India - Media Institutional Equities
010101001 - A slow revolution 1Q2013
A tug-of-war for revenue share Institutional Equities India - Media
Broadcasting industry’s carriage cost exceeds subscription revenue from cable
LCO MSO
Rs174bn Rs30bn Rs22bn 10 large MSOs 100,000 LCOs 8,000 ICOs Subscription Subscription Subscription
Subscribers Broadcasters
Rs23bn ~95m cable subs 450+ pay channels ARPU ~Rs150/month Rs1.6bn Carriage ~38m DTH subs
DTH
6 DTH operators Subscription Subscription
Rs70bn Rs24bn
Bijal Shah Jaykumar Doshi ELMDO#LLÀFDSFRP -D\NXPDUGRVKL#LLÀFDSFRP (91 22) 4646 4645 (91 22) 4646 4668
Contents
Executive summary ...... 1 Digitisation – a long road ahead ...... 2 Low ARPU – the real challenge ...... 13 Broadcasters - best play on digitisation ...... 22
Companies Zee Entertainment (BUY)...... 33 Sun TV Networks (ADD) ...... 51 Dish TV (BUY) ...... 63 Hathway Cable (REDUCE) ...... 79 Den Networks (Not Rated) ...... 97
Annexure 1: HD: A long-term positive...... 112 Annexure 2: Comparison of distribution platforms ...... 115 Annexure 3: Package prices ...... 116
Glossary...... 117 Institutional Equities India - Media
Executive summary
Digitisation would drive the much-needed structural change in the Indian broadcasting distribution, enabling fair monetisation of content and equitable distribution of pay revenue. The magnitude of gains would depend on ARPU increase, which is likely to be gradual, in our view. Following partial success of Phase I of digitisation, we turn cautious on the timely and effective implementation of the remaining phases. Street’s expectations of large gains for the media value chain build in an immediate and material increase in the multi-system operators’ (MSOs) revenue share – an optimistic assumption. Valuations of Hathway and DEN build in seamless execution of all the four phases making risk- reward unfavourable. We prefer Zee, Sun TV and Dish TV.
Digitisation – a long road ahead: Seeding of set-top boxes (STB) completes an important but easier task in the process of digitisation. The envisaged increase in revenue share of the MSOs requires a sharp cut in profit of the local cable operators (LCOs) by about 50%. An agreement to this effect is unlikely. Resolution of taxation issues and building of a customer database are still pending. Experience from phase I suggests that phase II would be more challenging, given the scale and involvement of several state governments. Low ARPU and the need to upgrade last-mile cable in some areas make us sceptical about the implementation of phase III and IV.
Low ARPU - the real challenge: ARPU growth of ~5% p.a. over the past 20 years has trailed inflation (8.2%), even as content quality and quantity improved in leaps and bounds. At sub- US$4/month, ARPU represents price of access and barely factors in payment for content. An industry-wide focus on raising ARPU is critical. A review of subscription packs indicates that meaningful acceleration in ARPU growth is unlikely. As channels offered in the low-priced base pack account for >80% of viewership, ARPU growth would primarily come from price increases rather than up-trading.
We prefer broadcasters and DTH to MSOs: Incumbent broadcasters would be the key beneficiaries of effective implementation of digitisation, since it would drive pay revenue, enhance entry barriers, and reduce carriage cost. Digitisation would erode the longstanding advantage of cable arising from tax evasion and underpayment for content. Consequently, higher cable tariffs would provide pricing flexibility to DTH operators. Although digitisation is a structural positive for the MSOs, non-ownership of last mile is the weak link in its business model vis-a-vis DTH. We prefer Zee and Sun TV as they are the best plays on booming consumption; the revival in ad-spend growth would act as a trigger. Valuation support, likely uptick in ARPU, and stable subscriber addition underpin our positive view on Dish TV.
Valuation summary M. Cap PT CMP EPS (X) PER (x) EV/EBITDA (x) P/B (x) ROE (%) Company Reco (US$ m) (Rs) (Rs) FY13ii FY14ii FY15ii FY13ii FY14ii FY15ii FY14ii FY15ii FY14ii FY15ii FY14ii FY15ii Zee Enter. BUY 4,268 253 236 7.7 8.9 10.1 30.7 26.5 23.4 19.1 16.4 5.1 4.5 20.2 20.3 Sun TV ADD 3,530 505 475 18.2 21.4 24.0 26.1 22.2 19.8 10.5 9.1 5.7 4.9 27.6 26.8 Dish TV BUY 1,469 90 73 (1.3) 0.7 2.6 (55.2) 100.5 27.7 10.7 7.8 (96.2) 38.9 (64.7) 472.0 Hathway Cable* REDUCE 676 214 250 0.4 7.1 9.6 582.9 35.4 26.0 12.7 9.4 3.9 3.4 11.7 14.1 Den Networks* NR 566 NR 224 6.5 10.5 10.5 34.2 21.3 21.3 11.1 9.0 2.8 2.5 14.3 12.5 Source: IIFL Research; prices as at close of business 5 February 2013, * Attributable multiples
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Digitisation – a long road ahead
Discontinuation of analogue signals is just one of the several steps required to achieve equitable distribution of subscription revenue, the most important objective of digitisation. In phase I cities, progress on other critical steps such as mapping of subscribers and striking revenue sharing deals with LCOs has been unsatisfactory. Gains for MSOs and broadcasters based on TRAI’s suggested revenue share formula could prove to be simplistic and optimistic. Taking cues from phase I, we believe implementation of phase II would be more challenging and time taking. Low ARPU potential and need to upgrade last-mile network in some areas make us skeptical of effective implementation of phase III and IV.
Agreement on revenue share – a tough battle
At present, LCOs pay Rs25- Likely gains for MSOs and broadcasters from digitisation hinge on the 30/sub/month (~15-20% new revenue sharing agreement between the LCO and the MSO. At of subscription) to the MSO present, LCOs pay MSOs ~15-20% of the subscription fees collected. As per the Telecom Regulatory Authority of India (TRAI), the MSOs and LCOs should try to arrive at an agreement on revenue share. In the absence of such an agreement, revenue share of 65:35 in favour of the MSO would hold good. MSOs indicate that a favourable TRAI has recommended 65:35 revenue sharing in revenue share with complete declaration would drive a six-fold favour of the MSOs increase in their revenue. Our interactions with LCOs indicate that a revenue share agreement on the lines of TRAI formula is unlikely. Additionally, the discussion between MSOs and LCOs seem to be at early stages. This makes us sceptical about magnitude and immediate realisation of gains.
Under-declaration – a myth or reality? It is widely believed that under-declaration of subscriber base would not be possible post digitisation, driving step-jump in MSOs’ revenues. Note that, MSOs are aware of LCOs’ actual subscriber base within an error margin of 5%. The carriage and placement fees, contributing >50% to MSOs' revenue, are negotiated on the basis of actual subscriber base of every single LCO serviced by the MSO. Hence, it would be incorrect to say that the LCO’s subscriber base is unknown and digitisation would lead to its discovery.
Figure 1: Hathway’s digital subscriber base was higher than declared (subscriber base paid for) Voluntary digitisation did not translate into higher (nos) Declared subscriber base Digital subscriber base revenue for the MSOs 200,000
150,000
100,000
50,000
0 Mumbai Delhi
Source: Company, IIFL Research. Data as at FY11 end (Prior to phase I digitisation)
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Digitisation would have gained momentum had it been effective in reducing so called ‘under-declaration’, which would have translated into an increase in MSOs’ subscription revenue. But in many markets, digitisation did not translate into an increase in the declaration: the declared subscriber base is actually lower than the number of set-top boxes (STBs) deployed (Figure 1).
Figure 2: Level of digitisation of ~95m cable subscriber base is low at present
Analog Digital 85% 15%
Source: Industry, IIFL research
Present revenue distribution – a function of low ARPU and relative bargaining power High revenue share of the Typically, MSOs and LCOs negotiate revenue share on a lump sum LCOs is a function of basis without getting into a subscriber-level details. After agreeing abysmally low ARPU in on a specific amount, the number of subscribers paid for is derived India based on the cost of the pay channels. The LCOs also report a much lower subscriber base to the tax authority to evade entertainment tax. However, all these by no means suggest that LCOs are depriving MSOs of their legitimate revenue share. Firstly, the abysmally low ARPU means a large part of it should go only in provision of cable service i.e., the share of the LCO should be higher. Secondly, two factors, content exclusivity and control over last mile that could give the MSO an upper hand, are missing.
MSOs and LCOs have mutual dependence Another argument for a sharp increase in MSOs revenue share is that digitisation would alter the equation between the MSOs and LCOs. In the digital environment, the LCO can not readily switch to other MSOs as STBs lack inter-portability. A switch to another MSO would require the incoming MSO to invest a substantial amount in seeding the new STBs. This makes switching from one MSO to another very difficult, though not impossible.
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Figure 3: Last mile ownership makes LCOs equally relevant even in the digital environment
Subscribers
MSO LCO
LCO
Source: Industry, IIFL research
Tough task for LCOs – As evident from the above diagram, the relationship between the collecting higher MSO and LCO is not one sided. LCOs own the last mile cable subscription fee for lesser network. This network is impossible to replicate, given the high cost content and taking a cut in of laying the cable. Besides the financial consideration, there are its profit several practical difficulties in building a parallel cable network to eliminate the monopoly of the LCOs. Accordingly, MSOs can reach the subscriber base only by using the LCOs network, making the relationship mutually dependant. Higher switching costs associated Even post digitisation the MSO would remain in digital environment makes the option of blacking out an LCO dependant of the LCO potent. However, it does not help the MSO’s cause as subscribers may choose DTH.
LCOs are not profiteering at others’ expense LCOs do not make Another argument in favour of sharp increase in MSOs revenue share humongous absolute profit; is that LCOs are profiteering at the expense of the MSO and the LCOs earn broadcasters. Our analysis of the LCO business economics does not 4 [email protected] Institutional Equities India - Media Figure 4: LCOs profitable but no signs of excessive profits LCOs’ business economics Weak Median Strong Subscriber base (in '000s) 500 750 1,000 ARPU (Rs/month) 150 200 250 Economics (Rs/year) Total revenue 900,000 1,800,000 3,000,000 Expenses Taxes 45,000 90,000 150,000 Content cost 180,000 360,000 600,000 Other expenses 120,000 180,000 240,000 Total 345,000 630,000 990,000 Profit 555,000 1,170,000 2,010,000 Source: Company, IIFL Research Proposed revenue share may kill LCO’s profitability Proposed revenue share of MSOs indicate that the new revenue share with LCOs would be 35% for the LCOs would similar to the TRAI’s suggested 65:35 sharing in favour of MSO. As lead to >40% decline in evident from the table below, under all scenarios, LCOs would see a their profit sharp drop in profitability. On migration to the addressable system, if all subscribers were to choose the mid-tier package, we estimate a 54% drop in profit. It is worthwhile to note that under all these scenarios, an LCO is required to convince the customer to pay higher tariff. At the same time, the LCO would see a sharp drop in profit. This proposition looks inherently flawed to us. Figure 5: LCOs’ profit would sharply decline if 65:35 revenue share is implemented Present Based on 65:35 revenue share Subscriber base 750 750 750 750 Tier opted for Analogue Basic Pay Mid Premium Net tariff (Rs/month) 160 220 275 Add: Entertainment tax 45 45 45 Add: Service tax 25 32 38 Gross tariff (Rs/month) 200 230 297 358 Economics (Rs/year) Revenue 1,800,000 2,066,400 2,671,200 3,225,600 Increase in revenue (%) 15 29 21 Expenses Taxes 90,000 626,400 691,200 750,600 Payment to MSO (65% of net 360,000 936,000 1,287,000 1,608,750 revenues for digital) Other expenses 180,000 180,000 180,000 180,000 Total 630,000 1,742,400 2,158,200 2,539,350 Ebitda 1,170,000 324,000 513,000 686,250 Drop in Ebitda (%) 72 56 41 Source: Company, IIFL Research 5 [email protected] Institutional Equities India - Media Second TV in home – an opportunity or a problem? At present, LCOs rarely charge for second TV whereas DTH operators charge Rs160/month. MSOs indicate that post digitisation, subscribers would have to pay for the second TV, which would significantly improve the LCO’s economics. However, MSOs would find it difficult to offer a discount for the second TV. MSOs are not in direct contact with the subscribers. The LCOs may exploit this loophole by classifying several first TV accounts as the second TV. This would reduce the LCO’s payment to MSOs. Accordingly, servicing multiple-TV homes would be a challenge for the MSO. Second TV does not sharply improve profitability Setting aside the above practical challenge for a while, we tried to assess the MSOs’ assumption that payment for the second TV would drastically improve the LCOs’ economics. The calculation in following table reveals that even with a potential increase in the subscriber base, profit would decline 48% based on 2nd TV ARPU of Rs160/month (inclusive of taxes) and assuming 20% homes have 2nd TV. Figure 6: Sharp drop in LCOs’ profitability even after declaration of second TV Analogue Digital Payment for the second TV Existing subscriber base 750 750 unlikely to change profitability materially Second TV declared on digitisation 150 Tariffs incl. tax (Rs/month) For first TV (Mid tier for digital cable) 200 297 For second TV 0 160 Economics (Rs/year) Revenue 1,800,000 2,959,200 Increase in revenue (%) 64 Expenses Taxes 90,000 722,057 Payment to MSO (65% of net revenues for digital) 360,000 1,454,143 Other expenses 180,000 180,000 Total 630,000 2,356,200 Ebitda 1,170,000 603,000 Drop in Ebitda (%) 48 Source: Company, IIFL Research Sizable second TV This drop in profit of LCO is after assuming a 65% increase in population only in large revenue. Here again, the argument is that the LCO would convince cities; LCOs in other cities the customer to pay more money even though the LCO’s earnings will not benefit would erode sharply. Note that, several subscribers with multiple TVs do not switch to DTH only because they are not charged for their second TV. If such a large increase is made in subscription cost, churn to DTH would definitely rise. Sharp jump in tax liability on digitisation Tax evasion is a key source As mandated by TRAI, the MSO would be billing the digital subscriber of the cost advantage cable base post digitisation. At present, the billing and collection of has subscription fee are functions of the LCOs. Their small scale of operations and the analogue cable system allow them to evade a 6 [email protected] Institutional Equities India - Media large part of the taxes. As for service tax, most LCOs get an exemption as their annual revenue does not exceed Rs1m. Under- declaration of the subscriber base leads to massive evasion of entertainment tax. Post digitisation, it would be difficult to evade taxes. Figure 7: Digitisation could lead to a sharp drop in net ARPU Delhi tariff Rs200/month Mumbai tariff Rs200/month Mumbai tariff Rs300/month LCO MSO LCO MSO LCO MSO Billed by (Analog) (Digital) (Analog) (Digital) (Analog) (Digital) Cable tariff 200 200 200 200 300 300 Less: Service tax 0 21 0 21 0 32 Less: Entertainment tax * 3 20 8 45 8 45 Net ARPU 197 159 193 134 293 223 Drop due to digitisation (%) 19.4 30.6 23.8 Source: Company, IIFL Research * Entertainment tax in Mumbai/Delhi is Rs45/20 per month A large part of ARPU As shown in the table above, net subscription revenue may drop 20- increase would go in paying 30%. This drop in the net revenue would be a direct loss to the tax media value chain. While clarity on how this incremental tax liability would be met is lacking, both MSOs and broadcasters are looking at huge increase in subscription revenue on digitisation. We remain sceptical about the magnitude of the increase in MSO’s subscription revenue. Sharp drop in profitability of LCO could jeopardise phase II A sharp cut in revenue The process of digitisation is not possible without the consent and share for LCO unlikely active involvement of the LCOs. Any move leading to a sharp drop in before rollout of phase II profitability of the LCOs covered in Phase I could send a scare among the LCOs covered under Phase II. This would jeopardise Phase II of the digitisation. Accordingly, MSOs might not be aggressive until phase II is completed. More challenges ahead Phase I: Glass half full or half empty? Two out of four phase I The first phase envisaged digitisation of subscribers in four cities – cities fully digitised as of Mumbai, Delhi, Chennai and Kolkata. The implementation though date perceived as a big success, is a mixed bag in reality. Analogue signals in two cities Mumbai and Delhi have been largely discontinued. Whereas in Kolkata, level of digitisation is estimated at 70% and analogue signals are still prevalent. In Chennai, deadline for digitisation has been extended. Also note that in Mumbai and Delhi, progress on building subscriber data base and concluding revenue share agreement is far from satisfactory. Figure 8: Digitisation phase I implementation a mixed bag City Digitisation Remark Mumbai Analogue signal Building of subscriber data, pack selection and Delhi discontinued revenue share agreement with LCO pending Kolkata 70% subscribers digitised Inadequate support from state government Chennai Stayed by court Digitisation unlikely in the near term Source: Company, IIFL Research 7 [email protected] Institutional Equities India - Media Phase I: Cable largely retains its subscriber base DTH operators were banking on digitisation to boost their relatively weak market position in metros. Their healthy balance sheet and strong brand franchise were expected to help them wean away subscribers from cable. Our back-of-the-envelope calculation suggests that aggregate market share of DTH operators in phase of digitisation was ~10%. The phase I cities are primarily serviced by large MSOs, who have been able to retain their subscriber base. This was widely expected given MSOs strength in metros. Figure 9: DTH acquired ~10% cable subscribers in phase I cities during digitisation Cable DTH 90% 10% Source: Industry, IIFL research Phase II fraught with several challenges Phase II more challenging The phase II, covering 38 cities with 1mn+ population, is the most due to large-scale important phase of digitisation. Implementation of Phase II involves involvement of several states far more practical and political challenges compared with the first phase. Accordingly, even replicating the partial success of phase I would prove to be a tough task. We would not be surprised to see longer delays than market estimates of 3-6 months. • Massive scale: Phase II envisages digitisation of ~23m subscribers compared with 8-10m in phase I. Additionally, it covers 38 cities across 14 states. Note that in the first phase, the MSOs’ pace of digitisation in foreign city was significantly slower than that in home city. Such a large scale of deployment would test management bandwidth of even large MSOs • Procurement of set-top boxes: Our interactions with industry sources suggest that it may be difficult to procure 20-25m STBs, even assuming a delay in the implementation of phase II. • Political challenge: As seen in Kolkata, lack of adequate political support from the ruling party in the state would delay or stall the process of digitisation even beyond the set deadline. 8 [email protected] Institutional Equities India - Media Figure 10: Phase II covers 38 cities having more than 20m pay TV homes City State / Union territory Population (mn) Phase II of digitisation Bangalore Karnataka 8.43 covers 38 cities across 14 states Hyderabad Andhra Pradesh 6.81 Ahmedabad Gujarat 5.57 Surat Gujarat 4.46 Pune Maharashtra 3.12 Jaipur Rajasthan 3.07 Lucknow Uttar Pradesh 2.82 Kanpur Uttar Pradesh 2.77 Nagpur Maharashtra 2.41 Indore Madhya Pradesh 1.96 Thane Maharashtra 1.82 Bhopal Madhya Pradesh 1.80 Vizag Andhra Pradesh 1.73 Pimpri chinchwad Maharashtra 1.73 Patna Bihar 1.68 Vadodara Gujarat 1.67 Ghaziabad Uttar Pradesh 1.64 Ludhiana Punjab 1.61 Agra Uttar Pradesh 1.57 Nashik Maharashtra 1.49 Faridabad Haryana 1.40 Meerut Uttar Pradesh 1.31 Rajkot Gujarat 1.29 Kalyan Dombivli Maharashtra 1.25 Varanasi Uttar Pradesh 1.20 Srinagar Jammu & Kashmir 1.19 Aurangabad Maharashtra 1.17 Amritsar Punjab 1.13 Navi Mumbai Maharashtra 1.12 Allahabad Uttar Pradesh 1.12 Ranchi Jharkhand 1.07 Howrah Kolkata 1.07 Coimbatore Tamil Nadu 1.06 Jabalpur Madhya Pradesh 1.05 Jodhpur Rajasthan 1.03 Chandigarh Chandigarh 0.96 Solapur Maharashtra 0.95 Mysore Karnataka 0.89 Total 74.6 Source: Census population 2011 Low risk to digitisation given dominance of large MSOs Dominance of large MSOs Despite several challenges, we do not expect phase II of digitisation would ensure digitisation, to be stalled. Large MSOs have more than 80% cable market share but delays likely in phase II cities. Disciplined behaviour, as exhibited in phase I, would facilitate implementation. That said, implementation may take longer than the current estimates. 