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Zee: A mixed show

Jul 24, 2006

Performance summary:
Zee Telefilms (Zee), India’s leading broadcaster, announced its 1QFY07 results today. While the topline grew at a decent pace for the first quarter, operating margins and consequently, net profits have declined. This is largely due to the launch of new channels (regional and sports), towards which Zee incurred initial launch expenses to the tune of Rs 571 m (14% of consolidated sales). Excluding the same (the benefits of which are yet to reflect at the topline level completely), operating profits have risen by 31% YoY on a consolidated basis. We participated in the conference call the company had organised today, the excerpts of which are also a part of this analysis.

Consolidated snapshot…
(Rs m) 1QFY06 1QFY07 Change
Net Sales 3,131 3,884 24.0%
Expenditure 2,140 3,157 47.5%
Operating Profit (EBDITA) 991 727 -26.7%
EBITDA margin (%) 31.7% 18.7%  
Other income 120 162 35.6%
Interest 25 125 404.0%
Depreciation 97 92 -5.3%
Profit before tax 989 672 -32.0%
Tax 210 109 -48.0%
Profit after Tax/(Loss) 779 563 -27.7%
Miniority interest 19 13 -31.2%
Net Income 760 550 -27.6%
Net profit margin (%) 24.9% 14.5%  
No. of Shares (m) 412.5 414.5  
Diluted earnings per share*   4.7  
Price to earnings ratio (x)   52.4  
(*trailing twelve months)

Company profile
Zee is India’s first private TV channel covering nearly 30% of Indian television homes. It reaches an estimated over 225 m people worldwide (including Indian viewership). Though the channel did not face competition in the initial years of its launch (early 1990s), 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. 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 1QFY07?
Strong topline growth: Zee derives its revenues primarily from advertisements and subscriptions, which together accounted for 91% of total revenues in 1QFY07. The balance is contributed by other sales and services, which include revenues from film production and distribution, education sales and sale of set top boxes. The ‘others’ segment grew by 431% YoY during the quarter, albeit on a small base and was the key contributor to the revenue growth.

As far as the company’s advertisement revenues are concerned, these witnessed an encouraging 31% growth during 1QFY07. This growth is largely a factor of increased advertisement rates on its channels, which is seemingly a factor of improved quality content and better promotional and marketing efforts. It must be noted that the company continues to lead the Hindi movies, music and the regional channels genre, which have contributed their bit to the overall improvement in advertisement revenues.

Subscription revenues registered a 2.8% growth in 1QFY07. Zee’s subscription revenues comprise of both international and domestic markets. Beside this, Zee TV continues to climb the ratings chart. 2 programmes in top 10 and 21 in top 100.

Costs breakup
(as % of net sales) 1QFY06 1QFY07
Transmission & Prog. Costs 43.9% 56.8%
Staff Costs 8.5% 8.6%
Other expenses 16.1% 15.9%
Total 68.4% 81.3%
Margins under pressure: Zee’s operating margins came under pressure during the quarter and were lower by 18.7%. This was primarily owing to a sharp rise in its largest cost head, cost of goods and operations, which is responsible for over 2/3rd of the company’s total operating expenditure (from under 44% of net sales to over 57% in 1QFY07). This was primarily due to investments made in new channels like Zee Sports, Zee Smile, Zee Telugu, Zee Jagran and the marketing spend on Dish TV, the company’s DTH venture. These costs (Rs 571 m) have been fully expensed by the company in the June quarter, while the benefits of these would continue to accrue over the following quarters.

Cushioned bottomline: Net profit, on a consolidated basis, fell by 27% YoY in 1QFY07. However, if one were to exclude the initial launch expenses from the analysis i.e. Rs 571 m, net profit has risen by over 40% YoY. As per the conference call, the management expects to recover the initial launch expenses over the rest of the fiscal. The bottomline growth was also impacted by higher interest charges to the increased guarantee commission payable to banks and product fluctuations.

What to expect?
At the current price of Rs248, the stock is trading at a price to earnings multiple of 52 times trailing twelve month earnings. With the Delhi High Court asking the government to issue a revised notification with respect to the implementation of CAS (conditional access system) in key cities by December 2006, there is a lot to look forward for Zee from a long-term standpoint. Though the stock appears to be expensive on a P/E basis, we suggest investors to look at the potential upside from its cable and DTH operations over the long-term.

Towards bringing in more focus to its operations, the current Zee TV will be split into four listed entities (approval awaited). The four companies are:

  1. The global content business (non-news channels in India and all international businesses, including investments in Zee Turner, ETC and Aplab Limited).

  2. The Wire & Wireless (India) Limited, which is broadly Siticable, which is the MSO (multi service operator).

  3. Zee News Limited- All the regional and national news channels.

  4. ASC Enterprises Limited – DTH broadcasting services.

The demerger is not just to provide focus but also due to the current broadcasting regulation, which has placed significant restrictions on foreign ownership in India media houses (news operations, cable distribution and content). We believe that this is a step in the right direction and will unlock significant value to the shareholders in general. We maintain our HOLD rating on the stock from a long-term standpoint.

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