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Zee: In the investment phase… - Views on News from Equitymaster
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Zee: In the investment phase…
Jan 31, 2006

Performance summary
Zee Telefilms (Zee), India’s leading broadcaster, announced dismal 3QFY06 results just a short while ago. While the company’s topline has registered a good double-digit YoY growth, intense pressure on operating margins led to a significant decline in profits. The pressure on margins was a factor of the company continuing to account initial investments pertaining to its new ventures as ‘operating expenses’.

Consolidated snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net Sales 3,225 3,777 17.1% 9,056 10,267 13.4%
Expenditure 2,134 3,412 59.8% 5,956 8,325 39.8%
Operating Profit (EBDITA) 1,091 365 -66.5% 3,100 1,942 -37.4%
EBITDA margin (%) 33.8% 9.7%   34.2% 18.9%  
Other income 173 254 46.7% 418 516 23.4%
Interest 79 120 51.5% 230 221 -3.7%
Depreciation 82 104 27.5% 238 290 21.6%
Profit before tax 1,103 395 -64.2% 3,050 1,947 -36.2%
Extraordinary items - 19   - 19  
Tax 237 103 -56.5% 803 452 -43.7%
Profit after Tax/(Loss) 866 310 -64.1% 2,248 1,514 -32.6%
Net profit margin (%) 26.8% 8.2%   24.8% 14.7%  
No. of Shares (m) 412.5 412.5   412.5 412.5  
Diluted earnings per share*         5.9  
Price to earnings ratio (x)         28.1  
(* trailing 12-months)            

Company profile
Zee is India’s first private TV channel covering nearly 30% of Indian television homes. It reaches an estimated 250 m people worldwide (including Indian viewership). Though the channel did not face competition in the initial years of its launch, it had faced tough times in the last few years owing to the competition from other channels like Star and Sony. However, increased efforts over the last few quarters have seemingly yielded positive results for the company, as it now claims to have grabbed the No. 2 spot in the general entertainment category. Further, 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. Also, venturing into production of films, selling its distribution rights and the DTH (Direct-To-Home) services should augur well for the company in the long-term.

What has driven performance in 3QFY06?
Topline going strong: Zee’s primary sources of revenue are advertisements and subscriptions, which contributed to about 91% of the company’s topline in 3QFY06. However, this figure was much higher (97%) in the corresponding quarter of the previous fiscal. The balance amount is contributed by other sales and services, which include revenues from film production and distribution, education sales and sale of set-top- boxes. Contribution from this segment has been on the rise since the last few quarters. In 3QFY06, revenues of this segment grew by 266% YoY during the quarter to Rs 328 m, albeit on a small base (Rs 90 m) and was the key contributor to the revenue growth. To put this in perspective, this segment contributed nearly 43% of incremental sales during the quarter.

However, advertisements (45% of revenues) and subscriptions (46% of revenues) continue to remain the mainstay of the company’s topline. On the advertising front, Zee had been witnessing good times since the last three quarters, which has continued into 3QFY06 as well, as this revenue stream notched a 12% YoY growth. This growth in the company’s ad revenues could be attributed to the increased focus on Zee TV, the company’s flagship channel, which, as per the company release, has clawed to the No. 2 spot in the general entertainment category. This is seemingly a factor of improved quality content and better promotional and marketing efforts. It must further be noted that the company continues to lead the Hindi movies, music and the regional channels genre, which have seemingly contributed their bit to the overall improvement in advertisement revenues.

Subscription revenues registered an 8% YoY growth in 3QFY06. Zee’s subscription revenues comprise of both international and domestic markets. For the quarter, while international subscriptions (around 47% of total subscription revenues) registered a 11% YoY growth, domestic subscriptions (including DTH and Siticable) grew at a relatively slower pace of 5% YoY. Further, as at the end of 9mFY06, while international subscription revenues clocked a growth of over 9% YoY, the same for domestic subscriptions was a tad lower at about 8%.

Margins nose-dive: Zee’s operating margins nose-dived in the quarter under consideration as the company continued to account for the investments in new activities like Zee Telugu, Zee Smile and Zee Sports, the collective amount of which was at Rs 597 m, as ‘operating expenses’. This led to the operating margins to decline from 33.8% in 3QFY05 to 9.7% in 3QFY06. This increased cost is reflected in the programming and operating costs (65% of operating expenses), which leapfrogged from 43% of net sales to 59% of net sales in 3QFY06. Apart from this, significant rise in staff costs as well as selling and other expenses contributed to the damage.

Costs breakup
(as % of net sales) 3QFY05 3QFY06 9mFY05 9mFY06
Transmission & Prog. Costs 43.3% 58.9% 41.4% 51.2%
Staff Costs 6.3% 7.2% 6.8% 7.8%
Other expenses 16.6% 24.2% 17.6% 22.1%
Total 66.2% 90.3% 65.8% 81.1%

It all flows to the bottomline: Considering the adverse effect of the above, the 64% decline in net profits was a given. The 45% rise in other income during 3QFY06 could not prove to be of any help for the bottomline, as the rise in interest (52% YoY) and depreciation expenses (28% YoY) nullified this effect. However, just to put things in perspective, if one were to remove the Rs 597 m effect in additional costs, then net profit growth would have been at 5% YoY, still lower than the topline growth owing to non-programming related expenses.

What to expect?
At Rs 165, the stock is trading at a price to earnings multiple of 17.3 times our FY08 estimates. However, it must be noted that this unexpected underperformance by the company during the quarter warrants a downgrade of our full year estimates.

However, though the valuations of the stock may not look attractive at the current juncture, we remain positive on the company per se owing to its recent image/brand makeover along with efforts to improve the quality of content, which have started yielding positive results. Also, the change in strategy of its DTH venture, wherein the company is now aiming at spreading its reach, as is evident from the 0.8 m subscribers that the company has already signed up, will augur well for the company. As rightly put by the company and a view we subscribe to, the potential subscription revenue from these subscribers would be significant going forward.

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