9 [email protected] Institutional Equities India - Media Figure 11: Large MSOs have around 80% cable market share in phase II cities Large MSOs Small MSOs 80% 20% Source: Industry, IIFL research Implementation of Phase III and IV face material risks At present, we are not The last two phase of digitisation would also see the same challenges building in effective as phase II but on much larger scale. Besides that, the following implementation of phase factors would make implementation of these phases more difficult III and IV and less desirable. At present, we see a low probability of implementation of digitisation beyond phase II. Accordingly, we are only building first two phases in our forecasts. • Large number of MSOs and LCOs: The cable market is more fragmented in phase III and IV areas compared with the first two phases. Additionally, the presence of independent cable operators (ICOs) would make implementation an uphill task. It is estimated that there are 8,000 MSOs/ICOs. • Upgradation of last mile network; Low ARPU potential: Our industry interactions suggest that the last two phases of digitisation would require upgradation of last mile cable in many areas. This incremental capex may not be desirable, given low ARPU potential of these markets. • Limited industry oversight: Broadcasters and MSOs have a strong presence in markets covered by the first two phases. This enables prompt reporting of non-compliance to authorise and ensure corrective action. Barring a few cities in phase III, the media industry has a limited oversight in areas covered by phase III and IV, making implementation difficult. 10 [email protected] Institutional Equities India - Media Digitisation is a lengthy process Deploying set-top box is just the first step Digitisation has been implemented in three of the four metros in an extremely narrow sense. Digitisation is widely construed as deployment of STB and discontinuation of analogue signal. These are actually just the initial steps of a longer process. Every customer is required to be mapped to a particular STB. The subscriber should be educated on the available packages and should be able to choose from among them. The last and most critical step is to strike a revenue share agreement with the LCO, which should be hugely in favour of the MSO so that more revenue flows to MSOs and broadcasters. Here are some of the challenges: Building subscriber database In the present analogue system, the LCO is the only person directly dealing with the subscribers. For the digital system to be fully functional, the central database of subscribers should be available with the MSO. Our test check in Mumbai reveals that in most of the places, subscriber level details are yet not collected (like filling of know your customer forms). This makes mapping of a STB to a particular subscriber almost impossible. This is a pre-requisite for adoption of package billing and offering valued added services by the MSO. Our interactions with some unlisted MSOs and LCOs suggest that the later, fearing loss of control over their subscribers, are not keen to share the details. We believe it would be a difficult task to convince the LCOs to part with the details of their subscriber base. In the absence of absolute certainty that their profit would be protected, the LCOs may not reveal their subscriber base. Figure 12: Digitisation Phase I addressability yet not achieved Set-top box seeding & activation De-activation of analog signal Procuring subscriber details Addressability achieved Building database & subscriber management system Billing subscribers Source: IIFL research 11 [email protected] Institutional Equities India - Media Adoption of packages In line with the instructions of the Ministry of Information and Broadcasting, all MSOs have announced tariff packages. The analog subscriber base is not accustomed to the process of choosing a tariff package. Once the subscriber data base is built and subscriber management system is the full function, subscribers need to be educated about the packages. This should be followed up by subscriber choosing his preferred package. Resistance from subscribers cannot be ruled out At present, digitisation has been implemented in a pretty narrow sense i.e. discontinuation of the analogue signal. As and when addressability is achieved, the subscriber would have to choose a package from among the tariff packages announced by their respective MSOs. A comparison of these packages with the prevalent tariffs in metros suggests that most of the subscribers would have to pay higher subscription fees. Despite higher fees, there would be reduction in content available to them. Figure 13: Sharp increase in tariffs likely on addressability Tier Basic Medium Premium Package price (Excl. taxes) 160 220 275 Add: Taxes For Delhi 42 49 55 For Mumbai 70 77 83 Gross tariff For Delhi 202 269 330 For Mumbai 230 297 358 Increase (%) assuming analog tariff of Rs200/m For Delhi 1 26 39 For Mumbai 13 33 44 Increase (%) assuming analog tariff of Rs200/m For Delhi (24) 7 24 For Mumbai (9) 16 30 Source: Company, IIFL Research As shown in the table above, the minimum tariff post addressability works out to Rs200/month for Delhi and Rs230/month for Mumbai. At present, even in the metros, a large number of subscribers avail cable service at less than Rs200/month. A subscriber in Mumbai paying Rs200/month and choosing a mid-tier package would see a 50% increase tariff. For a Delhi subscriber, this works out to 35%. Accordingly, these tariff packages may find resistance from subscribers. Over and above this increase, the subscriber may have to buy some add-ons. 12 [email protected] Institutional Equities India - Media Low ARPU – the real challenge In the past 20 years since the introduction of pay TV in India, the annual 5% ARPU growth has not only trailed consumer inflation of 8.2% but also failed to account for manifold improvement in quantity and quality of content. At sub- US$4/month, ARPU largely represents the price of access and barely factors in payment for content. We believe that rather than the alleged under-declaration of subscribers, this low ARPU is the key challenge. Digitisation, along with higher focus on subscription revenue stream, would pave the way higher ARPU. However, our analysis of subscription packages announced by MSOs suggests that net ARPU growth could be gradual. ARPU growth has not kept pace with inflation Since 1992, India’s ARPU Pay TV was introduced in India in 1992. In the initial years, cost of grew at 5.4% Cagr, much cable subscription in Mumbai was Rs100/month. The subscription slower than inflation cost for cable TV has increased in the past 20 years, but is still less than Rs300/month. This translates into 5.3% Cagr, much lower than the rate of consumer price inflation of 8.2% over the same period. Figure 14: Cable ARPU growth in India has significantly lagged consumer price inflation CPI Cable 600 500 400 300 200 100 0 CY1992 CY2012 Source: Industry, IIFL Research Cable ARPU is ~Rs150 on The above calculation is based on the upper end of the tariff range. an all-India basis In Mumbai, subscription price is in the Rs150-300/month range. Median tariff for the city is most likely around Rs200/month. The situation is not far different in the rest of India. According to the industry estimates, India’s median cable tariff is ~Rs150/month, inclusive of all taxes. Moreover, most of second TVs in cable household are unpaid for. Meanwhile, content has significantly improved In its maiden year, cable service offered two channels - Star World and Zee TV, and telecast of two movies per day by the LCOs. In Mumbai, subscription fees were Rs100/month. Since then, availability of content has increased dramatically. There are more than 450+ active channels in India. Content is now available across many genres, viz. regional entertainment, infotainment, lifestyle movies, news, and kids, among others. Subscribers are not yet paying for this exponential growth in content. 13 [email protected] Institutional Equities India - Media Figure 15: Exponential increase in number of available channels There are 450+ channels in India across several genres 700 623 (No. of channels) 552 600 461 500 363 400 308 263 300 200 170 200 130 55 66 75 100 5 11 13 29 0 CY91 CY92 CY93 CY94 CY95 CY96 CY99 CY00 CY02 CY04 CY05 CY06 CY07 CY09 CY10 CY11 Source: Industry, IIFL Research Figure 16: Emergence of several new genres has enriched viewer experience English GEC Regional English 0.2% channels movies 34% 1% Infotainment 1% Sports Others 4% 12% Music 3% Kids Hindi GEC 6% 27% Hindi Movies 12% Source: Industry, IIFL Research Subscriber yet to pay for content Subscription fees largely The above discussion suggests that subscription fees are primarily represent cost of provision paid for cable service provided by LCO. MSOs receive a small portion of cable service by the LCO of LCO’s collection to meet its operating expense. Note that, at industry level, content cost paid by MSOs to broadcasters is lower than the carriage and placement fees received from the broadcasters. Subscription fees cover the operating expenses of cable network and provide for the LCOs’ profit. Accordingly, subscription revenue of one set of broadcasters largely represents carriage cost of another set of broadcasters. At the industry level, broadcasters do not receive any money from the MSOs. 14 [email protected] Institutional Equities India - Media Figure 17: Broadcasting industry’s carriage cost exceeds subscription revenue from cable LCO MSO Rs174bn Rs30bn Rs22bn • 10 large MSOs • 100,000 LCOs • 8,000 ICOs Subscription Subscription Subscription Subscribers Broadcasters Rs23bn • ~95m cable subs • 450+ pay channels • ARPU ~Rs150/month Rs1.6bn Carriage • ~38m DTH subs DTH • 6 DTH operators Subscription Subscription Rs70bn Rs24bn Source: Industry, IIFL Research Broadcasting industry pays Figure 18: Hathway’s carriage revenue covers its pay channel costs the MSOs on a net basis Pay channel costs Carriage revenue 6,000 (Rs m) 5,000 4,000 3,000 2,000 1,000 0 FY07 FY08 FY09 FY10 FY11 FY12 FY13ii Source: Company, IIFL Research Indian pay-TV ARPU far lower than peers Indian ARPUs significantly India’s average ARPU is estimated at ~Rs150/month, which is lower compared with significantly lower than ARPUs in developed as well as developing developing nations countries. High penetration of pay-TV (85%+) is explained by the low subscription cost and limited free to air content. Strong ARPU growth is a pre-condition for higher revenue share for the MSOs and broadcasters. Digitisation, along with addressability, would enable the industry participants to increase their ARPU over time. 15 [email protected] Institutional Equities India - Media Figure 19: India’s cable TV ARPU is the lowest amongst developing and developed nations 80 (US$/month) 60 40 20 0 India Korea Thailand Sri Lanka Australia Malaysia Indonesia Singapore Hong Kong Philippines New Zeland Source: Industry, IIFL Research Systemic challenges kept ARPUs depressed Broadcasting distribution in India flourished despite abysmally low pay TV ARPUs. It evolved an ecosystem that can sustain on low payout from subscribers. Broadcasters devised their business models primarily banking on advertising revenue. Since the large potential subscription revenue base was not tapped, advertising revenue largely determined the spending on content. The following factors contributed to sustained under-pricing of cable services in India: Tax liability on digitisation • Rampant tax evasion: The Indian cable distribution space is could go up by more than highly fragmented with 100,000 LCOs servicing ~95m 6x subscribers. These small proprietors largely transact their business on a cash basis. Most LCOs avail turnover-based exemption from service tax. Additionally, by underreporting subscriber base, they pay only a fraction of entertainment tax. Figure 20: LCOs pay fraction of their tax liability Gross ARPU (Rs/month) 300 250 200 Meagre payment for Service tax (at 12%) 32 27 21 content and tax evasion kept LCOs in profit despite Entertainment tax (for Mumbai) 45 45 45 low tariffs Total tax 77 72 66 LCO's present tax payment 10 10 10 Payment as % of potential tax liability 13 14 15 Source: Industry, IIFL Research • Broadcasters’ focus on advertising revenue: Broadcasters have an overwhelming focus on advertising revenue, which is driven by viewership. The need to reach the maximum number of subscribers did not allow them to force higher payment for content at cost of viewership. Hitherto, under-pricing of content is one the key reason for lower ARPUs. • LCOs remain profitable despite low tariffs: Evasion of tax and under-priced content keep LCOs profitable. Beside these factors, the local cable business requires limited investments and oversight. As evident from the table below, local cable operation is profitable even on a very small scale. 16 [email protected] Institutional Equities India - Media Figure 21: Small LCO earns ~US$14,000 per annum Particulars Amount No. of subscribers 500 Subscription cost (Rs/month) 200 Annual subscription fees (Rs) 1,200,000 Expenses Taxes 60,000 Content cost 210,000 Other expenses 180,000 Total costs 450,000 Profit 750,000 Profit margin 62.5 Source: Industry, IIFL Research Expect a gradual improvement in ARPU Coordinated efforts from all stakeholders required Digitisation, an enabler, by itself would not result in the much needed acceleration in ARPU growth. All industry participants, LCOs, DTH service operators, MSOs and broadcasters, would have to work towards forcing customers to pay higher tariffs. An increase in ARPU growth can be achieved by a combination of tariff increases, packaging of content, offering niche channels, and pay per view, amongst others. A greater focus from broadcasters on subscription revenue, digitisation, and credible competition from DTH, lead us to believe that ARPU growth would pick up in the medium to long term. Digitisation would help ARPU growth in the medium term Digitisation to facilitate Digitisation is an important step in monetising content through ARPU growth but higher ARPU. Once digitisation is implemented in its earnest, it would improvement to be gradual bring addressability and enable differentiation among subscribers and allow channel selection. This would allow service providers to devise different channel packages, offer niche channels and newer services. The increased maneuverability would enable operators to increase ARPU without crude tariff increases. However, an analysis of subscription packs suggests that the gains from migration would be limited. Accordingly, tariff increase, a gradual process, would largely drive the ARPU growth. 17 [email protected] Institutional Equities India - Media Figure 22: DTH has several subscription packs and ala carte offerings Source: Company, IIFL Research A large part of ARPU growth 1. Tariffs increase – key ARPU driver: We believe the most should come from tariffs potent ARPU driver for cable would be tariff increases from the increases current abysmally low levels. Experience from DTH suggests that gradual price increases have not met with much resistance from the subscribers. Despite competition, the DTH industry has taken three price increases (totaling to 15-25% depending on package) in past two years. The importance of a tariff increase is high, given that the base pack includes most popular channels. Figure 23: Dish TV has taken three price hikes in past 2 years totaling to 15 25% increase Tiers Package May 07 Sep 09 Sep 10 May 11 Nov 11 Jul 12 Base Packs Silver 130 150 150 Discontinued Silver saver 160 165 Discontinued Super Family 176 180 200 Mid tier Packs Gold 235 250 250 Discontinued Gold saver 265 285 Discontinued Super Gold 235 255 Super World 285 305 Top tier Packs Platinum 285 300 335 350 360 380 Paradise 400 HD Packs HD World 375 385 HD Premium 450 450 460 HD Royale 550 550 560 Source: Company, IIFL Research 18 [email protected] Institutional Equities India - Media 2. Packaging and migration to higher-value packs: The present cable tariff is lower than the cost of the base pack announced by the MSOs. Accordingly, a large number subscriber may initially choose the base package yielding low ARPU. Smart packaging generally accelerates migration from the base pack to mid-pack and furthers offerings. We believe the current base packages are fairly attractive. Hence there is little incentive for a large part of subscribers to upgrade. Experience from DTH suggests that an attractive base pack makes up-trading difficult. Figure 24: Attractive base packs has led to a down trading in DTH industry DTH has seen downtrading over past three years Base pack Mid pack Premium pack 100 (%) 80 60 40 20 0 2009 2012 Source: Company, IIFL research An attractive base pack An attractive base pack: The base package announced by makes uptrading difficult large MSOs includes all popular Hindi general entertainment and movie channels. It also offers a wholesome entertainment across other genres. An upgrade to mid-pack would give subscription to English movies, entertainment and news channels. These, put together, account for less 2% of total viewership in Mumbai. At the national level, viewership share of English genre would be even lower. Mid-pack also gives subscription to select sports channel. 19 [email protected] Institutional Equities India - Media Figure 25: Attractive base pack of cable (viewership share > 80%) is a disincentive to upgradation Hathway’s pack* Genres Viewership Basic Pay Medium Premium Share (%) Rs160/month Rs220/month Rs275/month Hindi GEC 33.7 Hindi Movies 11.7 Hindi News 3.0 English GEC 0.2 English Movies 1.5 English News 0.3 Kids 6.4 Sports 3.1 Infotainment 1.2 Lifestyle 0.2 Music 1.7 Religious 0.3 Regional Marathi 21.2 Other regional & Misc 15.5 Viewership 83.9 91.5 93.8 All major channels Select channels None Source: TAM Data (Mumbai market, Aug Sep 2012); IIFL Research * Excl. taxes Another difference between base, mid and premium package is Channels offered in base number of sports channels included in respective packages. pack account for 84% of viewership However, we do not expect sports to drive up-trading as an add- on cricket package is economical. Accordingly, we expect an overwhelmingly large subscriber base to settle with the base pack. Figure 26: Channels included in Hathway’s base pack account for more than 80% viewership share 100 93.8 (Viewership share %) 91.5 90 83.9 80 70 60 50 Basic Pay Medium Premium (Rs160/month) (Rs220/month) (Rs275/month) Source: TAM Data (Mumbai market, Aug Sep 2012); IIFL Research Note: Pack price excl. taxes 3. Adoption of HD to boost ARPU: High Definition (HD) television was introduced in India in 2011 by DTH service providers. The service has been well received in the market with HD connections accounting for ~5% of subscriber additions. We expect adoption 20 [email protected] Institutional Equities India - Media of HD to accelerate sharply, driven by: 1) a rising proportion of HD television set sales; 2) increase in availability of content in the HD format; and 3) network effect. Given significantly higher tariff of HD connections, the expected increase in the proportion of HD subscribers would contribute to improvement in ARPU (more on this in annexure on page 112). Figure 27: ARPU from HD customers is significantly higher than SD HD tariffs are 50% higher than SD tariffs 600 (Rs/month/sub) 450 300 150 0 Super Super Super Super Paradise World Premiere Royale Family Gold World Platinum SD packs HD packs Source: Dish TV, IIFL research. Conclusion: ARPU will increase; Phase II inflection point After a couple of decades of paltry increases, growth in Indian pay TV ARPUs is likely to accelerate. A meaningful improvement in ARPU hinges on tariff hikes as we expect limited gains from up-trading and adoption of HD. We expect the tariff increase to be implemented gradually. Additionally, a large part of initial increase in subscription fees would go to the government as a transparent system would make tax evasion difficult. An immediate meaningful hike in tariffs may negatively impact phase II of digitisation. Hence, MSOs may refrain from taking large price increases until completion of phase II. Figure 28: Digitisation timelines Phase Area Timeline Subscribers (mn) Phase 1 Delhi, Mumbai, Chennai, Kolkata 31st Oct 2012 8 Phase 2 Cities with population > 1m 31st Mar 2013 23 Phase 3 All urban areas (Municipal areas) 30th Sep 2014 60 Phase 4 Rest of India 31st Dec 2014 Source: Company, IIFL Research 21 [email protected] Institutional Equities India - Media Broadcasters - best play on digitisation Potential gains from digitisation vary significantly among the key players, the broadcasters, DTH operators and MSOs, and would start accruing at different times. Large broadcasters are likely to be the key beneficiaries. More importantly, digitisation does not require any investment from them. Digitisation would erode the longstanding advantage of cable arising from tax evasion and underpayment for content. This would translate into higher cable tariffs, giving pricing flexibility to DTH operators. However, we do not foresee a sharp increase in subscriber additions for DTH from digitisation. Digitisation, though a structural positive for MSOs, but the non-ownership of last mile keeps its business model weaker than that of DTH. Triple benefit for broadcasters Entry barrier further enhanced Digitisation to increases The key but little appreciated benefit of digitisation for broadcasting gestation period and start- industry is increase in entry barriers. Digitisation is likely to drive up losses step jump in subscription revenue of large incumbent networks allowing them to increase