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Zee Telefilms: Investing for future
Oct 20, 2005

Performance summary
Zee Telefilms (Zee), India’s leading broadcaster, announced its 2QFY06 results just a short while ago. The results came as a surprise with the bottomline registering a steep fall despite the YoY growth in topline. Pressure at the operating level led to a sharp fall in margins, which percolated down to the bottomline. The current quarter’s performance overshadowed the decent performance of the previous quarter (1QFY06), thus adversely impacting the company’s 1HFY06 numbers.

Consolidated snapshot…
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net Sales 3,092 3,359 8.6% 5,830 6,490 11.3%
Expenditure 2,063 2,774 34.5% 3,822 4,914 28.6%
Operating Profit (EBDITA) 1,029 585 -43.2% 2,008 1,576 -21.5%
EBITDA margin (%) 33.3% 17.4%   34.4% 24.3%  
Other income 91 143 57.4% 247 263 6.5%
Interest 77 76 -0.9% 150 101 -32.8%
Depreciation 79 89 12.1% 157 186 18.6%
Profit before tax 964 563 -41.6% 1,948 1,552 -20.3%
Tax 273 138 -49.5% 565 349 -38.4%
Profit after Tax/(Loss) 691 425 -38.5% 1,383 1,204 -12.9%
Net profit margin (%) 22.4% 12.7%   23.7% 18.5%  
No. of Shares (m) 412.5 412.5   412.5 412.5  
Diluted earnings per share* 6.7 4.1   6.7 5.8  
Price to earnings ratio (x)   37.8     26.7  
(* annualised)            

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, 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 2QFY06?
Topline holds: Advertisement and subscription form the key components of Zee’s topline with these contributing 44% and 52% respectively, thus making up almost the entire (96%) of Zee’s consolidated revenues. 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. This segment grew by 37% YoY during the quarter, albeit on a small base. Advertisement revenues registered a YoY growth of 12% during the quarter, which was the result of better ad rate realisations on most of the company’s channels. Further, subscriptions also logged in a 4% YoY growth, which though not very encouraging, is nonetheless respectable. The growth in this segment came in from domestic subscriptions (57% of subscription revenues in 2QFY06), which grew by 14% YoY. However, the international subscriptions were lower by 7% YoY.

Margins nose-dive: Zee’s operating margins came under tremendous pressure during the quarter and nearly halved to 17% from over 33% in the corresponding quarter of the previous fiscal. While costs increased across costs heads, a sharp escalation in programming and operating costs, which were up 39% YoY in absolute terms (almost 11% percentage points as % of net sales), delivered the biggest damage. It must be noted that this cost head accounts for over 60% of the company’s operating costs and contributed to over 65% of the incremental operating expenses during the quarter. The company has continued to attribute this largely to the investments made (Rs 327 m) in new channels and on marketing spend on Dish TV. This, thus, also explains the rise in selling and other expenses. Staff costs also increased by 140 basis points as percentage of net sales (see table below).

Costs breakup
(as % of net sales) 2QFY05 2QFY06 1HFY05 1HFY06
Transmission & Prog. Costs 38.5% 49.4% 40.4% 46.7%
Staff Costs 6.4% 7.8% 7.1% 8.1%
Other expenses 21.8% 25.4% 18.1% 20.9%
Total 66.7% 82.6% 65.6% 75.7%

Bottomline succumbs: The above developments finally was reflected in the 39% YoY drop in profits. However, just to put things in perspective, if one were to remove the Rs 327 m effect in additional costs and keep the tax incidence at the 28% levels as in 2QFY05, then the net profit fall would have been a much lower 7% YoY.

What to expect?
At Rs 156, the stock is trading at a price to earnings multiple of 14.7 times our estimated FY08 earnings. We had recommended a ‘Buy’ on the stock in April 2005 at Rs 132 with a price target of Rs 190, which was achieved in June 2005. Considering the company’s below than expected performance in 1HFY06, we would be re-visiting our numbers and we believe that the company will not be able to meet our targets, thus calling for a downgrade. Nonetheless, we remain positive on the future prospects of the company considering the various initiatives that it has been taking over the past few quarters.

The recent image/brand makeover by the company along with efforts to improve content quality seems to have started yielding positive results for the company in terms of growth in ad revenues. Also, the change in strategy of its DTH venture wherein the company is now aiming at spreading its reach is delivering results as is evident from the almost 0.5 m subscribers (0.3 m in 1QFY06) that the company has signed up. Though the first year of operations may not yield much in terms of profits for the company, the potential subscription revenue from these subscribers would be significant. We believe that Zee Telefilms is well placed to capitalise on the growth opportunities existent in the media sector over the next 2 to 3 years.

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