direction is right and companies like Zee are expected to benefit from the same in the long term.

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