investments in existing and new channels. On the other hand, as it takes a large bouquet and substantial time to build strong subscription revenue stream, a new network would have to primarily rely on advertising revenues. Consequently, Strong incumbent gestation period and losses would be significantly higher in digital broadcasters to benefit from surge in pay revenue environment. This translates into a meaningful advantage for large incumbent networks. Figure 29: Rapidly growing subscription revenue further strengthens well established incumbent broadcasters like Zee 25,000 (Subscription revenue Rs m) 50% increase on effective implementation of Phase I & II 20,000 15,000 10,000 5,000 0 FY08 FY09 FY10 FY11 FY12 FY13ii FY14ii FY15ii Source: Zee Ent’s total subscription revenue, IIFL research Carriage – subscription revenues dynamics to reverse Broadcasting industry According to our estimates, domestic cable industry pays Rs22bn to expected to turn net all broadcasters for content. On the other hand, it collects ~Rs23bn receiver from cable from the broadcasting industry as carriage and placement fees. Accordingly, on a net basis, there is no payment for content at the industry level. We expect this to change gradually with the onset of digitisation. Firstly, increase in ARPUs and a more equitable distribution of revenue would lead to an increase in payment for content. Secondly, carriage fees would trend downward. Our calculation suggests that domestic subscription revenue of Zee 22 [email protected] Institutional Equities India - Media Entertainment is expected to increase ~60% on implementation of first two phases of digitisation. On complete digitisation of India this could increase ~150%. Additionally, carriage cost would come down. Figure 30: At present, MSOs‘ content cost is comparable to carriage revenue (Rs m) Content cost Carriage recd. 25,000 20,000 15,000 10,000 5,000 0 Cable DTH Source: Industry, IIFL research Figure 31: Digitisation to lead to a step jump in Zee’s domestic subscription revenue Domestic subscription revenue 25,000 (Rs m) 150% increase 20,000 15,000 60% increase 10,000 5,000 0 FY12 FY15 Complete digitisation Source: Industry, IIFL research Faster ARPU growth for DTH on digitisation Digitisation would accelerate ARPU growth At present, DTH operators’ base pack tariffs are slightly higher than that of analogue cable, despite analogue cable offering more channels. This is set to change with digitisation. Digital cable tariff announced by MSOs is not only significantly higher than the extant cable tariffs, but also offers lesser content. Digitisation takes away the longstanding cost advantage of the cable industry arising from evasion of tax and miniscule payment for content. This puts cable and DTH on an equal footing for the first time. Accordingly, cable space would experience competition from DTH. 23 [email protected] Institutional Equities India - Media Figure 32: Digital cable and DTH tariffs are comparable Low cable tariffs acted as a cap on DTH package prices 350 (Rs/month) 280 210 140 70 0 Cable Base Mid Base Mid Analogue DTH Digital cable Source: Company, IIFL Research (Cable – Hathway Mumbai tariff packages) Digitisation puts cable and Low cable tariff acted as a cap on subscription price of DTH offering. DTH on equal footing As evident from the graph above, the monthly subscription cost of comparable packages for DTH and digital cable are approximately the same. Higher content cost and compliance of tax regulation would push up cable tariffs. This in turn would provide the DTH operators more flexibility in pricing their packages. Mandatory digitisation would eventually culminate into acceleration in ARPU growth for the DTH operators. However, large gains are unlikely before effective implementation of phase II. India - second-largest TV market is in a secular growth phase India, with 155m TV households, is second only to China in terms of TV homes. TV penetration at 61% of the addressable households is significantly lower than that in the developed and several developing markets. TV households have grown at ~6% annually over FY07-12. We expect growth in TV households to accelerate primarily driven by improving affordability on the back of increasing rural incomes and lower electronics prices. Figure 33: Television penetration itself offers huge scope for growth.. 130 (%) 98 97 98 100 97 100 100 70 60.9 40 China Australia USA S. Korea UK Japan India Source: Industry, IIFL Research 24 [email protected] Institutional Equities India - Media Figure 34: …and thus creates potential for the pay TV market Total Households 255 million TV Households 155 million DTH Households 38 million (25% of TV Homes) Cable TV Households 95 million (61% of TV Homes) Terrestrial & free TV subs 22 million Source: Industry, IIFL Research DTH is well-placed to capitalise on TV penetration growth India’s TV home set to grow A large part of the expected increase of 67m TV homes over the next at 8% Cagr five years will be from smaller towns and the countryside, which are cable black or cable deficient. In these less-densely-populated and single storied residential units, DTH has an advantage over able because: 1) In cable-black / deficient zones, cost of delivery of DTH would be a fraction of the cost of laying last-mile cable; 2) TV sets are often sold bundled with free set-top boxes and initial subscriptions—which enables DTH to wean away new TV households from the cable industry. 3) Digitisation of small towns may take much longer, given the limited interest of MSOs. DTH is a far superior product, as it offers digital quality and more channels than an analogue connection. New TV homes largely come Large gains for DTH only in phase III & IV in rural areas – a strong Of the estimated cable subscriber base of ~95m, only ~45m is hold of DTH reached by large the MSOs, largely through the LCOs. The rest of the subscriber base receives the signal from over 8000+ small ICOs, lacking the financial wherewithal and scale for digitisation. ICOs’ large subscriber base is seen as a low hanging fruit for DTH operators. However, these small ICOs are predominantly present in Weak presence of large MSOs in phase III and IV phase III and IV cities. Since, we are not convinced about effective areas would give DTH an implementation of phase III and IV we believe digitisation would not upper-hand translate into huge gains for DTH operators. 25 [email protected] Institutional Equities India - Media Figure 35: Large subscriber base of independent cable operators a low hanging fruit for DTH operators Regional and Independent cable operators 10 National MSOs 50 m 45m Cable Homes 60 m DTH & Terrestrial ICOs: Around 8,000 TV Homes 100 m Non- 155 m TV Homes TV Homes 255m Homes National MSOs (IMCL, Hathway, SITI, DEN and DigiCable, control around 40 million subscribers Regional MSOs like Ortel and SCV control possibly another 5 6 million subscribers Independent cable operators, with their own analog head ends (around 8,000) control another 50 million homes Source: Industry, IIFL Research MSO – Last mile ownership holds the key Without last mile MSOs’ lack of control of last mile - a serious draw back ownership, the MSOs would MSOs, unlike DTH operators, do not own the last mile, which makes remain largely a B2B them dependant on the LCOs. Lack of full control of the last mile is business the biggest drawback in the MSOs’ business model and hence it cannot be compared with DTH or other access businesses. This makes MSOs’ business model somewhat akin to that of carriers in the wholesale voice business. The key question is, would digitisation materially alter the MSO’s position? Admittedly, digitisation would increase the MSOs’ ability to exert influence on the subscriber, but this would hardly dilute the LCOs stranglehold on the subscriber base. Figure 36: Even after Digitisation subscription fees would be collected by the LCO Collection of subscription fees remains with the LCO Analog cable system MSO LCO Subscriber Post Digitisation MSO Subscriber LCO Billing Collection Source: IIFL research 26 [email protected] Institutional Equities India - Media In the digitised cable space, the MSO takes over the function of billing the subscriber. However, the more important function of collecting subscription would be retained by the LCOs. The LCOs control over collection makes us skeptical about the easy agreement and implementation of revenue share on the lines suggested by the MSOs. Subscription fees are largely paid in cash and are not amenable to monitoring by the MSOs. Akin to any other industry, a large part of the value in media is appropriated by the producers and businesses providing access to the customer. In the Media business these roles are played by the content owner, i.e. the broadcasters and access providers — the LCO or DTH operator. The MSOs’ contribution to the value chain does not increase materially just by investing in a STBS. Admittedly, the MSOs’ bargaining power has improved, compared with the LCO, but it is not adequate to tilt the bargaining power completely in favour of the MSO. This is because the LCO continues to enjoy monopoly over the last mile. Suggested economics for MSO look too good Our analysis of incremental investment of the MSOs and corresponding revenue and Ebitda look optimistic. The MSO would invest Rs1,000/subscriber for digitisation. Based on the indicative revenue share, this would translate into an additional Ebitda of Rs576-900/subscriber p.a. This translates into pay-back period of less than two years. Figure 37: MSO’s return on investment on digitisation looks too good to be true Package Base Mid Premium MSOs’ guidance suggests less than 2 years pay-back Price (Rs/month) 160 220 275 on investment in Expenses digitisation LCO's share (Rs/month) 56 77 96 Broadcaster's share (Rs/month) 48 66 83 Additional expenses (Rs/month) 8 11 14 Ebitda (Rs/month) 48 66 83 Ebitda (Rs/year) 576 792 990 Investments / subscriber (Rs) 1,000 1,000 1,000 Return on investment (%) 58 79 99 Pay back period (years) 1.7 1.3 1.0 Source: Company, IIFL Research MSO business has low entry barriers Low capital and technical intensity make MSOs’ business vulnerable to new entrants. A digital head-end, along with extensive cable to reach the LCOs for the largest state like Uttar Pradesh, could be built at a cost less than Rs250m. For a smaller state, the cost could be even lower. This cost could be further lowered by use of leased cable from telecom companies. Material improvement in profitability of the MSOs would attract new entrants. Our channel checks suggest that a large distributor extinguished its JV with a leading MSO to start its own operation. 27 [email protected] Institutional Equities India - Media Figure 38: Indicated economics of digital cable very attractive for new entrants Particulars Amount MSOs’ business is neither technology nor capital Cost of head end (Rs m) 50 intensive Cost of cable (Rs m) 200 Other capex (Rs m) 20 Cost of digitisation (assuming 100% subsidy; set top box cost Rs1600) 4,800 Total investment (Rs m) 5,080 Subscriber base (mn) 3 ARPU 200 Annual revenues (Rs m) 7,200 Expenses LCO's share (Rs m) 2,520 Broadcaster's share (Rs m) 2,160 Cost of running digital network (Rs m) 360 Other expenses (Rs m) 360 Ebitda (Rs m) 1,800 Ebitda margins (%) 25 Return on investment (%) 35 Payback period (years) 2.8 Source: Company, IIFL Research Carriage revenue on a firm downward trajectory We expect 30-40% The Indian cable service providers’ business model over the years reduction in carriage has transitioned from subscription-only to subscription + carriage. As revenue in digitised channel count increased over the past 10 years (it now stands at markets within two years 500+), broadcasters started paying cable operators for preferential carriage over their clogged analog networks, which can carry only 80 channels to subscribers. On the top of carriage fees, broadcasters pay ‘placement fees’ to have their channels placed at specific positions in relation to others in a given genre. It is a general practice to negotiate carriage and placement fees on a consolidated basis. At present, carriage and placement revenue are estimated at ~Rs23bn for the industry. Figure 39: At present. carriage accounts for more than 50% of MSOs cable revenue Carriage Subscription 56% 44% Source: Hathway FY13ii, IIFL research 28 [email protected] Institutional Equities India - Media Digital networks can carry ~1,000 channels compared with 80 in analogue network eliminating capacity constraints. Also note, that in the digitised environment, the MSO is selling channels listed in its package to the subscribers and hence bound to deliver those channels. Accordingly, we believe most large networks would not be required to pay carriage. However, several channels with lesser pull would pay carriage for being included in the most popular package. This implies carriage and placement fees would persist. However, we foresee a drop of ~30% within three years of digitisation of a market. 29 [email protected] Institutional Equities India - Media This page is kept blank intentionally 30 [email protected] Institutional Equities India - Media Companies 31 [email protected] Institutional Equities India - Media This page is kept blank intentionally 32 [email protected] The cable television network Institutional Equities Major satellites Transponder capacity Coverage INSAT 4A 12 Ku band, 12 C band India INSAT 4B 12 Ku band, 12 C band India INSAT 4CR 12 Ku band India NSS 5 12 Ku band, 52 C band Europe, Africa, Middle East, Asia NSS 6 60 Ku band Middle East, Southern Africa, Subconti nent LCO NSS (SES) 7 48 Ku band, 49 C band Americas, Europe, Africa, Middle East MEASAT 3 16 Ku band, 24 C band Asia, Australia, Middle East, East Africa ST 1 16 Ku band, 14 C band Middle East, Southeast Asia LCO Signals downlinked by ICOs (independent cable Transmission on C band Transmission on C band operators) Frequency - 4-8 GHz LCO (local cable operator) Coa Secondary subscriber xia l c ab Broadcaster uplinks le content LCO Signal downlinked by MSOs (multi-service operators) MSOs Footprint (m subscribers) Primary subscriber Den Networks 11.0 REACH Hathway 8.9 Digi Cable 8.0 In Cable 6.5 Siti Cable 6.5 You Telecom 1.5 The DTH network Institutional Equities DTH operator Main satellite used Dish TV NSS 6 Tata Sky INSAT 4A Airtel Digital INSAT 4CR, NSS 7 Sun Direct INSAT 4CR, 4B Reliance Big TV MEASAT 3 Videocon D2H ST 1 Sa te lli C-band transmission te T ra n s m is s io n Broadcast signal DTH operator 12-18 GHz frequency range Encrypted signal from C-band transmission Ku-band transmission, Broadcaster DTH operator downlinks uplinks content content, applies encryption Important details of C&S market Figures and uploads content onto its Housholds (m) 255 own transponders TV households (m) 155 Pay TV subscribers (m) 133 DTH operators Subscribers (m) Analog cable subscribers (m) 80 Dish 13.9 Digital cable subscribers (m) 15 Tata Sky 9.7 DTH subscribers (m) 38 Airtel 8.4 Multi Service Operators 10 Sun Direct 7.8 DTH players 6 Videocon 6.6 Independent Cable Operators 8,000 RCOM 4.5 Local cable operators 100,000 Gross subscribers as at Sep-12 end Institutional Equities CMPRs236 Target12mRs253(7%) Zee Entertainment BUY Marketcap(US$m) 4,343 Firing on all cylinders Enterprisevalue(US$m)4,060 Zee Entertainment (Zee), India’s leading television network, Bloomberg ZIN is the best play on structural improvement in India’s pay Sector Media television market and booming consumption. Digitisation and its distribution joint venture with Star network would help secure a rightful share of subscription revenue. Furthermore, Feb 05 2013 its diversified bouquet of channels and improving network market share would translate into above-industry ad-revenue 52Wk High/Low (Rs) 247/115 growth. Meanwhile, Zee is investing in new channels and Shareso/s(m) 959 markets, which we believe would buttress long-term growth. Dailyvolume(US$m) 13 The company could largely pay back the expected, strong free DividendyieldFY13ii(%) 0.8 cash flow to investors as dividend. BUY. Freefloat(%) 56.6 Investing in new growth drivers: Zee has a well-diversified revenue stream. Its high subscription revenue (~45% in FY12) Shareholdingpattern(%) shields its earnings during periods of slowdown in ad spend. Its large Promoter 43.4 bouquet of channels provides resilience to absorb weakness in FII 37.5 individual channels. Zee is investing afresh in existing channels and DII 11.4 in newer genres, which would improve network’s market share in the Others 7.7 medium term. Pay revenue – a huge opportunity that reduces risk of Priceperformance(%) increasing competition: Following effective implementation of first 1M 3M 1Y two phases of digitisation, Zee’s domestic subscription revenue could Zee 4.0 21.4 78.1 increase ~60% even without price increases. This would not entail Absolute(US$) 7.8 24.7 67.9 any specific cost increase giving Zee the flexibility to invest in Rel.toSensex 4.6 16.6 66.4 strengthening its network market share. Furthermore, digitisation CAGR(%) 3yrs 5yrs reduces the risk of entry of new players who typically depend on EPS 13.2 17.5 advertising revenue, since they would find it difficult to compete with incumbents with sizable pay revenue. Stockmovement High earnings visibility, increased payout: Contrary to market Shares(000') Volume(LHS) (Rs) Price(RHS) expectations, we believe Zee’s margins would remain stable as 25,000 250 narrowing of sports losses and strong growth in subscription revenue 20,000 200 would offset increased losses from new launches. Zee’s cash 15,000 150 10,000 100 generation has significantly improved over the past few years and 5,000 50 the company has also increased its payout (dividend + buyback at 0 0 68% of PAT in FY12 vs. 27% in FY08). At 23.3x FY15ii P/E, 11 11 11 11 11 11 12 12 12 12 12 12 13 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ valuations are reasonable considering high earnings visibility and Apr Jun Oct Apr Jun Oct Feb Aug Feb Aug Feb Dec Dec potential upside from digitisation. We see upside risks to our estimate of 18% EPS Cagr for FY12-15ii from recovery in GDP growth and effective implementation of digitisation. Financialsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Revenues(Rsm) 29,436 30,405 36,761 41,222 46,318 Ebitdamargins(%) 25.7 24.3 26.1 26.7 27.3 PreͲexceptionalPAT(Rsm) 5,600 5,891 7,337 8,530 9,671 ReportedPAT(Rsm) 6,370 5,891 7,337 8,530 9,671 PreͲexceptionalEPS(Rs) 5.7 6.1 7.7 8.9 10.1 BijalShah Growth(%) (17.9) 7.3 25.2 16.3 13.4 [email protected] IIFLvsconsensus(%) 3.8 (1.1) (9.8) 912246464645 PER(x) 41.2 38.4 30.7 26.4 23.3 ROE(%) 16.2 18.1 19.9 20.3 20.4 JaykumarDoshi Netdebt/equity(x) (0.3) (0.3) (0.3) (0.4) (0.4) [email protected] EV/Ebitda(x) 29.3 29.2 22.1 18.9 16.2 912246464668 Price/book(x) 7.5 6.6 5.7 5.0 4.5 www.iiflcap.com Source:Company,IIFLResearch.Priceasatcloseofbusinesson05February2013. 