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Zee Telefilms: Preparing for tomorrow - Views on News from Equitymaster

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Zee Telefilms: Preparing for tomorrow
Oct 27, 2006

Performance summary
Zee Telefilms (Zee), India’s leading broadcaster, declared its results for 2QFY07. The company registered an impressive topline growth of 38% YoY for the quarter, while the margins were under pressure on the back of losses from the new businesses (majorly Zee Sports) and investments in the newer business. Operating margins tumbled by as much as 10% of the quarter; consequently the profitability of the company was under pressure.

Consolidated financial snapshot…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Net Sales 3,359 4,638 38.1% 6,490 8,522 31.3%
Expenditure 2,774 4,300 55.0% 4,914 7,457 51.8%
Operating Profit (EBDITA) 585 338 -42.2% 1,576 1,065 -32.5%
EBITDA margin (%) 17.4% 7.3%   24.3% 12.5%  
Other income 143 203 41.9% 263 365 39.0%
Interest 76 30 -59.9% 101 156 54.2%
Depreciation 89 102 14.3% 186 193 4.1%
Profit before tax 563 409 -27.4% 1,552 1,081 -30.4%
Tax 138 76 -44.9% 349 186 -46.8%
Profit after Tax/(Loss) 425 333 -21.7% 1,204 895 -25.6%
Net profit margin (%) 12.7% 7.2%   18.5% 10.5%  
No. of Shares (m) 412.5 425.6   412.5 425.6  
Diluted earnings per share (Rs)* 1.03 0.78   2.92 2.10  
Price to earnings (times)         69.0  

What is company’s business?
Zee is India’s first private TV channel covering nearly 30% of Indian television homes. It reaches an estimated over 300 m people worldwide (including international viewership). Zee is India’s largest cable distributors through its wholly owned subsidiary, Siticable. 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 company’s performance?
Growth across segments: Topline of the company witnessed a growth of 38% YoY for the 2QFY07. The growth was fueled by increase in revenue across various segments with advertising revenues leading from the front. The growth in the advertising revenues was a result of higher average rates on most of the network channels, which inturn is depending on the eyeballs captured. Thus, increased revenues can be traced to an extent towards increasing viewership on the back of better content. During the quarter, Zee Sports telecasted seven one-day (ODI) cricket matches played, however the profitability of this series was affected because of rains interrupting two matches involving India, which results in reduced advertising revenues to an extent.

Revenue break- up…
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Advertisement 1,477 2,107 42.6% 2,792 3,836 37.4%
% of total revenue 44% 45%   43% 45%  
Subscription 1,745 1,930 10.6% 3,494 3,727 6.7%
% of total revenue 52% 42%   54% 44%  
Other sales and services 137 601 337.9% 205 958 368.7%
% of total revenue 4% 13%   3% 11%  

Subscription revenues for the quarter grew by 11% YoY on the back of better content and increased viewership. Analysis of the business model of the company reveals that the advertisement revenues and subscription revenues had followed a similar trend, as better content delivery brings in more viewers, thereby increasing advertisement and subscription revenues. During the 2QFY07, the viewership share rose to 28% from 25% in 1QFY07, along with significant growth on time spent.

Margins- Investment effect: For expanding its horizons and strengthening its channel bouquet, Zee is making investment in new channels. The aim of the same is to offer wider offerings and capture larger chunk of sunrise DTH segment. During the quarter, production and operating cost soared by 83% on the back of investments in new channels like Zee Sports, Zee Smile and Zee Telugu. A large part of the incremental cost was on account of programming cost of cricket rights on Zee Sports.

Cost break-up…
Particulars 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Production and Operating cost 1,660 3,041 83.2% 3,032 5,246 73.0%
as % of net sales 49.4% 65.6%   46.7% 61.6%  
Staff cost 261 328 25.5% 526 661 25.8%
as % of net sales 7.8% 7.1%   8.1% 7.8%  
Selling and other expenditure 853 931 9.1% 1,356 1,550 14.4%
as % of net sales 25.4% 20.1%   20.9% 18.2%  

The company has been in the aggressive investment mode from FY06 onwards, for substantial marketing and content improvement along with wider offerings in the form of new channel launches. Thus, such investments are bound to yield returns with a lag. For better understanding of the business, one can segregate into continuing business and new businesses (required outlay currently with delayed returns). The continuing business witnessed a decent growth in operating profit, as the same expanded by 28%. However, it was the newer business requiring significant investment outlay dragged the overall margins. Continuing phased investment plan, the company invested a sum of Rs 832 m (18% of sales) during the quarter in programming, marketing and distribution.

Bottomline under pressure: Factors at the operating level had a significant say on the bottomline of the company, as the same decline by 22% during the quarter. A significant reduction in the interest expenditure coupled with increase in other income by 42% prevented the bottomline from a sharp fall.

What to expect?
At the current price of Rs 302, the stock is trading at the price to earnings multiple of 69 times based on trailing twelve months earnings. However, the same does not reflect the fundamentals, as the company is in investment phase, the benefits of which will be realized with a lag. Given, the fact that the business is highly scaleable, the yield from the initiatives will add to the profitability. DTH (direct-to-home) segment is expected to growth at a faster clip and Zee is well placed to capitalized on the same. With recent addition of the Star Bouquet from August 2006, the subscribers have wide range of offerings, which will improve the growth in the segment. Number of DTH subscribers has crossed 1.5 m and continues to grow at the rate of 30,000 per week.

Proposed de-merger of its content, broadcasting and news business will unlock value for shareholders. On the overall basis, we maintain a HOLD on the stock.

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