33 Institutional Equities Zee Entertainment – BUY Company snapshot Zee Entertainment is one of the largest broadcasting houses in India. Its portfolio of 30+ plus channels includes the flagship Hindi General Entertainment Channel (GEC) Zee TV, movie channel Zee Cinema, sports channel Ten Sports, and regional channels Zee Bangla and Zee Marathi, among others. The flagship channel, Zee TV, is at second (or a close third) spot in the Hindi GEC space. Its Hindi movie channel Zee Cinema and regional GECs Zee Bangla and Zee Marathi are leaders in their respective genres/markets. Zee enjoys a strong overseas franchise with a reach in 168 countries and has more than 650m subscribers worldwide. In July 11, the company formed Media Pro, a JV with the Star Group, for joint distribution of channels. Background Zee Entertainment Enterprises Limited, founded in 1982, was the first company to launch a satellite TV channel in India in 1992. Zee started its business as Asia Today, which was operated as a JV with the Rupert Murdoch-run Star TV. Later Zee TV bought out the stake of Star in the JV, which also heralded Zee’s gradual expansion into regional entertainment and the news space. It underwent a major restructuring in FY07 when its news and regional channels and distribution businesses were demerged into three separately listed entities: Dish TV (DTH business), WWIL (MSO operations) and Zee News (news and regional channels). In FY11, Zee brought back into its fold some of the previously de-merged regional businesses. Subscriptionrevenuepickedupin2HFY12asMediaPro StrongcomebackbyZeeTVinFY13 becameoperational Subscription revenue (LHS) (%) (Rsm) (%) Colors Sony StarPlus ZeeTV SubscriptionrevenuegrowthYoY(RHS) 4,000 40 30 26 3,500 30 22 3,000 20 18 2,500 10 14 2,000 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 10 Ͳ Ͳ 11 12 11 12 12 12 11 12 12 12 12 12 12 13 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ FY11 FY12 FY13 Mar May Jul Oct Oct Jan Apr Jun Jan Nov Dec Feb Aug Sep Nov Dec Source:Companydata,IIFLResearch Source:TAMData,IIFLResearch Management Name Designation Remarks/managementdescription SubhashChandra Chairman FirstͲgenerationentrepreneurwithexperienceinbuildingsuccessfulbusinessesindiverse industries PunitGoenka CEO JoinedtheEsselGroupin1995andbecamebusinessheadofZeeTVin2004;hasexperience ofheadingdiversebusinesseswithintheGroup [email protected] 34 Institutional Equities Zee Entertainment – BUY Core business on a strong footing Subscription revenue, Diversified revenue base – a huge advantage which is sticky in nature, Zee’s key strength is its ability to monetise its content better contributes 44% to Zee’s total revenue compared with competitors. In FY12, domestic subscription revenue accounted for 30% and international pay revenue constituted 13% of total revenue. The subscription revenue stream is stickier compared with advertising revenue. This significantly reduces the impact of weakness in ad spend or a temporary weakness in the performance of a channel. A high base of subscription revenue gives Zee the flexibility to invest in existing as well as new channels. This is a big advantage vis-a-vis other young and less diversified networks that depend largely on ad revenue. Figure1.1: Zee’ssubscriptionrevenueas%oftotalrevenueissignificantlyhigher thanpeers (%) Subsciptionrevenueas%oftotalrevenue 50 40 30 20 10 0 Zee Sun* Sony TV18 Source:Company,IIFLResearch*Sun’sslotsalemodelfortelecastofcontentbumpsupthe proportionofsubscriptionrevenue A diversified bouquet of Zee - more than just a flagship channel channels de-risks Zee’s A large and diversified bouquet of channels, coupled with a business model diversified audience base, significantly de-risks Zee’s business model. Contrary to the perception that Zee is equivalent to the flagship channel Zee TV, Zee’s viewership base is spread across genres. A comparison with competing networks shows that Zee and Star have the most formidable bouquet of channels in India. Thus, Zee’s profitability is not linked to the performance of a single channel, which de-risks earnings. Figure1.2: Awelldiversifiedcontentoffering Channel MktͲShare* Ranking Remarks ZeeTV 18.7 2 Closecompetitionbetweentop4channels ZeeCinema 22.4 3 Closecompetitionbetweentop3channels ZeeBangla 25.4 2 Strongmarketposition, ZeeMarathi 21.6 2 Strongmarketposition,leadershipalternatingbetweenZeeandStar ZeeTamil 3.4 4 Distant#4;Zeeisnowincreasinginvestmentsinthismarket ZeeKannada 11.9 3 MarketleaderUdayaTV(SunGroup)has27% ZeeTelugu 14.1 3 Joint#3withETV Sports# 36.4 2 Somegoodcricketandotherproperties ZeeCafe 13.5 3 Distant#3;AXNhas~50%share. ZeeStudio 4.3 5 Distant#5;StarMovieshas34%share Source:TAMdata,IIFLResearch*Marketshareofa)2QFY13forZeeCinema,b)3QFY12Ͳ2QFY13forsportsandc)1HFY13forallothergenres #SonyMAXwhichtelecastsmoviesandcricket(IPL)isnotincludedformarketsharecalculationofsportsgenre [email protected] 35 Institutional Equities Zee Entertainment – BUY Figure1.3: ZeeandStarhavethemostformidablebouquetofchannels Keygenres ZeeEntertainment StarNetwork Sony Network18 SunNetwork Hindi SonyEnt. ͲGEC ZeeTV StarPlus Colors SonySAB ZCinema,ZClassic, StarGold ͲMovies SonyMAX ZAction,ZPremier MoviesOk Regional ͲTamil ZeeTamil StarVijay SunTV+6channels ͲKannada ZeeKannada AsianetSuvarna ETVKannada Udaya+5channels ͲTelugu ZeeTelugu ETV Gemini+6channels ZeeBangla ͲBangla StarJalsha ETVBangla ZeeBanglamovie ZeeMarathi ͲMarathi StarPravah ETVMarathi ZeeTalkies(movie) ͲMalayalam Asianetchannels Surya+2channels ͲBhojpuri TenCricket,TenSports StarCricket SONYMAX Sports TenAction,TenGolf StarSports,ESPN SONYSIX English ͲGEC ZeeCafe StarWorld AXN ComedyCentral ͲMovies ZeeStudio StarMovies,MoviesNow SonyPIX Others(Hindi/English) TheDisney ͲKids ZeeQ channel Nick,Hungama ͲYouthEntertainment LifeOK ͲLifestyle ZeeTrendz ͲMusic Zing,ETC VChannel SonyMIX MTV,Vh1 NationalGeographic ͲInfotainment Historychannel FoxHistory Source:Company,IIFLResearch Legend StrongPlayer WeakPlayer Nopresence(ornegligible) [email protected] 36 Institutional Equities Zee Entertainment – BUY Well diversified ad revenue Diversified advertising revenue base cushions earnings from Zee TV, the flagship channel, accounts for ~38% of Zee’s advertising weakness in performance of revenue and ~20% of total revenue. The remaining advertising an individual channel revenue comes from regional movies, sports, music and other channels; none of these channels contributes more than 15% to the company’s advertising revenue. Zee also earns advertising revenue from overseas markets and the bouquet of local channels (Zee Aflam and Zee Alwan) offered to the Indian Diaspora in overseas markets. This well diversified advertising revenue base cushions the company’s earnings from weakness in the performance of an individual channel. Figure1.4: Zee’sadvertisingrevenueiswellspreadacrosschannels Oveseas ZeeRegional 6% 24% Others 11% ZeeTV Sports 37% 8% Movies 14% Source:IIFLResearch Reinvesting in existing bouquets Hitherto, Zee had chosen profitability over viewership share while making programming decisions. Its underinvestment in content was a source of worry because it could have led to loss of market share and helped competition to strengthen its foothold. In a welcome change of strategy, the management indicated that it would increase investment across genres. Zee Entertainment’s spend on movie acquisition increased 52% YoY to Rs3.3bn in FY12. Besides the higher investment in the acquisition of movies rights, the change in strategy is also evident in increased original programming hours (OPH) on its flagship channels. The results are already visible with Zee’s advertising revenue growth outpacing industry growth. Figure1.5: OPH*oftheflagshipchannelincreased~25%;themanagementexpects OPHtoincreaseto30Ͳ35inthemediumterm (Originalprogramminghours/week) 28 24 20 16 NovͲ09 OctͲ10 FebͲ12 NovͲ12 Source:Company,IIFLResearch*Originalprogramminghours [email protected] 37 Institutional Equities Zee Entertainment – BUY Figure1.6: Zee’sadvertisingrevenuegrowthhassignificantlyimprovedrelativeto competitionasitsinvestmentsincontenthavestartedpayingͲoff (YoYgrowth%) ZeeEntertainment SunTV 40 30 20 10 0 (10) (20) Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY12 FY13 Source:Company,IIFLResearch New channels launches and New channels lay the foundation for long-term growth investments in existing In keeping with its tradition, Zee is creating newer genres and channels would further making renewed push in genres where the opportunity is now easier strengthen Zee’s strong bouquet to exploit. We believe these initiatives would further strengthen its already strong channel bouquet, increasing the network’s market share. A stronger bouquet of channel would enable the company to exploit the subscription revenue stream in digital broadcasting- distribution space better. Additionally, in the medium term, as these channels garner viewership share, it would enable Zee to beat industry’s advertising revenue growth. Figure1.7: Zee’srecentchannellaunchesinIndianmarket Channel Comment ZeeBanglaMovie India'sfirst24hoursBengalimoviechannel ZeeQ Children'schannelforeducationandentertainment;thismarks Zee'sentryinfastgrowingkidsentertainmentsegment Source:Company,IIFLResearch Inspired by the success of Overseas markets present new growth opportunity its movie channel in Middle Zee is embarking on increasing its viewer base from 670m to 1bn in East, Zee recently launched the medium term, which would partly come from overseas markets. a GEC in the region Expansion in the overseas markets, especially the Middle East and Africa, is the corner stone to Zee’s long-term growth strategy. Zee already had presence in the Middle East market through its movie channel Zee Aflam. It recently strengthened its presence in the market with the launch of Zee Alwan, a general entertainment channel. The advertising market in the Middle East is estimated at US$2bn and thus represents a big opportunity. The prospects for overseas ventures look promising, given that Zee Aflam has been able to build a loyal viewer base and achieve Ebitda breakeven within three years. Zee’s overseas investments could boost medium– to-long-term earnings growth prospects. Outlook for sports business improving Zee’s strategy for the sports business came under investor scrutiny as sports losses spiralled over the past two years. The following two key changes should improve profitability of the sports business in the years ahead. Firstly, profitability of the key sporting event depends on the ability to exploit the subscription revenue stream. Impending digitisation would significantly improve monetisation of the sports [email protected] 38 Institutional Equities Zee Entertainment – BUY properties. Secondly, a nominal increase in cost of rights for key cricketing properties on renewal is a positive. For example, Zee renewed rights for cricket in South Africa at US$22.5m/year for 2012-19 compared with the US$18.5m/year for 2008-11. Sports losses are likely to Incipient signs of improvement in profitability are visible come down from Rs1.5bn in Zee’s high sports losses are typically associated with higher FY12 to less than Rs1bn in cricketing days involving India. In 2QFY13 despite telecast of India FY13 Sri Lanka series, sports losses reduced and were below the quarterly run-rate, led by significant improvement in advertisers’ interest. In addition, note that higher FY12 losses were partly associated with one-time events - launch of Ten Golf and a sports channel in high definition. Figure1.8: RevenueandEbitdatrendsofZee’ssportsbusiness (Rsm) Revenues(LHS) Ebitda(RHS) (Rsm) 2,000 0 (200) 1,500 (400) 1,000 (600) (800) 500 (1,000) 0 (1,200) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY10 FY11 FY12 FY13 Source:Company,IIFLResearch [email protected] 39 Institutional Equities Zee Entertainment – BUY Subscription story keeps getting better Subscription revenue – multiple drivers Hitherto, a combination of low ARPUs, monopoly of local cable operators (LCOs) on the last mile and focus on advertising revenue deprived Indian broadcasters of their legitimate share of subscription revenue. We see this situation changing in coming years. Ongoing digitisation and increasing proliferation of DTH services would ensure equitable distribution of subscription revenue in the years ahead. In this environment, Zee is best placed to monetise its content, given its strong bouquet of channels and a distribution joint venture with Star, another strong broadcasting network in the country. Digitisation would ensure Digitisation to drive cable subscription revenues equitable distribution of Complete transparency in the broadcasting distribution space would subscription revenue increase Zee’s subscription revenue threefold, even without a price increase. At present, broadcasters barely receive their due share from the cable operators. This is evident from the fact that DTH, with less than half of the cable subscriber base, contributes ~10% higher subscription revenue than cable. Figure1.9: Despite a lower subscriber base, DTH contributes more to Zee’s subscriptionrevenuecomparedwithcable (Rsm) Revenues(LHS) Netsubbase(RHS) (mn) 1,500 100 1,350 75 1,200 50 1,050 25 900 0 Cable DTH Source:Company,IIFLResearch.(2QFY13ii) As per our calculations, Zee’s ARPU from its cable subscriber base is a third of that from its DTH subscriber base. We believe digitisation is the first and an important step in bridging this gap. It is easier to increase cable tariffs and gain higher revenue share from LCOs in the digitised broadcasting distribution space. On phased implementation of mandatory digitisation, we expect gradual improvement in cable ARPU for Zee. Experience from DTH suggests that digitisation of broadcasting delivery leads to a sharp improvement in subscription revenue of broadcasters. Figure1.10: Digitisationtimelines Phase Area Timeline Subscribers(mn) Phase1 Delhi,Mumbai,Chennai,Kolkata31stOct2012 8 Phase2 Citieswithpopulation>1m 31stMar2013 23 Phase3 Allurbanareas(Municipalareas) 30thSep2014 60 Phase4 RestofIndia 31stDec2014 Source:Company,IIFLResearch [email protected] 40 Institutional Equities Zee Entertainment – BUY Figure1.11: Rapid growth in Zee’s subscription revenue from DTH; Pay revenue fromcablewouldfollowthistrendondigitisation 1,600 (Rsm) 1,200 800 400 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY08 FY09 FY10 FY11 FY12 FY13 Source:Company,IIFLResearch Figure1.12: Zee’scableARPUhasahugeupsidepotential FY12 DTH Cable Paysubscriberbase(net)mn 22 66 Contributiontosubscriptionrevenues(Rsm) 4,801 4,417 ARPU(Rs/month) 18 6 Zee'scableARPUas%ofDTH 30.7 Source:Company,IIFLResearch Figure1.13: Zee’ssubscriptionrevenuecouldtripleoncompletedigitisation,even withoutanypriceincrease FY12 Oncompletedigitisation Sub.base Revenues Sub.base Revenues Analoguecable 62 4,417 0 0 Digitalcable 4 NA 72 15,487 DTH 22 4,801 37 8,179 Totalrevenue 9,218 23,666 ARPU Analoguecable 6 NA Digitalcable NA 18 DTH 18 18 Source:Company,IIFLResearch Strong bargaining power of MediaPro has formidable prospects MediaPro has helped Zee In July 2011, India’s two largest broadcasters Zee and Star Network better monetise its content merged their distribution arms to form MediaPro. As per the agreement, MediaPro, a single entity, is now distributing all channels, excluding the sports channels. Its bouquet consists of 67 channels, including some of the most popular channels in the country. This bouquet enjoys market share upward of 50% in several micro markets, e.g. Maharashtra and West Bengal. MediaPro would enable Zee to improve monetisation of its content even in case there are delays in implementation of the remaining three phases of digitisation. Since formation of the joint venture, Zee’s domestic subscription revenue increased 35%, largely because of higher revenue from cable operators. [email protected] 41 Institutional Equities Zee Entertainment – BUY Figure1.14: Zee’s subscription revenue increased ~35% within five quarters of formationofMediaPro Subscriptionrevenue(LHS) Sub.revenuegrowthYoY(RHS) (%) 3,000 35 (Rsm) FormationofMediaPro 2,500 30 25 2,000 20 1,500 15 1,000 10 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q1 Q2 Q3 Q4* FY11 FY12 FY13 Source:Company,IIFLResearch*WehaveequallydistributedRs506m(includedin4QFY12 subscriptionrevenue)pertainingtoJuly11ͲMarch12periodacross2QͲ4QFY12. [email protected] 42 Institutional Equities Zee Entertainment – BUY Strong earnings growth; high visibility Advertising revenue growth to remain robust Ad spend in FMCG, the key Zee’s ad revenue, post 7% decline in FY12, is set to grow by ~25% advertising category, in FY13. Low base, increased OPH and sizeable investment in movie remains strong library were key drivers. We believe gains from these tailwinds have been largely realised. Zee’s ad revenue growth would remain healthy but a significant outperformance over industry is unlikely. Despite lower GDP growth we expect industry’s ad-spend growth to remain at ~10% (vs. ~14.2% over CY05-12ii) on the back of structural drivers such as low ad-spend-to-GDP ratio, strong consumption growth and increasing reach of television. We forecast 13% Cagr in Zee’s ad-revenue over FY13-15ii, slightly higher than the industry, given its increasing network market share. Figure1.15: AdͲrevenuegrowthtoremainrobust (Rsm) Adrevenue(LHS) GrowthYoY(RHS) (%) 25,000 30.0 20,000 20.0 15,000 10.0 10,000 0.0 5,000 (10.0) FY11 FY12 FY13ii FY14ii FY15ii Source:Company,IIFLResearch Digitisation: We build in benefit from phase I and II of digitisation with a lag We forecast a 17% Cagr over FY12-15ii driven by combination of digitisation and better monetisation of content by Media Pro. Based on our industry interactions we model a slightly lower ARPU from digital cable subscriber as compared to DTH. Digital cable and DTH ARPU would converge eventually. However, in initial years broadcasters are likely charge less for their content to support cable business. We also build in a 6-months lag between digitisation and increase in subscription revenues. For DTH, we model 8% growth in line with increase in net subscriber base. [email protected] 43 Institutional Equities Zee Entertainment – BUY Figure1.16: Zee's domestic subscription revenue could increase by ~60% on completionofphaseII Domesticsubscriptionrevenue 25,000 (Rsm) 150%increase 20,000 15,000 60%increase 10,000 5,000 0 FY12 FY15 Completedigitisation Source:Company,IIFLResearch Margins not at risk despite investments Lower sports losses and Zee has been increasing its investments in the existing bouquet and higher subscription revenue launching new channels as well. Investors are concerned that the would cushion margins resultant increase in expenses would lead to erosion of Ebitda margins. Despite an expected increase in expenses, we forecast an improvement in margins over the next two years. We see three margins levers. Firstly, sports losses would come down drastically in the quarters ahead. Additionally, digitisation would lead to better monetisation of sports content. Subscription revenue does not have any cost attached to it. Expected strong growth in this revenue stream increases Zee’s flexibility to invest without hurting margins. Lastly, in the medium term as new initiatives build revenue streams their losses would reduce. Figure1.17: Zee’sEbitdamarginssettoimprove (Rsm) Revenue(LHS) Ebitdamargin(RHS) (%) 50,000 30.0 40,000 28.0 30,000 26.0 20,000 24.0 10,000 22.0 0 20.0 FY11 FY12 FY13ii FY14ii FY15ii Source:Company,IIFLResearch [email protected] 44 Institutional Equities Zee Entertainment – BUY Figure1.18: Lowersportslossestooffsetincreaseinlossesonnewinitiativespartly (Rsm) Sportslosses Lossesonnewinitiatives 3,000 2,400 1,800 1,200 600 0 FY12 FY13ii Source:Company,IIFLResearch Expect earnings to grow at 18% Cagr over FY12-15ii Higher subscription revenue We expect strong revenue growth and improving Ebitda margins and better monetisation of would drive 18% Cagr in earnings over FY12-15ii. There are several sports content on digitisation pose upside upside risks to our estimates, namely: 1) lower sports losses as risks to our estimates monetisation of sports content improves in the digital environment; and 2) higher subscription revenue in FY15 if there is no delay in implementing phase II of digitisation. Cash conversion remains strong Conversion of gross cash Despite strong profitability, Zee’s operating cash flow until FY10 flow to operating cash flow remained subdued owing to funds lent to group companies. In FY10, has increased from <50% until FY09 to >75% in Zee recovered all the loans and stopped the practice of extending recent years loans to group companies. This led to significant improvement in its cash generation. Conversion of gross cash flow to operating cash flow increased from less than 50% until FY09 to more than 75% in recent years. The decline in conversion of operating cash flow into free cash from 90% in FY11 to 75% in FY12 is primarily because of higher spend on movie rights. Figure1.19: RelatedͲpartylendinghascomedownsinceFY10 Loansandadv.given Loansandadv.(repaymentrecd.) 18,000 (Rsm) 15,000 12,000 9,000 6,000 3,000 0 FY06 FY07 FY08 FY09 FY10 FY11 FY12 Source:Company,IIFLResearch. [email protected] 45 Institutional Equities Zee Entertainment – BUY Figure1.20: Cash conversion remains healthy, although it is marginally hurt by higherworkingcapitalinFY12 Op.CashflowbeforeWͲCapchanges Op.CashͲflowafterWͲCapchanges 16,000 (Rsm) 11,500 7,000 2,500 (2,000) FY06 FY07 FY08 FY09 FY10 FY11 FY12 Source:Company,IIFLResearch.Cashprofitfromoperations=NOPAT+depreciation Payout to shareholders has improved Zee’s payout has gone up Zee has been consistently increasing its payout over the past five from 26% of PAT in FY08 to years. The company’s payout (dividends + buyback) has gone up 68% in FY12 from 26% of PAT in FY08 to 68% of PAT in FY12. During the same period, the company has also turned from a net-debt (~Rs2bn net debt in FY08) to a net-cash company (Rs10.6bn net cash in FY12). This improvement is largely due to improved cash conversion led by better working capital management. The management believes that its growth plans and any inorganic growth can be easily funded from existing cash reserves and debt. Thus, we believe, the company will largely use free cash flow to pay shareholders. Figure1.21: Payouttoshareholdersontherise (Rsm) Totalpayout(LHS) Totalpayoutas%ofPAT(RHS) (%) 5,000 75 4,000 60 3,000 45 2,000 30 1,000 15 0 0 FY08 FY09 FY10 FY11 FY12 Source:Company,IIFLResearch [email protected] 46 Institutional Equities Zee Entertainment – BUY Figure1.22: Overallcashpositionhasimproved Cash&cashEq. GrossDebt 12,000 (Rsm) 10,000 8,000 6,000 4,000 2,000 0 FY08 FY09 FY10 FY11 FY12 Source:Company,IIFLResearch Strong earnings growth and high visibility to drive performance Zee’s cash generation has significantly improved over the past few years and the company has also increased its payout (dividend + buyback at 68% in FY12 vs 27% in FY08). A large proportion of subscription revenue and dependence on bouquet of channels lend high visibility to Zee’s earnings. At 23.3x FY15ii P/E, valuations are reasonable considering high earnings visibility and potential upside from digitisation. We see upside risks to our estimate of 18% EPS Cagr for FY13-15ii from recovery in GDP growth and effective implementation of digitisation. Figure1.23: Zeeistradingat27x1ͲyearforwardP/Emultiple 270 30x (Rs) 25x 220 20x 170 15x 120 70 20 (30) 06 06 07 07 08 08 09 09 10 10 11 11 12 12 13 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Jul Jul Jul Jul Jul Jul Jul Jan Jan Jan Jan Jan Jan Jan Jan Source:Company,IIFLResearch Assumptions Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii AdͲrevenuegrowth(%) 59.4 (6.9) 23.5 12.9 13.1 Subscriptionrevenuegrowth(%) 14.1 17.6 18.8 11.3 11.7 Source:Companydata,IIFLResearch [email protected] 47 Institutional Equities Zee Entertainment – BUY Financial summary Incomestatement summary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Earnings suppressed by Revenues 29,436 30,405 36,761 41,222 46,318 sports losses and Ebitda 7,566 7,395 9,596 11,010 12,629 investments in new initiatives Depreciationandamortisation (288) (323) (380) (436) (491) Ebit 7,277 7,072 9,216 10,574 12,137 NonͲoperatingincome 851 1,384 1,285 1,600 1,615 Financialexpense (104) (50) (80) (60) (20) PBT 8,025 8,406 10,421 12,114 13,732 Exceptionals 770 0 0 0 0 ReportedPBT 8,795 8,406 10,421 12,114 13,732 Taxexpense (2,544) (2,500) (3,074) (3,574) (4,051) PAT 6,251 5,906 7,347 8,540 9,681 Minorities,Associatesetc. 118 (15) (10) (10) (10) AttributablePAT 6,370 5,891 7,337 8,530 9,671 Ratioanalysis Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Persharedata(Rs) PreͲexceptionalEPS 5.7 6.1 7.7 8.9 10.1 DPS 2.0 1.5 2.0 3.0 3.5 BVPS 31.7 35.8 41.3 46.8 52.9 Growthratios(%) Revenues 33.8 3.3 20.9 12.1 12.4 Ebitda 23.3 (2.3) 29.8 14.7 14.7 EPS (17.9) 7.3 25.2 16.3 13.4 Profitabilityratios(%) Ebitdamargin 25.7 24.3 26.1 26.7 27.3 Ebitmargin 24.7 23.3 25.1 25.7 26.2 Taxrate 28.9 29.7 29.5 29.5 29.5 Netprofitmargin 21.2 19.4 20.0 20.7 20.9 Returnratios(%) ROE 16.2 18.1 19.9 20.3 20.4 ROCE 23.1 25.9 28.4 28.9 28.9 Solvencyratios(x) NetdebtͲequity (0.3) (0.3) (0.3) (0.4) (0.4) NetdebttoEbitda (1.2) (1.4) (1.4) (1.5) (1.6) Interestcoverage NM NM NM NM NM Source:Companydata,IIFLResearch [email protected] 48 Institutional Equities Zee Entertainment – BUY Balancesheetsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Cash & cash equivalents 8,722 10,607 13,331 16,630 20,611 Healthy net cash position is sufficient to Inventories 5,396 7,339 8,647 9,936 11,132 fund growth Receivables 8,955 8,690 10,507 11,782 13,238 Othercurrentassets 4,818 6,105 6,105 6,105 6,105 Creditors 5,315 6,886 8,130 9,041 10,082 Othercurrentliabilities 2,486 1,933 2,033 2,133 2,233 Netcurrentassets 20,090 23,922 28,427 33,279 38,771 Fixedassets 8,582 9,432 10,042 10,396 10,694 Intangibles 00 0 00 Investments 2,099 675 675 675 675 OtherlongͲtermassets 192 337 337 337 337 Totalnetassets 30,963 34,366 39,481 44,686 50,477 Borrowings 17 12 12 12 12 OtherlongͲtermliabilities 0 46 46 46 46 Shareholdersequity 30,946 34,308 39,423 44,628 50,419 Totalliabilities 30,963 34,366 39,481 44,686 50,477 Cashflowsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Ebit 7,277 7,072 9,216 10,574 12,137 Taxpaid (2,657) (2,500) (3,074) (3,574) (4,051) Depreciationandamortization 288 323 380 436 491 Networkingcapitalchange (683) (1,947) (1,781) (1,553) (1,512) Otheroperatingitems 1,501 1,151 0 00 Operatingcashflowbefore 5,727 4,099 4,741 5,884 7,066 Steady free cash flow; interest Significant improvement in payout in FY12 Financialexpense (104) (50) (80) (60) (20) NonͲoperatingincome 851 1,384 1,285 1,600 1,615 Operatingcashflowafterinterest 6,475 5,433 5,946 7,424 8,661 Capitalexpenditure (389) (1,260) (1,000) (800) (800) LongͲterminvestments (217) 1,424 0 00 Others (949) 274 0 0 0 Freecashflow 4,919 5,872 4,946 6,624 7,861 Equityraising 70 (2,311) (5) 0 (1) Borrowings (1,178) (5) 0 00 Dividend (2,274) (1,671) (2,217) (3,325) (3,879) Netchgincashandequivalents 1,537 1,885 2,724 3,299 3,981 Source:Companydata,IIFLResearch [email protected] 49 Institutional Equities Zee Entertainment – BUY This page is left blank intentionally [email protected] 50 Institutional Equities CMPRs475 Sun TV Networks ADD Target12mRs505(6%) Marketcap(US$m) 3,523 Out of eclipse Enterprisevalue(US$m)3,465 Bloomberg SUNTV IN Sun TV, the largest broadcaster in south India, is one of the the key beneficiaries of digitisation and secular growth in Sector MEDIA advertising spend. The company’s business is firmly back on the strong growth path despite the negative impact of change Feb052013 in the political regime in Tamil Nadu. The company has largely been able to retain viewership share even in a hostile 52WkHigh/Low(Rs) 495/177 environment, exhibiting the inherent strength of its business model. Recovery in ad-revenue growth, along with multiple Shareso/s(m) 394 drivers for subscription revenue, would drive ~15% earnings Dailyvolume(US$m) 10 Cagr over FY13-15ii. Its diversified revenue stream, low-cost Dividend yield FY13ii (%) 1.8 business model, and low-risk programming strategy, offer a Freefloat(%) 23.0 high earnings visibility. Retain ADD. Shareholdingpattern(%) Southern media powerhouse: Sun TV is the dominant TV Promoter 77.0 broadcaster in southern India with leadership in three of the four FII 13.5 major markets. Despite the recent increase in competition and a hostile environment in the key Tamil market, Sun TV has managed DII 2.2 to retain its No. 1 position in all the three states. A strong and Others 7.2 diversified bouquet of channels and an unmatched movie library are its key strengths. These place Sun TV in a good position to capitalise Priceperformance(%) on the fast-growing Rs40bn+ advertising market of south India. 1M 3M 1Y SunTV 8.2 40.3 54.1 Subscription revenue set for strong growth: Sun TV’s pay Absolute(US$) 12.8 45.9 40.6 revenue growth suffered due to a sharp reduction in cable Rel.toSensex 8.8 35.5 42.5 subscription revenue in Tamil Nadu following Arasu’s takeover of cable operations in the state. We believe pay revenue growth is set CAGR(%) 3yrs 5yrs to accelerate driven by: 1) digitisation of over 4m subscribers in its EPS 23.4 22.9 key markets in phase II; 2) better monetisation of content in digitised markets ex-south India; 3) ongoing migration from cable to Stock movement DTH in some markets driving DTH pay revenue; and 4) focus on Shares(000') Volume(LHS) (Rs) newer overseas markets and increase in penetration in the US. Price(RHS) 50,000 600 40,000 500 Strong earnings growth; reasonable valuations: Revival in ad- 400 30,000 spend growth, coupled with acceleration in pay revenue, would 300 20,000 200 translate into 15% Eps Cagr over FY13-15ii. Sun TV’s stock price is 10,000 100 up ~55% over the past year as the company exhibited strong 0 0 operating performance despite a hostile political regime. The stock is 11 11 11 11 11 11 12 12 12 12 12 12 13 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ currently trading at 19.8x FY15ii P/E, in line with the historical Apr Jun Oct Apr Jun Oct Feb Aug Feb Aug Feb Dec Dec trading multiple. We believe valuations do not fully capture improvement in business outlook from digitisation. ADD. Financialsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Revenues(Rsm) 20,135 18,472 19,323 22,294 25,092 Ebitdamargins(%) 78.4 76.6 75.7 75.5 74.4 PreͲexceptionalPAT(Rsm) 7,698 6,929 7,160 8,420 9,476 ReportedPAT(Rsm) 7,698 6,929 7,160 8,420 9,476 PreͲexceptionalEPS(Rs) 19.5 17.6 18.2 21.4 24.0 Bijal Shah Growth(%) 48.1 (10.0) 3.3 17.6 12.5 [email protected] IIFLvsconsensus(%) 1.5 (0.4) (6.2) 91 22 4646 4645 PER(x) 24.3 27.0 26.1 22.2 19.8 ROE(%) 37.2 29.1 26.8 27.6 26.8 Jaykumar Doshi Netdebt/equity(x) (0.3) (0.1) (0.2) (0.3) (0.5) [email protected] EV/Ebitda(x) 11.4 13.0 12.4 10.5 9.1 912246464668 Price/book(x) 8.3 7.5 6.6 5.7 4.9 www.iiflcap.com Source:Company,IIFLResearch.Priceasatcloseofbusinesson05February2013. 51 Institutional Equities Sun TV Networks – ADD Company snapshot Sun TV, one of the largest broadcasters in India, caters primarily to the south Indian markets. The network has a bouquet of 33 channels in four south Indian languages that span across general entertainment, news and children’s entertainment genres. It is the leading broadcaster in three of the four southern states and is second in the fourth state, Kerala. Sun TV’s reach extends to more than 95m households in India. It is also broadcast in more than 27 other countries. Sun TV has a unique, low-risk business model compared with most traditional media companies. Its huge movie library (>9,000 movies titles) with perpetual rights and in-house production are its key competitive advantages. It has also entered the radio business through various tie-ups and now owns and operates 46 FM radio channels across India through its various subsidiaries. Background Sun TV Network is a part of India’s largest media conglomerate, the Sun Group, run by Kalanithi Maran. Sun TV is a leader in the cable distribution business in Tamil Nadu through its cable arm Sumangali Cable Vision (SCV). In 2005, the Group entered the DTH segment through Sun Direct, which is a joint venture between the Maran family and the Astro Group of Malaysia. In 2008, Sun TV Networks entered the Tamil movie production and distribution business by setting up Sun Pictures. The Group owns two large-selling Tamil dailies—Tamizh Murasu and Dinakaran. The Group has close ties with DMK, the leading opposition party (was the ruling party prior to May 2011) in Tamil Nadu. SunTV’srevenuebreakͲup(FY13ii) SunTVhasleadingviewershipshareinTamilNadu,Karnataka andAndhraPradesh Programlicensing Broadcastfees (Marketshare%) TamilNadu Kerala income 8.9% Karnataka AndhraPradesh 4.5% 80 Cable 60 8.8% DTH 40 Advt.revenue 18.0% 51.2% 20 Moviedistr. 0 3.2% Jan Jan Oct Oct Oct Others July July July April April April 5.4% 2011 2012 Source:Companydata,IIFLResearch Source:TAMData,IIFLResearch Management Name Designation Remarks/managementdescription KalanithiMaran Chairman Holdsabachelor’sdegreeincommerceandamaster’sdegreeinbusinessadministration from the University of Scranton, USA. He launched Sun TV, India’s first regional entertainmentchannel,in1993. K.VijayKumar MD&CEO Has been the CEO of the company since July 2011. Prior to this, he served as Chief OperatingOfficer,Sr.VPofKannadaProgrammesandVPofUdayaTVatSunTV. Mr.SLNarayanan GroupCFO Mr.NarayananistheCFOofSunGroupwhich housestelevisionbroadcasting,airlines,DTH, IPL franchise, radio, newspaper and movies business. In past, he has worked with Max Healthcare,BhartiAirtel,HCLTechamongothers. Mr.VCUnnikrishnan CFO Mr.UnnikrishnanhasbeentheCFOofSunTVsince2010.PriortojoiningSunin2007,he workedwithKCPSugarandIndustries.Heisafellowcharteredaccountant. [email protected] 52 Institutional Equities Sun TV Networks – ADD Sun TV – A dominant force in the South Sustainable lead over competition in the southern markets Sun TV market leader in Sun TV is dominant force in the ~Rs40bn southern television three of the four southern advertising market. Sun TV’s strong bouquet of regional channels, a markets large movie library, and a deep understanding of the market has enabled it to maintain leadership in three of the largest southern markets. Despite a hostile operating environment in the Tamil market, Sun TV’s viewership was not negatively impacted. That said, Sun TV’s leadership has marginally weakened in Kannada and Telugu as competitors have gained market share. In the Malayalam market, Sun TV faces stiff competition from a newly launched channel - Mazhavil Manorama, to retain its second position. Nonetheless, Sun’s leadership in the southern market is undisputable and sustainable. Figure2.1: Sun TV enjoys dominating position in all southern market with an exceptionofMalayalam Linguisticmarket SunNetwork 2ndlargestnetwork Channels MͲshare Channels MͲshare Tamil 6 66 1(StarVijay) 9 Telugu 7 42 5(Maa) 26 Kannada 6 42 2(Star) 19 Malayalam 3 32 3(Star) 47 Source:TAMdata(FY13sofar),IIFLResearch Figure2.2: TamilisthelargestinRs40bnadͲmarketofthesouth Telugu Kannada 27% 19% Malayalam 15% Tamil 39% Source:Company,IIFLResearch Tamil market – Sun remains undisputed leader Sun’s leadership not Tamil is the largest southern market with ad-spend estimated at negatively impacted despite Rs15bn. Sun TV is the dominant network in this market with a inimical interests of the viewership share of ~67%. Despite a hostile political regime and loss state government of control of broadcasting distribution in the state, Sun TV’s viewership share has not been negatively impacted. Sun TV’s strong market position in the Tamil market is attributable to content and better understanding of the market. An analysis of the progress competing networks and their plans leads us to believe that these networks do not present a credible threat to Sun TV in the foreseeable future. [email protected] 53 Institutional Equities Sun TV Networks – ADD Figure2.3: Market share in Tamil Nadu remains healthy Figure2.4: Flagshipchannel,SunTV,hascloseto50%market despitehostilepoliticalenvironment shareintheTamilNadu (Marketshare%) TamilNadu SunTV StarVijay KalaignarTV 90 60 Changeinregime FormationofstateͲ (Marketshare%) 80 ownedArasucable 50 70 40 30 60 20 50 10 40 0 Jan Jan Jan Jan Oct Oct Oct Oct Jan Jan Jan Jan Oct Oct Oct Oct July July July July July July July July April April April April April April April April 2009 2010 2011 2012 2013 2009 2010 2011 2012 2013 Source:Tamdata,IIFLResearch Kannada: Maintains strong position despite competition Kannada market Sun TV, with viewership share of 42%, is the leading network in competition on the rise but Rs7bn the Kannada ad-market. This market is more competitive Sun remains a comfortable compared with Sun’s Tamil home market. Udaya TV, Sun TV’s leader general entertainment channel faces competition from Star Network’s Suvarna, but it enjoys a comfortable lead. The three other channels are ETV Kannada, TV9 Kannada and Z Kannada, with ~10% viewership share. Despite competition, Sun TV has been able to maintain its leadership position and a massive network lead of ~170% over the nearest competitor. Figure2.5: SunNetwork'sviewershipshareinKarnatakais Figure2.6: UdayaͲ Sun's flagship channel in Karnataka, has twicethatofitsnearestcompetitorͲStarNetwork significantleadovercompetition SunNetwork AsianetSuvarna(StarNetwork) (Marketshare%) UDAYA ETVKannada 60 Suvarna ZKannada (Marketshare%) 35 50 30 40 25 30 20 20 15 10 10 0 5 Jan Jan Jan Jan Oct Oct Oct Oct Jan Jan Jan Jan Oct Oct Oct Oct July July July July July July July July April April April April April April April April 2009 2010 2011 2012 2009 2010 2011 2012 2013 2013 SourceTamdata,IIFLResearch Telugu: Sun leader in a fairly competitive market Maa network could post Telugu, the second-largest regional entertainment market with serious competition in the estimated ad spend of Rs11bn, is fairly competitive. Telugu general long term entertainment space is even more completive with presence of four channels including Sun’s Gemini, which is leader in the market with viewership share of 27%. Sun TV is an undisputed leader in the market with viewership share of 42%. Maa, an upcoming network in the market, has gained 5% viewership share in a couple of years. However, with network viewership share of ~26%, it does not pose a credible threat to Sun TV’s leadership. [email protected] 54 Institutional Equities Sun TV Networks – ADD Figure2.7: Maa network has gained market share with Figure2.8: Gemini, Sun's flagship channel, maintains strong launchofnichechannels leadershipincompetitiveTelugumarket (Marketshare%) SunNetwork MaaNetwork Gemini Maa ZTelugu ETV 60 40 (Marketshare%) 50 30 40 30 20 20 Maalaunches's 10 10 dedicatedmoviechannel 0 0 Jan Jan Jan Jan Jan Jan Jan Oct Oct Oct Oct Jan Oct Oct Oct Oct July July July July July July July July April April April April April April April April 2009 2010 2011 2012 2009 2010 2011 2012 2013 2013 Source:Tamdata,IIFLResearch Malayalam: Asianet enjoying strong lead Mazhavil Manorama is The Malayalam market, with ad revenue of Rs5.5bn, is dominated by giving tough competition to two large networks Asianet (owned by Star) and Sun TV. Asianet has Sun for the second position viewership share of more than 50%. Its flagship channel Asianet in Kerala with viewership share of 42% is 3x more popular than Sun TV’s general entertainment channel Surya TV. Competition for the second spot in the general entertainment segment has intensified with the launch of Mazhavil Manorama (MM) from the Malayala Manorama group, publisher of the widely circulated Malayalam Manorama daily. Figure2.9: StarnetworkenjoysastrongleadinKerala Figure2.10: Surya TV, Sun's flagship channel in Kerala, faces closecompetitionforsecondspot SunNetwork Asianet(StarNetwork) SuryaTV Asianet MazhavilManorama 70 50 (Marketshare%) Asianetlaunches'smovie (Marketshare%) 60 channel 40 50 30 40 20 30 20 10 10 0 Jan Jan Jan Jan Jan Jan Jan Jan Oct Oct Oct Oct Oct Oct Oct Oct July July July July July July July July April April April April April April April April 2009 2010 2011 2012 2009 2010 2011 2012 2013 2013 Source:Tamdata,IIFLResearch [email protected] 55 Institutional Equities Sun TV Networks – ADD Subscription revenue: Multiple drivers Diversified subscription revenue stream Sun registered 25% Cagr in Subscription revenue contributed ~32% to Sun TV’s total revenue in subscription revenue over FY12. Pay revenue from the DTH subscriber base accounts for more FY07-12 than two-third its subscriber revenue. On an aggregate basis, subscription revenue grew at 25% Cagr over FY07-12, primarily driven by the stupendous growth in pay revenue from DTH. Subscription revenue from the overseas market grew at an annualised rate of 19%. The next phase of growth in subscription revenue would be led by digitisation. We expect subscription revenue to grow at 16% Cagr over FY13-15ii. Figure2.11: DTHisprimarilythedriverofSunTV’spayrevenue Overseas 14% DTH 58% Cable 28% Source:Company,IIFLResearch(FY12revenuebreakup) Cable: Digitisation to drive growth Phase I and II could double After a drop of 28% YoY in FY12, cable contributed 28% and 9% to Sun’s cable subscription Sun TV’s subscription and total revenue respectively. This drop was revenue owing to takeover of broadcasting distribution in key market of Tamil Nadu by Arasu, the state-owned cable operator. Cable subscription revenue started growing again as Arasu and Sun TV struck a content deal in 2QFY13. From here on, digitisation would primarily lead growth. Our calculation suggests that phase I and II of digitisation would double Sun’s cable subscription revenue. Figure2.12: SharpdropincablerevenueposttakeoverbyArasu 600 (Rsm) Takeoverof distributioninTN 450 byArasu 300 150 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY10 FY11 FY12 FY13 Source:Company,IIFLResearch [email protected] 56 Institutional Equities Sun TV Networks – ADD Tamil Nadu – digitisation may get delayed Digitisation-led gains from The first two phases of digitisation will cover six cities from Sun TV’s Tamil Nadu remain four markets (see table below). There is limited clarity with respect uncertain to the status of digitisation in Tamil Nadu. The state-owned cable operator Arasu has yet not received a digital cable license to operate in the state. In the absence of this issue being resolved, mandatory digitisation is unlikely to progress in the state. Even under an optimistic assumption of quick implementation, potential upside for Sun TV remains unclear. This is due to the fact that Arasu may not offer Sun TV a fair revenue share agreement. Arasu is in a strong bargaining power, given support of state and control over distribution in the state. Figure2.13: SizeoftelevisionmarketsinSunTV’skeystates PhaseI&IIcities City inmn Population TVhousehold 5mn subscribers in Sun’s TamilNadu Chennai 5.0 1.0 market covered in the first two phases of digitisation Coimbatore 1.1 0.2 AndhraPradesh Hyderabad 6.8 1.4 Visakhapatnam 1.7 0.3 Karnataka Bangalore 8.5 1.7 Mysore 0.9 0.2 Total 24.0 4.8 Source:Company,IIFLResearch DTH growth picking up Growth in pay revenue from DTH, after a registering a stupendous growth over FY08-11, has started languishing. Over the past few quarters, the paid DTH subscriber base of Sun TV has grown at a slow pace. Growth in the DTH subscriber base has recently picked up, driven primarily by digitisation. The management indicated that DTH uptake has significantly increased in Chennai. Due to the failure of state-owned MSO Arasu to digitise, cable subscribers have started to migrate to DTH. After several quarters of subsided growth, DTH subscription revenue grew 5% QoQ, driven by subscriber additions. We forecast 12% annualised growth in DTH subscription revenue over FY13-15ii Figure2.14: GrowthinDTHpayrevenuelikelytopickup (Rsm) DTHrevenue(LHS) Growth(RHS) (%) 1,000 100.0 750 75.0 500 50.0 250 25.0 0 0.0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY10 FY11 FY12 FY13 Source:Company,IIFLResearch [email protected] 57 Institutional Equities Sun TV Networks – ADD Newer markets to drive overseas subscription revenue Focus on new geographies Sun TV enjoys a loyal overseas viewership base of more than 575k. and deals with more platforms would drive Its international subscription revenue has grown at ~18% Cagr in overseas pay revenue constant currency over FY08-12ii. The company intends to tap newer overseas markets to monetise its content better. Additionally, it also plans to increase penetration in the US. The management expects these initiatives to drive ~8% Cagr over next 2-3 years. Figure2.15: Overseassubscriptionrevenuesettogrow~27%inFY13partlyaided bydepreciatingrupee 1,200 (Rsm) 900 600 300 0 FY08 FY09 FY10 FY11 FY12 FY13i Source:Company,IIFLResearch Digitisation to drive cable revenues from rest of India At present, Sun TV’s cable subscription revenue comes from the four southern markets. Its flagship channels are available in several large cities and are popular among the south Indians. In digital environment the company would be in position to monetise its content in these markets. At present, it is difficult to quantify potential upside from the same. [email protected] 58 Institutional Equities Sun TV Networks – ADD Growth revival to drive stock performance Ad-revenue growth - firmly back Sun TV’s ad revenue growth suffered in FY12 along with industry. After 18 months of anemic growth, industry’s ad-spend growth has started reviving. This was evident in strong 20% growth in Sun TV’s ad revenue in 3Q. Additionally, according to the management, this recovery was broad based and the momentum continues even after the festive season. The management is contemplating ad–rate increase in the coming six months. In the medium term, we expect Sun TV’s ad revenue to track industry growth. Figure2.16: Sun'sadrevenuegrowthreboundsin3QFY13 Expect Sun TV’ ad-revenue to grow in line with 60 industry (YoYAdrevenuegrowth%) 40 20 0 (20) 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q FY09 FY10 FY11 FY12 FY13 Source:Company,IIFLResearch Earnings to grow at 15% Cagr over FY13-15ii We expect Sun TV’s revenue to grow at 14% Cagr, driven by strong growth in subscription and advertising revenue. We expect Ebitda margins to remain stable at 75% as increase in costs would be in line with revenue growth. Sun TV accounts cost of movie rights in depreciation. Although the company increased its budget to acquire movies, we expect growth in depreciation expense to trail revenue growth. Reduction in distribution of movies explains the slower growth. We expect 15% Cagr in Eps over FY13-15ii. Upside risks to our earnings include: 1) strong ramp-up in margins of the radio business; and 2) higher-than-estimated ad-revenue growth. Valuations reasonable Sun’s low risk programming Sun TV enjoys an unmatched franchise in the southern region, with strategy, diversified revenue base, and cost leadership position in three of the four markets. Its diversified control, lend high visibility revenue model, tight leash on costs, and low-risk programming to earnings strategy offer high earnings visibility. Although, competition increased in recent times, it has not been able to dislodge Sun TV from its strong position in the market. Contrary to street’s fears, Sun TV’s business has withstood the political challenges, exhibiting the inherent strengths of its business model. Its earnings are now firmly back on growth trajectory. Sun TV’s PER since listing in April 2006 has ranged between 10-50x. The median PER over this period has been 20.8x. The stock is currently trading at 19.8x FY15ii PER and ~15% discount to peer Zee as against a premium in the past. Valuations have recovered from the lows of PER of 14x touched in August 2012. We recommend ADD, given reasonable valuations and strong earnings growth [email protected] 59 Institutional Equities Sun TV Networks – ADD Figure2.17: Sun TV's stock is trading at ~22.9x 1 yr forward P/E, as against 3 yr medianof~20x 800 40x (Rs/share) 30x 600 20x 400 10x 200 0 06 07 07 08 08 09 09 10 10 11 11 12 12 13 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Jul Jul Jul Jul Jul Jul Jul Jan Jan Jan Jan Jan Jan Jan Source:Company,IIFLResearch [email protected] 60 Institutional Equities Sun TV Networks – ADD Financial summary Incomestatementsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Revenues 20,135 18,472 19,323 22,294 25,092 Director’s remuneration accounts for ~26% of Ebitda 15,779 14,143 14,627 16,835 18,663 total cost above Ebitda Depreciationandamortisation (4,805) (4,736) (4,826) (5,234) (5,574) Ebit 10,974 9,408 9,801 11,601 13,089 NonͲoperatingincome 487 796 796 875 963 Financialexpense (23) (58) (58) (58) (58) PBT 11,439 10,145 10,538 12,418 13,993 Exceptionals 0 0 0 0 0 ReportedPBT 11,439 10,145 10,538 12,418 13,993 Taxexpense (3,831) (3,317) (3,477) (4,098) (4,618) PAT 7,608 6,828 7,060 8,320 9,376 Minorities,Associatesetc. 90 101 100 100 100 AttributablePAT 7,698 6,929 7,160 8,420 9,476 Ratioanalysis Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Persharedata(Rs) PreͲexceptionalEPS 19.5 17.6 18.2 21.4 24.0 High dividend payout at DPS 8.7 9.5 8.8 8.8 8.8 63% BVPS 57.2 63.7 71.7 82.9 96.8 Growthratios(%) Revenues 38.6 (8.3) 4.6 15.4 12.6 Ebitda 44.6 (10.4) 3.4 15.1 10.9 EPS 48.1 (10.0) 3.3 17.6 12.5 Profitabilityratios(%) Ebitda margins are significantly high owing Ebitdamargin 78.4 76.6 75.7 75.5 74.4 to: 1) movie telecast Ebitmargin 54.5 50.9 50.7 52.0 52.2 cost being included in depreciation; and 2) its Taxrate 33.5 32.7 33.0 33.0 33.0 prime-slot sale business model Netprofitmargin 37.8 37.0 36.5 37.3 37.4 Returnratios(%) ROE 37.2 29.1 26.8 27.6 26.8 ROCE 51.3 40.1 37.5 39.0 38.0 Solvencyratios(x) NetdebtͲequity (0.3) (0.1) (0.2) (0.3) (0.5) NetdebttoEbitda (0.4) (0.2) (0.5) (0.7) (0.9) Interestcoverage NM NM NM NM NM Source:Companydata,IIFLResearch [email protected] 61 Institutional Equities Sun TV Networks – ADD Balancesheetsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Cash&cashequivalents 6,899 3,393 6,774 11,437 17,639 Inventories 14 5 5 5 5 Receivables 4,291 5,090 5,325 6,144 6,915 Othercurrentassets 2,536 6,156 6,156 6,156 6,156 Creditors 2,728 2,016 2,188 2,543 2,995 Othercurrentliabilities 1,735 364 464 564 664 Netcurrentassets 9,278 12,265 15,609 20,635 27,056 Fixedassets 8,559 8,147 8,477 8,703 8,847 Intangible assets Intangibles 4,513 4,347 3,806 2,946 1,827 primarily represent un- amortised cost of movie Investments 1,848 1,926 1,926 1,926 1,926 rights OtherlongͲtermassets 00 0 00 Totalnetassets 24,198 26,684 29,817 34,209 39,657 Borrowings 10 0 00 OtherlongͲtermliabilities 1,659 1,565 1,545 1,525 1,505 Shareholdersequity 22,537 25,119 28,272 32,684 38,152 Totalliabilities 24,198 26,684 29,817 34,209 39,657 Cashflowsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Ebit 10,974 9,408 9,801 11,601 13,089 Taxpaid (3,831) (3,317) (3,477) (4,098) (4,618) Depreciationandamortization 4,805 4,736 4,826 5,234 5,574 Networkingcapitalchange (1,007) (6,493) 37 (363) (219) Otheroperatingitems 531 5 0 00 Operatingcashflowbefore 11,472 4,339 11,186 12,374 13,826 interest Financialexpense (23) (58) (58) (58) (58) NonͲoperatingincome 487 796 796 875 963 Operatingcashflowafterinterest 11,936 5,076 11,923 13,190 14,730 Capex includes movie Capitalexpenditure (5,450) (4,157) (4,615) (4,600) (4,600) purchases and Long term investments 1080 80 80 maintenance capex Ͳ estimated at ~Rs750m Others (406) (72) 0 0 0 Freecashflow 6,082 847 7,389 8,670 10,210 Equityraising 0 0 0 0 0 Borrowings 0 (1) 0 00 Dividend (4,015) (4,351) (4,008) (4,008) (4,008) Netchgincashandequivalents 2,067 (3,506) 3,381 4,663 6,203 Source:Companydata,IIFLResearch [email protected] 62 Institutional Equities CMPRs73 Target12mRs90(23%) Dish TV BUY Marketcap(US$m) 1,465 Driving the DTH story Enterprisevalue(US$m)1,622 Bloomberg DITVIN Dish TV is a play on secular growth in India’s pay-TV market Sector MEDIA and on digitisation. DTH is likely to garner a lion’s share of subscriber growth in smaller cities, given the weak presence of cable. Digitisation would bring about two long-awaited Feb052013 changes in the distribution space: 1) achieving a level-playing field between cable and DTH; and 2) laying the foundation for 52WkHigh/Low(Rs) 85/52 acceleration in ARPU growth. Meanwhile, within DTH, Shares o/s (m) 1065 reducing competitive intensity and a marked pricing discipline Dailyvolume(US$m) 6 are reassuring. Stable subscriber adds, accelerating ARPU DividendyieldFY13ii(%) 0.0 growth, and favourable operating levers, would help Dish TV Freefloat(%) 36.5 deliver 25%+ Ebitda Cagr over FY13-16ii. BUY. Shareholdingpattern(%) Dish TV a multi-year growth story: India is expected to add 67mn Promoter 63.6 TV households over next five years, largely coming from rural and FII 13.3 semi-urban areas. In these less densely populated areas, DTH has an edge over cable due to its low cost of delivery. Digitisation-led DII 4.6 convergence of tariffs places DTH is a better position to acquire Others 18.6 subscribers, given better product offering — SD with recording and HD. Dish TV, with an industry -leading market share and strong brand Priceperformance(%) franchisee, would emerge a key beneficiary. 1M 3M 1Y DishTV (6.3) (1.9) 13.7 Cable and DTH on equal footing; ARPU outlook improving: Absolute(US$) (2.9) 0.9 4.5 Digitisation will bring cable and DTH on an equal footing by Rel.toSensex (5.7) (6.7) 2.0 eliminating two long standing cost advantages of cable, tax evasion CAGR(%) 3yrs 5yrs and miniscule payment for content. Low cable tariffs have suppressed DTH tariffs. Digital cable tariffs are 25-30% higher than EPS (51.8) (17.8) analogue cable in the same markets. We believe digitisation will bring about a one-time upward correction in cable tariffs and set the Stockmovement stage for accelerated ARPU growth. We see upward risks to our Shares(000') Volume(LHS) (Rs) terminal ARPU assumption of Rs287/month in FY20 for Dish TV. Price(RHS) 30,000 100 25,000 80 Earnings at inflection; valuations attractive: Increasing 20,000 60 15,000 bargaining power for Dish TV will limit increases in content costs; 10,000 40 inflation in other costs will trail revenue growth, driving earnings. We 5,000 20 0 0 expect Dish TV to turn PAT positive in FY14 and its Ebitda to grow at 11 11 11 11 11 11 12 12 12 12 12 12 13 25% Cagr over FY13-16. Although Dish TV is well funded for its Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Apr Jun Oct Apr Jun Oct present subscriber growth, proposed equity issuance would strengthen Feb Aug Feb Aug Feb Dec Dec the balance sheet. Our DCF-based valuation yields a target price of Rs90; we reiterate BUY. Financialsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Revenues(Rsm) 14,367 19,579 22,138 25,804 30,956 Ebitdamargins(%) 16.6 25.3 27.4 30.3 32.0 PreͲexceptionalPAT(Rsm) (1,920) (1,331) (1,406) 773 2,803 ReportedPAT(Rsm) (1,920) (1,331) (642) 773 2,803 PreͲexceptionalEPS(Rs) (1.8) (1.3) (1.3) 0.7 2.6 BijalShah Growth(%) 262.6 [email protected] IIFLvsconsensus(%) 64.9 78.0 57.5 912246464645 PER(x) (40.4) (58.3) (55.2) 100.5 27.7 ROE(%) NA NA NA NA 472.0 JaykumarDoshi Netdebt/equity(x) NA NA NA NA (0.4) [email protected] EV/Ebitda(x) 34.9 17.4 14.2 10.6 7.7 912246464668 Price/book(x) 209.8 (82.7) (49.1) (96.1) 38.9 www.iiflcap.com Source:Company,IIFLResearch.Priceasatcloseofbusinesson05February2013. 63 Institutional Equities Dish TV – BUY Company snapshot Dish TV is the largest DTH service provider in India, with a subscriber base of 14.7m, translating into market share of ~28% in DTH. Dish TV has a presence in 8,500+ towns through a network of more than 114,000 dealers. The company offers more than 400 channels on the MPEG 2 technology platform. It also offers exclusive national and international channels, movies on demand, and interactive TV. Background Dish TV, part of the Subhash Chandra-promoted Essel Group, is a pioneer and leader in the DTH space in India. The company was listed in 2007 as part of de-merger of the former Zee Telefilms into four entities operating in separate verticals. Under a scheme of restructuring, all DTH-related assets of the Essel Group were transferred to Dish TV and in return, Zee Telefilms’ shareholders received 57% ownership in Dish TV. DishTVisthemarketleaderinDTH Rapidgrowthinsubscriberbaseoverthepastfewyears 14.7 Sun 15.0 Direct (mnsubcribers) 12.9 16% 12.0 Airtel 10.4 BigTV Digital 10% 9.0 16% 6.8 5.1 Videocon 6.0 D2h 3.0 3.0 2.1 TataSky 11% 0.7 19% 0.0 DishTV 12 Ͳ 28% FY06 FY07 FY08 FY09 FY10 FY11 FY12 Dec Management Name Designation Managementdescription JawaharlalGoel ManagingDirector InvolvedincreationandexpansionoftheEsselGroupandinstrumentalinestablishing DishTV. R.C.Venkateish CEO JoinedDishTVinJuly2010.Priortothis,hewasMDͲIndiaandSouthAsia,ESPNStar Sports.AnIIT,IIMgraduate,Venkateishhasover27yearsofexperienceanda successfultrackrecordinturningaroundbusinessesandreͲdefiningbusinessprocesses forwinningbrandslikeOralͲB,NestleandKelloggs. RajeevDalmia CFO Mr.DalmiaisaCharteredAccountantwithover20yearsofexperienceinfinanceand accounts. SalilKapoor JoinedDishTVinJuly2008.Mr.Kapoorisresponsibleforbrandbuildinganddriving marketinginitiatives.Priortothis,hewasnationalsalesheadofSamsung(India). [email protected] 64 Institutional Equities Dish TV – BUY Secular growth in subscriber base India– world’s 2nd largest TV market in secular growth phase India, with 155m TV households, is second only to China in terms of TV homes. However, TV penetration at 61% of addressable households is significantly lower than in developed and several developing markets. We expect growth in TV households to accelerate, as: 1) Increasing rural income and lower electronics prices improve affordability; 2) Increasing availability of DTH extends reach of pay channels to ‘cable–deficient’ zones; and 3) increasing electrification in rural areas drives more rural consumers to buy TVs. Figure3.1: Televisionpenetrationitselfoffershugescopeforgrowth 130 (%) 98 97 98 100 97 100 100 70 60.9 40 China Australia USA S.Korea UK Japan India Source:Industry,IIFLResearch DTH is well-placed to capitalise on TV penetration growth New TV homes would A large part of the expected increase of ~67m TV homes over the largely come from small next five years will come from smaller towns and villages, which are towns – a stronghold of cable black or cable deficient. In these less-densely-populated and DTH single storied residential units, DTH has an advantage over cable because: 1) In cable-black / deficient zones, cost of delivery of DTH would be a fraction of the cost of laying the last-mile cable. DTH’s low cost of delivery is 2) TV sets are often sold bundled with free set-top boxes and initial the key advantage over subscriptions—which enables DTH to wean away new TV cable households from the cable industry. 3) Digitisation of small towns may take much longer, given limited interest of the MSOs. DTH is a far superior product since it offers digital quality and more channels than an analogue connection. [email protected] 65 Institutional Equities Dish TV – BUY Figure3.2: Indiaisexpectedtoadd67mnTVhouseholdsovernext5years 300 (TVhouseholdsinmn) 250 200 150 100 50 0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source:Industry,IIFLresearch Dish TV’s leadership in DTH to continue Dish TV, the pioneer in Indian DTH industry, continues to be the market leader. Indian DTH industry saw the entry of several new players over 2006-09, which transformed it into a six-player industry. Some of these new entrants carried out aggressive marketing. Notwithstanding the increase in competition, Dish TV has enjoyed the highest market share in subscriber additions. Competitive intensity in the DTH industry is on the decline as two players, Sun Direct and RCOM, who have become less active, are losing market share. We expect Dish TV to retain its ~22% subscriber market share in subscriber additions. Figure3.3: DishTVhadaheadͲstartoveritscompetitors DTHserviceprovider Launchdate Subscribers*(m) DishTV MayͲ05 13.9 TataSky AugͲ06 9.7 SunDirect DecͲ07 7.8 BigTV AugͲ08 4.5 Airtel DecͲ08 8.4 Videocon NovͲ09 6.6 Source:Industry,IIFLResearch.AsatSepͲ12end Figure3.4: DishTV’scontinuestobethemarketleaderinDTHindustry In a six- player market, Dish TV has maintained DishTV TataSky Airtel market share at ~22% in SunDirect Videocon BigTV subs adds 40.0 30.0 20.0 10.0 0.0 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 FY11 FY12 FY13 Source:Company,IIFLresearch [email protected] 66 Institutional Equities Dish TV – BUY Phase II would boost subscriber adds DTH operators’ expected to The phase II of digitisation covers 38 cities with an aggregate cable fare better in Phase II cities subscriber base of ~23m. This represents a large opportunity for given strong their base DTH operators. But they could face stiff competition MSOs. Our interactions with large MSOs suggest that they would be well prepared to digitise their respective subscriber base. Nonetheless, we believe DTH could gain market share in these markets from smaller MSOs. Even large MSOs may find it difficult to achieve seamless execution, given the sheer scale of phase II. Widely anticipated postponement of the phase would hurt DTH operators as it allows more time to smaller MSOs to prepare for digitisation. Figure3.5: Digitisationtimelines Phase Area Timeline Subscribers(mn) Phase1 Delhi,Mumbai,Chennai,Kolkata31stOct2012 8 Phase2 Citieswithpopulation>1m 31stMar2013 23 Phase3 Allurbanareas(Municipalareas) 30thSep2014 60 Phase4 RestofIndia 31stDec2014 Source:Industry,IIFLResearch Phase III and Phase IV - bigger opportunity for DTH Limited presence of cable in Phase III of digitisation covers all the remaining urban areas and Phase III and IV areas to Phase IV covers the rest of India. Traditionally, cable players have help DTH been weak in these markets due to low carriage potential. MSOs are not overly enthused to strengthen their presence in a large part of phase III and phase IV. Besides STB subsidies, digitisation in some areas could entail additional cost for upgrading the last mile cable. This, along with low ARPUs, makes a weak business case for the MSOs. On the other hand, DTH players with low cost of delivery would be the key beneficiaries of phase III and IV of digitisation. Although we see low probability of effective implementation of phase III and IV digitisation, this subscriber base would come in the fold of DTH industry, over a period. [email protected] 67 Institutional Equities Dish TV – BUY Digitisation to bring about a level-playing field Digitisation brings cable and DTH on an equal footing Full payment of taxes and In an analogue environment, the cable industry enjoyed lower cost content cost would diminish positioning compared with DTH. This was possible because of cable’s cost advantage negligible payment for content and evasion of tax. Digitisation would bring transparency in the cable distribution space, leading to erosion of these advantages. Accordingly, cable would not be able to offer services at lower cost compared with DTH in the medium term. This would give DTH players more flexibility to price their products. Figure3.6: DigitalcabletariffsprovidespricingflexibilitytoDTHpack Analog Digitalcablepack DTHpack Base Mid Base Mid Packpriceincltaxes(Rs/m) 200 230 297 200 255 Less:Taxes 10 70 77 66 72 Netrealisation(Rs/m) 190 160 220 134 183 Source:IIFLresearch Churn away from cable could increase Low churn in cable partly Low tariffs charged by cable are one the important reason for due to low tariffs and free subscribers to choose cable over DTH. As explained earlier, connection for second TV digitisation would require cable to raise tariffs. Additionally, the second television would not go unpaid for, in digitised markets. As against plain vanilla STBs offered by cable, DTH gives STBs with a recording facility. Furthermore, cable is yet to focus on offering HD services. DTH, with similar tariff and better products, is well placed in the digital environment to wean away subscribers from cable. Figure3.7: NewTVhomescontribute35%toDTHsubscriberadditions Churnfrom NewTV Cable homes 65% 35% Source:Industry,IIFLresearch Competition within DTH on a decline DTH operators have Presence of six players makes investors wary due to possibility exhibited remarkable predatory pricing. An analysis of pricing of DTH products and discipline competitive behaviors dispels this concern. Firstly, of the six players, two operators have been largely dormant in the subscriber acquisition space. The DTH industry has made a series of price increases for recharge packs as well as for STBs. We expect continuation of the pricing discipline exhibited by the industry. [email protected] 68 Institutional Equities Dish TV – BUY Figure3.8: DTHplayershavetaken3pricehikesinpasteighteenmonths Tiers Package MayͲ07 SepͲ09 SepͲ10 MayͲ11 NovͲ11 JulͲ12 BasePacks Silver 130 150 150 Discontinued Silversaver 160 165 Discontinued SuperFamily 176 180 200 MidͲtierPacks Gold 235 250 250 Discontinued Goldsaver 265 285 Discontinued SuperGold 235 255 SuperWorld 285 305 TopͲtierPacks Platinum 285 300 335 350 360 380 Paradise 400 HDPacks HDWorld 375 385 HDPremium 450 450 460 HDRoyale 550 550 560 Source:DishTV,IIFLResearch Figure3.9: DishTV’ssubscriberacquisitioncosthasstabilized (Rs/subscriber) Subscriberacquisitioncost(SAC) 2,800 2,600 2,400 2,200 2,000 1,800 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q FY10 FY11 FY12 FY13 Source:Company,IIFLresearch [email protected] 69 Institutional Equities Dish TV – BUY Financials – Profitability set to improve Subs add to remain stable; digitisation could provide a boost We see stable gross DTH subscriber addition in the past couple of years has stabilised in addition and churn rates for 10-12m per annum range. Dish TV has an average market share of DTH ~22% in the industry sub adds. We expect gross subscriber addition in the DTH space to remain stable in the foreseeable future. The first two phases of digitisation would help subscriber adds. However, given cable’s stronghold on these cities, gains for DTH would be limited. In the medium term, an increase in TV penetration and migration from cable to DTH in less affluent parts of the country would be the key driver for DTH subscriber growth. Note that, stable gross additions translate into falling net subscriber additions. Figure3.10: DishTVhas22%marketshareinDTHsubscriberadditions DTHIndustry'sGrosssubadds(LHS) DishTV(RHS) 15.0 30.0 (mnsubs) (Marketshare%ingrosssubadds) 12.5 25.0 10.0 20.0 7.5 15.0 5.0 10.0 2.5 5.0 0.0 0.0 FY10 FY11 FY12 1HFY13 Source:VideoconD2HDRHP,IIFLresearch Figure3.11: Stablegrosssubaddsof2Ͳ2.5mandstablechurnof12%impliesfalling netsubadds 3.0 2.8 (mnsubs) 2.5 2.0 1.8 1.4 1.5 1.1 1.1 1.0 0.9 1.0 0.5 0.0 FY09 FY10 FY11 FY12 FY13ii FY14ii FY15ii Source:Company,IIFLresearch Digitisation – a structural growth driver for ARPU Despite having made five tariff increases, DTH ARPU in India at Rs190/month (gross of taxes) is one of the lowest in the world. Digitisation is likely to lead to accelerated growth in ARPUs in both the DTH and cable space. At present, we build in slow growth in ARPU until the implementation of phase II of digitisation, beyond which we expect acceleration in growth. We are modelling ~8% Cagr in Dish TV’s ARPU over FY12-20 on abysmally low tariffs at present. We see a meaningful upside risk to our terminal (FY20) ARPU of [email protected] 70 Institutional Equities Dish TV – BUY ~Rs340/month (gross of taxes). However, the higher growth would be back-ended. Further, note that entertainment tax is expected to subsume on implementation of GST. This in itself could provide a 5% boost to ARPU in the year of implementation. Figure3.12: Weexpect~8%CagrinDishTV’sARPUoverFY12Ͳ20ii (Rs/monthpersub) DishTVARPU(LHS) GrowthYoY(RHS) (%) 300 40 250 30 200 20 150 10 100 50 0 0 (10) FY08 FY09 FY10 FY11 FY12 FY13ii FY14ii FY15ii FY16ii FY17ii FY18ii FY19ii FY20ii Source:IIFLresearch Operating levers playing out Dish TV’s Ebitda margin has increased from 16.6% in FY11 to 26.9% in 9MFY13. Such a consistent improvement in profitability has been driven by increase in ARPU increase and operating leverage. A rapidly growing subscriber base has increased the company’s bargaining power and helped it manage content costs. Note that Dish TV’s per sub content cost has dropped from ~Rs65/month to ~Rs51/month over the past couple of years. While Dish TV is yet to turn PAT positive, the company has become free cash flow positive in FY13. Figure3.13: DishTV’sEbitdamarginexpansiontocontinue We expect 670bps improvement in Dish TV’s (Rsm) Ebitda(LHS) EbitdaMargin(RHS) (%) Ebitda margins over FY12- 2,000 40 15 1,500 30 1,000 20 500 10 0 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q FY11 FY12 FY13 Source:Company,IIFLResearch [email protected] 71 Institutional Equities Dish TV – BUY Figure3.14: SteadyincreaseinEbitda/subonrisingARPUsanddecliningcosts/sub (Rs/month) ARPU Operatingcosts/Sub Ebitda/Sub 180 150 120 90 60 30 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 FY11 FY12 FY13 Source:Company,IIFLResearch Content cost growth to remain moderate Content cost increase likely Investor’s have been worried that content fees paid to broadcasters to be in line with net would rise at an accelerated pace following expiration of the fixed- subscriber addition price deals in FY12. The increasing subscriber base gives DTH service providers a better bargaining position vis-à-vis broadcasters. This is reflected in Dish TV’s declining content cost per subscriber and as a proportion of its revenue. Despite this drop, DTH’s content cost, on per subscriber basis, is still significantly higher than that for cable, analogue as well as digital. We see moderate growth in Dish TV’s content cost in years ahead. Figure3.15: Contentcostas%ofrevenuessteadilydeclining (Rsm) Contentcosts(LHS) Contentcostsas%ofrevenue(RHS) (%) 7,500 60.0 6,000 50.0 40.0 4,500 30.0 3,000 20.0 1,500 10.0 0 0.0 FY08 FY09 FY10 FY11 FY12 FY13ii Source:Company,IIFLResearch Growth in other costs likely to trail revenue growth Large fixed cost base to Dish TV’s other operating costs include variable (license fees, drive positive operating commission and entertainment tax), semi-variable (subscriber leverage management and transponder costs) and fixed expenses (admin and employee expenses). Among variable expenses retailers’ commissions on recharge (~5% of recharge value) should gradually moderate as more subscribers move to online recharge. Dish TV’s transponder costs are likely to remain stable in the near term as the company has sufficient bandwidth to offer channels. Lastly, we expect an increase in the company’s fixed costs and all other semi variable costs to marginally trail revenue growth. [email protected] 72 Institutional Equities Dish TV – BUY Figure3.16: Increaseinfixedandsemivariablecoststotrailrevenuegrowth Employeeexp. Entertainmenttax 5% 5% Adminexp. Licensefees 7% 14% Advtexp. Transpondercosts 5% 8% Commission 10% Otherexp 5% Contentcosts 41% Source:Company,IIFLResearch Set to turn PAT positive in FY14 Dish TV has reported Dish TV is likely to turn PAT-positive in FY14. We expect ~10% several quarters of positive growth in subscribers and 8% growth in ARPUs to drive a strong free cash flow 30% Ebitda growth in FY14 (~300bps margin expansion). Additionally, we do not expect forex losses that significantly impacted Dish TV’s earnings in FY13 to recur. We forecast Dish TV to report a modest PAT of Rs768m in FY14 as against a loss of Rs641m in FY13ii. Note that, the company has turned free cash flow positive in FY13. Not constrained by funds but equity raising strategically correct Dish TV has negative net Dish TV has been contemplating an equity issuance for a while. It worth; equity infusion has board approval for raising up to US$200m. In our view, the would strengthen the company can comfortably achieve the current subscriber addition run balance sheet rate (2-2.5m subs/year) through internal accruals and cash balance. Our calculations suggest that the company should be able to fund 6m sub adds (FY14-15ii) from present cash balance (Rs3.6bn) and expected internal accruals. For higher subscriber addition (say 7m), the company may require debt or equity capital. Its net debt-to- Ebitda ratio stands at ~1.5x (FY13ii). Note that we are building in gross subscriber addition of 4.6m over the next two years. Figure3.17: Cashandinternalaccrualssufficienttofundgrowth Basecasegrowth Highgrowth Subscriberacquisitioncost(Rs/subscriber) 2,300 2,300 FY14Subscriberaddition(m) 2.53.5 FY14Subscriberacquisitioncost(Rsm) 5,750 8,050 Cashbalance 3,320 3320 Cashneeded 2,430 4,730 Cashgeneration 6,186 6,186 CashatFY14end 3,756 1,456 FY15Subscriberaddition(m) 3.0 4.0 FY15Subscriberacquisitioncost(Rsm) 6,900 9,200 Cashbalance 3,756 1,456 Cashneeded 3,144 7,744 Cashgeneration 8,513 8,513 CashatFY15end 5,370 770 Source:Company,IIFLResearch [email protected] 73 Institutional Equities Dish TV – BUY The above discussion suggests that Dist TV is well placed to fund its growth and does not need any capital infusion. Nonetheless, an equity issuance would be prudent in our view because: • At present, Dish TV’s balance sheet is considerably weak, given negative net worth of ~Rs1.5bn (FY13ii). • We see strong potential for HD services in the medium term. All present calculations for funding requirement are based on an overwhelming share of SD services. The possible switch in favour of HD could be beneficial to DTH operators. • At present, we are not building in large gains from phase II of digitisation and do not foresee effective implementation of phase III and IV. Nonetheless, the company should be well prepared for the same. We recommend BUY; target price of Rs90 We value Dish TV using the DCF methodology since the company is still in the investment mode. Ebitda in the near term will not fully capture the expected moderation in content cost and long-term ARPU growth prospects. Based on our assumption of 13% cost of equity and 4% terminal growth rate, our fair value estimate works out to Rs90, which represents 13% upside from the current price. On an EV/ Ebitda basis, at our target price, the stock would be trading at 13.4x on FY14ii—higher than global comparables, but justifiable in light of Dish’s Ebitda Cagr of 25%+ over FY13-16ii, as against most global comparables’ less than 10%. Figure3.18: DCFassumptionsandtargetprice Particulars Values Discountrate 13% Terminalgrowthrate 4% Terminalvalue(Rsm) 148,658 NPV(Rsm) 91,183 Add:Cash(Rsm) 4,794 Equityvalue(Rsm) 95,977 Equityshares(m) 1,061 Valuepershare(Rs) 90 Source:Company,IIFLResearch Assumptions Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Avg.Grosssubscriberbase(m) 8.6 11.7 14.1 16.4 18.7 Avg.Netsubscriberbase(m) 7.1 9.1 10.1 11.1 12.2 NetARPU(Rs/month) 139.9 153.2 161.6 174.5 195.5 Contentcostas%ofrevenues 35.1 31.0 29.8 29.0 29.0 SubscriberAdditionͲgross(mn) 3.6 2.5 2.3 2.4 2.2 Source:Companydata,IIFLResearch [email protected] 74 Institutional Equities Dish TV – BUY Figure3.19: AssumptionandcashͲflowschedule Subscribers(m) FY13ii FY14ii FY15ii FY16ii FY17ii FY18ii FY19ii FY20ii ͲGross 15.2 17.6 19.8 21.8 23.6 25.3 27.0 28.9 ͲNet 10.1 11.1 12.2 13.0 13.6 14.0 14.3 14.7 NetARPU(Rs/month) 162 175 195 219 241 258 273 287 (Rsm) FY13ii FY14ii FY15ii FY16ii FY17ii FY18ii FY19ii FY20ii PAT (597) 848 2,878 5,862 7,789 8,547 10,052 11,480 Depreciation 6,465 6,628 6,886 6,260 5,873 5,592 5,328 5,255 ChangeinwͲcapital 1,334 1,786 2,393 2,582 2,386 1,857 1,722 1,811 Capitalexpenditure (6,896) (6,384) (5,795) (5,372) (5,047) (4,501) (4,821) (5,167) FreecashͲflow 306 2,879 6,362 9,333 11,000 11,494 12,282 13,379 Changeinloans (1,000) 0 0 (3,000) (2,000) 0 0 0 Cashforequityshareholders (694) 2,879 6,362 6,333 9,000 11,494 12,282 13,379 Source:Company,IIFLResearch [email protected] 75 Institutional Equities Dish TV – BUY Financial summary Incomestatementsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Revenues 14,367 19,579 22,138 25,804 30,956 Revenue growth driven Ebitda 2,381 4,960 6,059 7,807 9,920 by subscriber adds and moderate growth in Depreciationandamortisation (3,996) (5,219) (6,465) (6,628) (6,886) ARPUs Ebit (1,615) (259) (405) 1,178 3,033 NonͲoperatingincome 1,226 707 510 860 1,060 Financialexpense (1,534) (1,780) (1,511) (1,265) (1,290) PBT (1,923) (1,331) (1,406) 773 2,803 Exceptionals 0 0 764 0 0 ReportedPBT (1,923) (1,331) (642) 773 2,803 Taxexpense 3 0 0 0 0 PAT (1,920) (1,331) (642) 773 2,803 Minorities,Associatesetc. 0 0 0 0 0 AttributablePAT (1,920) (1,331) (642) 773 2,803 Ratioanalysis Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Persharedata(Rs) PreͲexceptionalEPS (1.8) (1.3) (1.3) 0.7 2.6 DPS 0.0 0.0 0.0 0.0 0.0 BVPS 0.3 (0.9) (1.5) (0.8) 1.9 Growthratios(%) Revenues 32.4 36.3 13.1 16.6 20.0 Ebitda 113.4 108.3 22.2 28.8 27.1 EPS (26.7) (30.7) 5.6 (155.0) 262.6 Profitabilityratios(%) Ebitdamargin 16.6 25.3 27.4 30.3 32.0 Ebitmargin (11.2) (1.3) (1.8) 4.6 9.8 Taxrate 0.2 0.0 0.0 0.0 0.0 Netprofitmargin (13.4) (6.8) (2.9) 3.0 9.1 Returnratios(%) ROE (92.8) 468.3 111.6 (64.7) 472.0 ROCE (3.2) 3.7 0.9 17.3 30.1 Solvencyratios(x) NetdebtͲequity 14.5 (9.1) (5.2) (6.7) (0.4) Net debt-to-Ebitda ratio NetdebttoEbitda 2.3 1.7 1.4 0.7 (0.1) suggests comfortable Interest coverage (1.1) (0.1) (0.3) 0.9 2.4 gearing despite negative net worth Source:Companydata,IIFLResearch [email protected] 76 Institutional Equities Dish TV – BUY Balancesheetsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Cash&cashequivalents 5,385 5,488 4,749 7,553 13,840 Inventories 44 69 79 89 99 Receivables 227 286 323 377 452 Othercurrentassets 2,717 2,409 2,409 2,409 2,409 Creditors 12,812 8,277 9,359 10,908 13,086 Othercurrentliabilities 3,286 4,999 5,299 5,599 5,899 DTH works on pre-paid Netcurrentassets (7,725) (5,024) (7,097) (6,079) (2,185) model, enjoys a negative working capital Fixedassets 18,858 18,088 18,519 18,274 17,183 cycle Intangibles 00 0 00 Investments 0 0 0 0 0 OtherlongͲtermassets 00 0 00 Totalnetassets 11,133 13,064 11,422 12,195 14,999 Borrowings 10,763 14,003 13,003 13,003 13,003 OtherlongͲtermliabilities 0 0 0 0 0 Shareholdersequity 370 (939) (1,581) (808) 1,996 Totalliabilities 11,133 13,064 11,422 12,195 14,998 Cashflowsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Ebit (1,615) (259) (405) 1,178 3,033 Taxpaid (3) 0 0 0 0 Depreciationandamortization 3,996 5,219 6,465 6,628 6,886 Networkingcapitalchange (4,538) 2,598 (1,334) (1,786) (2,393) Otheroperatingitems 6,108 (3,453) 2,671 3,572 4,785 Operatingcashflowbefore 3,948 4,105 7,395 9,593 12,312 interest Financialexpense (1,534) (1,780) (1,511) (1,265) (1,290) NonͲoperatingincome 1,226 707 510 860 1,060 Dish generated Operatingcashflowafterinterest 3,641 3,032 6,395 9,187 12,082 meaningful operating Capitalexpenditure (8,267) (4,448) (6,896) (6,384) (5,795) cash despite losses LongͲterminvestments 00 0 00 Others 1,494 (1,721) 764 0 0 We expect Dish to turn Freecashflow (3,132) (3,137) 263 2,804 6,287 generate free cash flow Equity raising 1 1 (2) 0 0 FY13 onwards Borrowings 1,405 3,240 (1,000) 00 Dividend 0 0 0 0 0 Netchgincashandequivalents (1,726) 103 (739) 2,804 6,287 Source:Companydata,IIFLResearch [email protected] 77 Institutional Equities Dish TV – BUY This page is left blank intentionally [email protected] 78 Institutional Equities CMPRs250 Hathway Cable REDUCE Target12mRs214(Ͳ15%) Marketcap(US$m) 673 Like it but not love it Enterprisevalue(US$m) 730 Bloomberg HATH IN Hathway is one of India’s leading multi system operators (MSO) with a robust broadband business. Credible execution Sector MEDIA during phase I and preparedness for phase II place it on a good footing to benefit from digitisation. That said, the Feb062013 envisaged transition of business model of MSOs is fraught with material risks and may not be seamless. In steady state, 52WkHigh/Low(Rs) 307/137 profitability of MSOs may be significantly lower than the present estimates. Despite these risks, Hathway’s valuations Shareso/s(m) 143 build in timely and effective implementation of digitisation Dailyvolume(US$m) 1 across India and an immediate jump in profit, making the Dividend yield FY13ii (%) 0.0 risk-reward unfavourable. We value Hathway at 8x steady- Freefloat(%) 50.5 state (FY16ii) EV/Ebitda which translates into TP of Rs214. REDUCE. Shareholdingpattern(%) Promoter 49.5 Hathway to emerge as leader in cable space: Hathway services its 8.9m subscribers (reach) through several entities in which it holds FII 28.7 varying economic interest. It has a strong presence in key urban DII 14.4 areas with ~75% subscribers falling in first two phases. Hathway’s Others 7.4 execution during phase I is commendable; it expects to gain some subscribers from other MSOs in this phase. Given ~30% subscribers Priceperformance(%) in phase II cities already digitised and a large STB inventory, 1M 3M 1Y Hathway is well positioned for phase II roll-out and market share Hathway (13.0) 6.4 71.0 gain cannot be ruled out. Absolute(US$) (9.9) 9.4 52.2 Paradigm change in business model; execution holds the key: Rel.toSensex (12.4) 1.6 59.3 Digitisation is the first step in the journey of the MSOs’ business CAGR(%) 3yrs 5yrs model from B2B to B2C, which would end with the acquisition of LCOs. EPS NA NA In the interim, digitisation is expected to give more choice to customers, bring transparency, and ensure equitable distribution of Stockmovement subscription revenue across the media value chain. Direct billing in phase I cities is expected to start in 1QFY14. Hathway expects 6x Shares('000) Volume(LHS) (Rs) Price(RHS) increase in subscription revenue in digitised markets and steady-state 30,000 400 Ebitda margins of 20-25%. We see risks to the magnitude and the 25,000 300 20,000 timing of step-jump in revenue as a result of digitisation. 15,000 200 10,000 Base case at risk; valuation pricing blue sky: Hathway’s shares 100 5,000 trade at 7.6x EV/Ebitda on best-case estimates for FY17. This looks 0 0 expensive given that growth would come off sharply post complete 12 12 13 11 11 11 11 12 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ digitisation and will likely be closer to 4-5%, in line with growth in Jul Oct Feb Feb Sep Dec Mar May ARPU on an All-India basis. Further, there are several risks to our underlying assumptions. We reiterate REDUCE. Financialsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Revenues(Rsm) 8,827 10,121 11,676 17,847 23,486 Ebitdamargins(%) 17.0 16.6 17.4 22.3 22.1 PreͲexceptionalPAT(Rsm) (457) (609) 70 1,010 1,378 ReportedPAT(Rsm) (313) (492) 70 1,010 1,378 PreͲexceptionalEPS(Rs) (3.2) (4.3) 0.5 7.1 9.6 BijalShah Growth(%) 1343.0 36.5 [email protected] IIFLvsconsensus(%) 262.8 122.1 912246464645 PER(x) (78.3) (58.8) 511.3 35.4 26.0 ROE(%) (5.3) (7.4) 0.9 11.7 14.1 JaykumarDoshi Netdebt/equity(x) 0.2 0.4 0.6 0.8 0.5 [email protected] EV/Ebitda(x) 24.7 28.9 23.5 12.7 9.4 912246464668 Price/book(x) 4.2 4.5 4.4 3.9 3.4 www.iiflcap.com Source:Company,IIFLResearch.Priceasatcloseofbusinesson05February2013. 79 Institutional Equities Hathway Cable – REDUCE Company Snapshot Hathway is one of the largest cable TV providers in India. The company offers analogue and digital cable TV across more than 140 cities and high-speed cable broadband services across 21 cities. Hathway has a reach across ~8.9m homes supported by 71 analog head-ends and 19 digital head-ends. In FY12, Hathway’s paid subscriber base stood at 1.8m, including its 0.6m direct subscribers. It has a broadband subscriber base of more than 400K subscribers. Hathway enjoys a strong presence in western and central India which are also important markets for broadcasters from a TAM rating perspective. This allows Hathway to garner a disproportionate share of the placement and carriage fees paid by broadcasters. Company background Hathway is part of the Rajan Raheja group, which owns several businesses across the media, software and real estate sectors. The group acquired 100% stake in the company in 1998. Post takeover by the Rajan Raheja group, News Corp made a strategic investment in 2000, which it sold recently. Hathway was the first company to launch digital cable services and cable broadband in India. The company raised Rs4.8bn through an IPO in Feb 2010. Hathway’sispresentacrossmorethan140citiesinIndia Ludhiana Chandigarh Faridabad Delhi Baroda Lucknow Ahmedabad Jaipur Allahabad Rajkot Bhopal Surat Indore Kolkata Aurangabad Nagpur Thane Nashik Mumbai Pune Hyderabad Legend Bangalore Metros Mysore 1 Million + Cities (Phase II) Other Hathway Cities Source:Company,IIFLresearch Managementprofile Name Designation Remarks/managementdescription K.Jayaraman ViceChairman Mr.JayaramanjoinedRajanRahejagroupin1993andtookoverasCEOofHathwayin1998. Priortojoiningthegroup,hewaswithICICIandCiticorp.HeisaCharteredAccountant. JagdishKumar MD&CEO Mr.KumarjoinedHathwayinDec12asMD&CEO.Priortothis,heservedasthePresident– Media&Entertainment,RelianceInds.Inpast,Mr.KumarhasworkedwithStarTVfor16 years.HewaspreviouslyontheboardofHathwayasitsnonͲexecutivedirector. G.Subramanian CFO Mr.SubramanianjoinedHathwayasCFOinDec10.Hehas30+yearsofexperienceacross sectors.Inpast,hehasworkedwithL&T,RPGGroup,BPLMobile,StarTVandTimesGroup. [email protected] 80 Institutional Equities Hathway Cable – REDUCE Hathway – Well placed in cable space Corporate structure – a web of operating entities Hathway’s 8.9m subscriber reach is serviced by close to eighty entities in which it holds varying economic interest. Its direct reach is estimated at 4m subscribers. The company has a large subsidiary – Gujarat Telelink Private Limited (GTPL), which caters to ~3.5m subscribers. The balance 1.4m subscribers are serviced by several small JVs or subsidiaries with less than 100% ownership. Its subscriber reach weighted for its economic interest in operating entities, would be about ~6.5m. Figure4.1: Hathway’s~55%subscribersareservicedby70+subsidiaries/JVs Hathway Direct Reach 4m subscribers 50% Subsidiary Other GTPL subsidiaries/JV 3.5mn subscribers 1.4mn subscribers Source:Company,IIFLResearch Hathway has strong Strong presence in central and western India presence in state capitals Hathway enjoys a strong presence in central and western India. It and large cities provides services in 140 cities including Mumbai, Delhi, Ahmedabad, Indore, Pune, and Bangalore. Out of Hathway’s estimated reach of 8.9m subscribers 25% fall in phase I and 51% in phase II. Its high share of carriage revenue vis-à-vis share of cable subscriber base is attributable to its strong presence in key urban markets. Subscription revenue accounted for 60% of its cable revenue in FY12. Figure4.2: About75%ofHathway'ssubscribersfallinphaseIandphaseIIregion PhaseIII&IV 24% PhaseII 51% PhaseI 25% Source:Company,IIFLresearch [email protected] 81 Institutional Equities Hathway Cable – REDUCE Figure4.3: Carriagerevenueaccountsformorethan50%ofcablerevenue Placement& carriage 57% Others 4% Cable subscription 39% Source:Company,IIFLFY13ii Phase I – retained market share; good execution Hathway is expected to Hathway is present in three out four cities covered in the first phase gain some subscribers of digitisation — Mumbai, Delhi, and Kolkata. It subscriber reach in during phase I these markets collectively stood at ~2.2m. Hathway deployed more than ~1.5m STBs in 9MFY13 compared with 0.6m for full-year FY12. Its digitised subscriber count in phase I would be close to 2.3m, in line with its initial estimates. This suggests that it did not lose subscribers to DTH or other MSOs. Additionally, there were no disruptions, suggesting a well-coordinated effort along with LCOs. Figure4.4: Hathwayhasseeded~2.2mSTBsinphaseIsofar Delhi,900,000 Kolkata*, 350,000 Chennai,0 Mumbai, 900,000 Source:Company,IIFLresearch*HathwayexpectsitsdigitalsubscriberreachinKolkatatobe ~700koncompletionofphaseI Back-end getting ready; expect revenues from 1QFY14 Direct billing to customer Post seeding of STBs and discontinuation of analogue signals likely from 1QFY14 Hathway is putting together other pieces essential to realising the benefit from digitisation. The company indicated that filling of know your customer (KYC) forms, preparation of subscriber database, and package selection would be competed by end-FY13. It has started raising provisional invoices to the LCOs on a net basis (excluding LCO’s revenue share). Direct billing to customers is likely to start from 1QFY14. Simultaneously, agreements with LCOs are being executed for revised revenue share. Gearing up for phase II of digitisation Hathaway remains the Hathway is present in 25 out of 38 cities covered in phase II of leader in digitising its digitisation. Some of the key cities for Hathway include Pune, subscriber base Bangalore, Bhopal, and Ahmedabad. Of these 25 phase II cities, four [email protected] 82 Institutional Equities Hathway Cable – REDUCE cities are serviced by its large subsidiary – GTPL (50% holding). Hathway’s estimated subscriber base covered in phase II is 4.5m. Of this ~1.5m subscribers are already digital. The company has an inventory of 0.5m STBs and has placed orders for the rest. We believe Hathway is well placed to digitise its subscriber base in Phase II and is likely to retain market share. Figure4.5: AthirdofHathway'ssubscribersinphaseIIarealreadydigital Already Tobe digital digitised 33% 67% Source:Company,IIFLresearch Funding for Phase II is not an issue Several options to fund Hathway requires ~Rs3bn for funding the second phase of phase II of digitisation, digitisation. The company has a tie-up with NDS (owned by Cisco) equity raising not needed for conditional access system and with Cisco for encryption (for STBs). These vendors have facilitated deferred payment arrangement for STBs by extending buyer’s credit for a period of 1-5 years. The company plans to avail 12-18 months of credit facility. Accordingly, immediate cash requirement to fund STBs is as low as Rs500m, which can be easily funded through incremental debt and cash flow. Figure4.6: HathwayiscomfortablyplacedtofundphaseIIofdigitisation CashrequirementforPhaseII Subscriberreach(mnsubs) 4.5 Alreadydigitised(mnsubs) 1.5 STBsrequired(mn) 3.0 STBinventory(mn) 0.5 BalanceSTBsrequired(mn) 2.5 SubsidyperSTB(Rs)1,000 Totalfundsrequired(subsidy)Rsm 2,500 Upfrontrequirement(@20%)(Rsm) 500 Vendorfinancing(Rsm) 2,000 NetDebt/Equity(DecͲ12end) 0.6 Source:Company,IIFLresearch Broadband – moderate growth Broadband business is Hathway, a pioneer and the leading cable broadband provider in the profitable, but competition country, has a broadband subscriber base of 400,000. Over the past from 3G and 4G set to three years there has been 15% growth in homes passed. However, increase subscriber base grew at a moderate annualised rate of 5.4%. The management’s guidance of 50,000 broadband subscriber additions looks achievable, though it is significantly higher than actual [email protected] 83 Institutional Equities Hathway Cable – REDUCE additions seen in the past five years. We are building in 5% growth in ARPU, primarily driven by improvement in subscriber mix. Figure4.7: Moderationinbroadbandsubaddsasfocusshiftstodigitisation Subscribers(LHS) Growth(YoY)(RHS) (%) 600,000 50 500,000 40 400,000 30 300,000 20 200,000 10 100,000 0 0 (10) FY08 FY09 FY10 FY11 FY12 FY13ii FY14ii FY15ii Source:Company,IIFLresearch Low focus on broadband for now; competition increasing On digitisation, contribution The Indian cable industry is in the middle of implementing from broadband to reduce mandatory digitisation. With more than 4.5m subscribers covered in phase II, the cable business would require a disproportionately high focus of the management. We believe until phase II of digitisation is completed and the concomitant increase cable business revenue is realised, broadband expansion would be on the backburner. Separately, competition in this space is likely to increase with proliferation of wireless technologies such as 3G and 4G. Hence we expect the importance of broadband business to reduce further. [email protected] 84 Institutional Equities Hathway Cable – REDUCE Paradigm change in business model Hitherto, MSOs’ received less than 20% of subscription fees paid by the consumer. They relied heavily on carriage fees (55-60% of cable revenue) to meet operating costs. Carriage revenue was higher than the content cost paid to broadcasters. Digitisation envisages a six- fold increase in MSOs’ subscription revenue (excluding LCOs’ share). Content cost is also set to jump as broadcasters receive their due share of subscription fees. This arrangement suggests that Hathway would earn 20-22% Ebitda margins on its expanded cable revenue. We estimate Hathway’s Ebitda to grow at 33% Cagr over FY12-16ii and report profit of Rs1.6bn in FY16ii. Manifold increase in subscription revenue Hathway expects a 6x Hathway’s subscription revenue at Rs3.1bn on reach of 8.9m increase in subscription translates into monthly subscription of Rs30/subscriber. Its 75% revenue from the digitised subscribers are covered in the first two phases of digitisation. Post market digitisation, Hathway would directly bill the end-customer. Accordingly, the entire revenue paid by the subscriber would accrue to the company. We are building billing to end-consumer with a lag of six months for phase I and nine months for phase II (vis-à-vis the digitisation timeline). We estimate initial ARPU of Rs190/month (net of taxes) growing at 10% on completion of phase II and 5% in FY16. Figure4.8: Hathway'sblendedARPUislikelytobe~5xoneffectiveimplementation ofphaseII Analog(LHS) Digital(LHS) AnalogARPU(RHS) DigitalARPU(RHS) BlendedARPU(RHS) 12 250 (mnsubs) (Rs/m) 200 9 150 6 100 3 50 0 0 FY12ii FY13ii FY14ii FY15ii Source:Company,IIFLresearch Carriage revenues set decline post digitisation We forecast 25-30% Carriage and placement fees contributed 60% to Hathway’s cable decline in carriage and revenue in FY12. These fees are paid by broadcasters to MSOs placement fees of digitised primarily for carrying their channels on the cable network. This markets revenue stream grew 5x in five years. Such a strong growth is attributable to significant increase in the number of channels without a corresponding increase in channel-carrying capacity of the analogue system. As the digital system addresses this capacity constraint, carriage fees are expected to gradually come down. We estimate 13% Cagr decline in carriage revenue over FY13-16ii. [email protected] 85 Institutional Equities Hathway Cable – REDUCE Figure4.9: Carriagerevenuetodeclineafter5xgrowthoverpast6years Carriagerevenue(LHS) Carriagerevenueas%ofCablerevenue(RHS) 6,000 70.0 (Rsm) (%) 5,000 60.0 50.0 4,000 40.0 3,000 30.0 2,000 20.0 1,000 10.0 0 0.0 FY07 FY08 FY09 FY10 FY11 FY12 FY13ii FY14ii FY15ii FY16ii Source:Company,IIFLresearch STB deployment boosts revenue Hathway receives Rs500-600 from the customer for every STB deployed as against the cost of STB of ~Rs1,600. This income is recognised as subscription revenue on deployment of STB. Digitisation has led to an acceleration of STB deployment, which would boost revenue in FY13 and FY14. Activation revenue is expected to contribute 8.8%/10% to total cable revenue in FY13/FY14. Figure4.10: STBdeploymenttoboostcablerevenues Activation revenue to see a jump on digitisation Activationrevenue(LHS) Activationrevenueas%ofCablerevenue(RHS) 1,800 18.0 (Rsm) (%) 1,500 15.0 1,200 12.0 900 9.0 600 6.0 300 3.0 0 0.0 FY12 FY13ii FY14ii FY15ii Source:Company,IIFLresearch LCO’s revenue share likely to settle at 40% We are building in LCO Following digitisation, the function of billing the end-customers would revenue share at 40%, in transfer from the LCOs to MSOs. MSOs would recognise the entire line with guidance subscription fee as revenue and pay a revenue share to the LCO. Hathway expects the revenue share agreement with LCO to be signed at 40% as against TRAI’s minimum mandated revenue share of 35%. The management has indicated that direct billing to phase I to customer would start only by 1QFY14. Content costs set to rise Presently, content cost paid by MSOs to broadcasters is low as a large proportion of subscription fee paid by consumer is retained by the LCO. On digitisation, broadcasters are expected to get their rightful share of the subscription revenue. MSOs and broadcasters are now entering into separate contracts for digital and analogue markets. Content cost for the digitised market is likely to be [email protected] 86 Institutional Equities Hathway Cable – REDUCE significantly higher. Hathway estimates that content costs would stabilise at ~33% of subscription revenue. However, in the first year following digitisation, it may be lower. We are building in increase in content cost from the second year of digitisation. Figure4.11: Contentcostssettorise42%overFY12Ͳ16iievenascarriagerevenue drops25% ContentCost Carriagerevenue 7,500 (Rsm) 6,000 4,500 3,000 1,500 0 FY08 FY09 FY10 FY11 FY12 FY13ii FY14ii FY15ii FY16ii Source:Company,IIFLresearch Digitisation-related expenses to drive other costs We estimate subscriber Digitisation would entail new costs pertaining to subscriber management cost of management. These include costs associated with billing and Rs7/month/sub for digital cable maintenance of subscriber databases and customer care centre. The management expects these costs to be around 5% of subscription revenue (~Rs10/month per sub) initially. As the digital subscriber base increases, it should gradually come down. The other large costs such as employee costs and administrative expenses are expected to grow broadly in line with inflation Figure4.12:ContentcostsandLCO'ssharewouldaccountfor2/3rdoftotalcosts DigitisationͲSMS costs Bandwidthand 3% leaselinecost 2% Staffcost LCO'sshare 7% 34% Administrative expenses 13% Other operating Paychannelcost 31% expenses 10% Source:Company,IIFLresearch(FY15ii) Ebitda set to grow at 33% Cagr over FY12-16ii Economics for digitised universe for MSOs are expected to be far superior to extant profitability. The full impact of first two phases of digitisation would be evident only in FY16 as revenue and cost trends would take a while to stabilise. On a steady-state basis, MSOs are expected to make 20-22% Ebitda margin on an increased revenue base. We expect Hathway’s Ebitda to increase from Rs1.7bnin FY12ii to Rs5.3bn in FY16ii. [email protected] 87 Institutional Equities Hathway Cable – REDUCE Figure4.13:Ebitdabreakup:ActivationrevenuewouldboostEbitdaintheinitialyrs Activation revenue provides huge boost to Ebitda in (Rsm) FY13/14 Cable Activation Broadband 6,000 5,000 4,000 3,000 2,000 1,000 0 FY13ii FY14ii FY15ii FY16ii Source:Company,IIFLresearch Earnings boosted by accounting policy In India, STBs are given to customers at subsidised rates. Called ‘activation fees’, Hathway treats this amount, paid by customers as subscription revenue. STBs are capitalised and depreciated over eight years. On deployment of the STBs, the company’s revenue and Ebitda receives a boost of Rs500-600/STB. STB deployment has picked up and will likely remain elevated until completion of phase II of digitisation. Accordingly, activation fees would provide a sharp boost to reported Ebitda in FY13 and FY14. As we are not building in phase III and IV of digitisation at present, the impact of STB deployment significantly reduces FY15 onwards. Figure4.14:Hathway'sEbitdamarginarelikelytostabilizeat20Ͳ22%oncompletion offirsttwophases (Rsm) Ebitda(LHS) Ebitdamargin(RHS) (%) 6,000 30.0 5,000 25.0 4,000 20.0 3,000 15.0 2,000 10.0 1,000 5.0 0 0.0 FY12 FY13ii FY14ii FY15ii FY16ii Source:Company,IIFLresearch Hathway’s economic interest in Ebitda - 15-20% lower Hathway does not have Hathway’s major subsidiary, GTPL and other subsidiaries/ JV 100% economic ownership companies account for ~55% of its subscriber reach. Accordingly, a of its subscriber base large part of Ebitda is attributable to minority shareholders of these entities. We do not have adequate details to accurately calculate attributable Ebitda. Our back-of-the-envelope calculation suggests attributable Ebitda of 15-20% lower than reported Ebitda in steady state (FY16ii). We estimate steady state profit of ~Rs1.6bn Transition of Hathway’s business model from largely analogue to digital would take more than a couple of years. Accordingly, we [email protected] 88 Institutional Equities Hathway Cable – REDUCE believe FY16 profit would be fairly representative of the company’s earnings capacity. We are building in phase I and II of digitisation and revenue share for broadcasters and customers as guided by the management. Hathway may generate attributable Ebitda of Rs5.3bn and attributable profit of Rs1.6bn in FY16ii. Figure4.15:On effective implementation of digitisation phase I & II, Hathway wouldgenerateasteadystateEbitdaofRs5.3bninFY16ii FY12 FY13ii FY14ii FY15ii FY16ii We are building in only the Assumptions first two phases, given low visibility on the remaining Subscriberbreakup two phases Wt.Avg.analogsubs(mn) 8.2 7.8 5.3 2.3 2.4 Wt.Avg.digitalsubs(incl 0.6 1.1 3.7 6.8 6.8 primary) TotalSubs 8.8 8.9 9.0 9.0 9.1 ARPU(Rs/month) Analogsubs 18 15 15 15 Digitised&Primarysubs 190 190 205 219 BlendedARPU 30 33 87 158 167 Revenuebreakup Subscriptionrevenue 3,112 3,545 9,365 17,098 18,278 ͲAnalog 1,754 1,630 937 404 420 ͲDigital(inclPrimary) 1,358 1,915 8,428 16,694 17,857 Activationrevenue 300 900 1,650 150 150 Carriagerevenue 4,893 5,236 4,607 3,686 3,502 Growth(%) 7 (12) (20) (5) Broadband 1,461 1,559 1,762 2,063 2,389 Others 355 437 463 489 517 TotalRevenue 10,121 11,676 17,847 23,486 24,835 Expenses LCO'sshare(@40%) 238 2,843 6,105 6,531 ContentCosts 4,295 4,810 5,571 5,708 6,127 ͲAnalog 4,295 4,810 4,473 700 770 ͲDigital(inclPrimary) 0 0 1,098 5,008 5,357 As%ofdigitalsubscriptionrev 0.0 13.0 30.0 SubMgmtcosts 96 337 584 536 Admin&otherOp.exp 3,224 3,478 3,995 4,606 4,971 Employeeexpenses 926 1,018 1,120 1,288 1,391 TotalExpenses 8,445 9,640 13,865 18,291 19,556 On transformation into a Ebitda 1,676 2,037 3,982 5,194 5,278 digital model, the MSOs EbitdaMargin(%) 16.6 17.4 22.3 22.1 21.3 would report 20-25% Ebitda margins Depreciation 1,443 1,416 1,709 2,298 2,207 Otherincome 165 150 150 200 250 Interestexpense 520 675 940 1,072 973 Exceptional (116) 0 0 0 0 PBT (238) 96 1,483 2,025 2,348 Tax 153 19 297 405 470 PAT (391) 76 1,186 1,620 1,879 MinorityInterest 101 8 177 242 281 AttributablePAT (492) 70 1,010 1,378 1,598 Source:Company,IIFLResearch [email protected] 89 Institutional Equities Hathway Cable – REDUCE Revenue recognition and depreciation for STBs aggressive Deployment of STBs in India generally entails a subsidy. These transactions are not treated as sale for tax considerations. Most DTH operators capitalise and depreciate STBs over its defined life. The upfront fees paid by customers is treated as lease rental and recognised over the life of the STB. Hathway, on the other hand, recognises upfront fees as subscription revenue immediately on deployment of the STB. Hathway depreciates the STB over a period of eight years compared with five years by Dish TV. Figure4.16:MSOs’accountingpolicyisaggressiveascomparedwithDTHplayers SetͲtopboxaccounting Den Hathway DishTV The MSOs follow aggressive CostofSTBorCPE*(Rs) 1,600 1,600 2,600 accounting policy, compared with DTH Cashfromcustomer(netof 550 550 1,300 operators dealercommission)(Rs) Entireamountis Entireamountis Recognizedas recognizedas recognizedas Revenuerecognition leaserentalover activationrevenue activationrevenue a5yearperiod onSTBdeployment onSTBdeployment NetrevenueperSTBorCPE 550 550 260 deployedinfirstyear StraightlineoverStraightlineover8Straightlineover Depreciation 8yrs yrs 5yrs DepreciationperSTB/CPE 200 200 520 Source:Company,IIFLResearch*ConsumerpremisesequipmentincaseofDTHplayers [email protected] 90 Institutional Equities Hathway Cable – REDUCE Base case at risk; Valuations pricing in blue sky Transition of business model makes valuation exercise difficult Transition of business MSOs business model is in a transition phase as we progress from model makes it difficult to largely analogue to a digital system. At present, there are several forecast cash flow with certainty unknowns: revenue share, content cost, timeline, and effective implementation of digitisation. An accurate estimation of the cash- generating capacity of the MSOs’ business is fairly difficult, given these uncertainties. At present, we are largely going by the management’s guidance on various cost and revenue items, even as we see material downside risks. In view of the fluid earnings estimates, we start the valuation exercise by attempting to understand what the market price is building in and assess the upside and downside risks. Market price builds in blue-sky scenario We see no upside, even on The above table suggests that Hathway’s market price is already the most aggressive factoring in seamless execution of all four phases. Assuming a delay assumptions of six months in implementation and time lag of six months in realisation of the benefits, these estimates are unlikely to materialise before FY17. The following discussion would explain why most of the above assumptions are at risk. At the current market price, Hathway’s shares trade at ~7.6x FY17ii estimates in the best-case scenario. This looks expensive to use, given that post complete digitisation of India, growth would sharply come off and will likely be closer to 4-5%, in line with all-India ARPU growth. Note that current all-India ARPU is ~150/month compared with our FY17 assumption of Rs260/month (gross taxes). Multiple risks to these assumptions Current revenue guidance is • Revenue share at risk: Our industry interactions suggest that fraught with material risks revenue share negotiation is still far from conclusion. Digital subscription packages would require LCOs to take at least 30% price increase even as the relevant content would be reduced. At the same time, the indicative revenue share implies that LCOs’ profitability would drop by at least 40%. This proposition looks inherently flawed to us. • Limited progress on other important steps: Discontinuation of analogue signal is just the first step of the process. Other required tasks to achieve higher revenue share such as creating a subscriber database and selling packages is at best slow. Note that, this is after four months digitisation in the most affluent cities in India. Inordinate delay in • Challenges in remaining phases of digitisation: Firstly, digitisation and revenue Phase I digitisation is not as much a success as perceived as two share negotiation cannot be out of four cities sill remain in the analogue mode. The ruled out complexity of implementation challenges would grow as later stages are much larger in scope. [email protected] 91 Institutional Equities Hathway Cable – REDUCE Recent industry deal value business way below markets Recently, Hathway acquired the remaining ~49% stake in its joint venture Hathway Bhaskar Multinet Limited. HBML is an MSO with strong presence in Madhya Pradesh with approximate reach of 0.5m. The deal valued HBML at an enterprise value of ~Rs500m (exact amount not known. This implies a per subscriber value of Rs1,000, significantly lower than the current valuation for Hathway of more than Rs6,000 per subscriber value. Even assuming a distress sale, the valuations look appalling to us. Figure4.17: MarketpricebuildinginbestͲcasescenariomakingriskrewardunfavourable Assumptions PhaseI&II All4phases Comments SubscriberReachbreakdown(mn) PhaseI&II 6.7 6.7 Including0.5mprimarysubscriberbase PhaseIII&IV 2.2 2.2 Total 8.9 8.9 Digital Buildsingrowthof10%/5%inFY15/FY16;gross Subscriberbase(inFY16)(mnsubs) 6.7 8.9 ARPUofRs250/monthinFY16 ARPU(Rs/month) 220 220 Notethat,HathwaygetsonlyRs30/subatpresent Analog Subscriberbase(inFY16)(mnsubs) 2.2 0 ARPU(Rs/month) 20 0 Revenues(Rsm) ͲDigitalsubscription 17,688 23,496 ͲAnaloguesubscription 528 0 ͲCarriage 3,400 3,150 Buildinga35Ͳ40%dropindigitisedmarket ͲBroadband 2,389 2,389 ͲOthers 300 300 Total 24,305 29,335 Additionalexpensefordigitalcable ͲLCO'sshare 7,075 9,398 40%Ͳaspermanagement'sguidance ͲContentcost 5,837 7,754 ~33%Ͳaspermanagement'sguidance Rs7/sub/monthͲsignificantlylowerthan ͲOthercosts 563 748 management'sguidance Total 13,475 17,900 Analoguecontentcost 770 0 IIFLestimate Otheroperatingcosts 5,000 5,000 ~7%CagrinothercostsfromFY12 CablebusinessgrossprofitͲRs91/sub/monthͲat Grossprofit(Rsm) 10,059 11,435 upperendofmanagement'sguidance Ebitda(Rsm) 5,059 6,435 Ebitdamargin 20.8 21.9 Less:minorityinterestinEbitda 860 1,094 IIFLestimate AttributableEbitda(Rsm) 4,199 5,341 CMP(Rs/share) 260 260 CurrentMarketcap(Rsm) 35,714 35,714 Attributabledebt(Rsm) 5,000 5,000 Enterprisevalue(Rsm) 40,714 40,714 EV/Ebitda(x) 9.7 7.6 Source:Company,IIFLResearch [email protected] 92 Institutional Equities Hathway Cable – REDUCE Reiterate REDUCE; target price Rs214 At our target price Hathway We value Hathway at 8x FY16ii EV/Ebitda. We use FY16 earnings to would trade at PER of 19x value Hathway since by then, its cost and revenue trends for the first FY16ii two phases of digitisation would have stabilised. Further, the impact of activation revenue on earnings would be negligible. We are building in only first two phases of digitisation as we remain sceptical of effective implementation of the later phases. Beyond FY16, earnings growth would be primarily driven by ARPU growth, which is expected to be at about 5-7% annually. Note that, this growth is post a step-jump in ARPUs on digitisation and hence not on the lower side. Given this growth and potential to risks to the same, Hathway’s business model does not justify a higher multiple, in our view. Figure4.18:WevalueHathwayatRs214/share Particulars Amount Ebitda(FY16ii) 5,278 EV/Ebitdamultiple(x) 8.0 TargetEV(Rsm) 42,227 Less:NetDebt(FY15ii)Rsm 5,357 Targetmarketcap(Rsm) 36,871 Less:minorityvalue(17%) 6,268 TargetequityvalueforHathway(Rsm) 30,603 Equityshare(mn) 142.9 Targetprice(Rs/share) 214 Source:Company,IIFLResearch Figure4.19: DespitenonͲownershipoflastͲmileandseveralrisks,Hathway’sstockistradingmuchhigherthanglobalpeerson FY16iiestimates(steadystatefactoringinphaseI&phaseIIdigitisation) Company Country MktCap EV Sales(US$m) Ebitda(%) EV/Ebitda(x)# P/E(x)# (US$m) (US$m) FY12 FY12 FY13 FY14 FY13 FY14 Comcast US 102,195 147,830 62,519 32 7.5 7.1 19.9 17.2 DIRECTV US 31,699 46,759 29,720 25 6.3 5.8 12.5 10.2 DISHNetwork US 16,703 20,620 14,243 19 7.5 6.5 19.1 15.7 SESSA LUXEMBOURG 12,316 17,501 2,510 73.9 9.7 9.2 15.4 15.0 ShawComm. CANADA 10,588 16,303 5,017 41.9 7.8 7.4 14.7 14.4 ScrippsNetworks US 9,325 10,669 2,314 46.0 10.0 9.2 18.5 16.5 EutelsatComm. FRANCE 7,577 10,654 1,486 78.2 8.0 7.5 15.8 14.7 JupiterTelecom. JAPAN 8,225 9,316 4,188 41.3 5.5 5.5 19.6 18.0 KabelDeutschland GERMANY 7,611 11,270 2,125 46.5 9.8 8.8 19.4 20.4 Cablevision US 3,828 14,347 6,742 30.2 7.0 6.9 25.3 18.8 NipponTelevision JAPAN 3,705 2,803 3,751 12.7 6.3 5.7 14.2 12.6 ModernTimesGroup SWEDEN 2,552 2,712 2,103 15.5 8.4 9.6 10.5 11.8 MegacableHoldings MEXICO 2,305 2,257 715 41.8 7.6 6.9 15.5 15.1 CogecoCable CANADA 2,098 4,390 1,282 45.5 7.5 5.8 11.9 9.9 DishTVIndia INDIA 1,484 1,645 365 25.1 14.3 11.2 NA 200.4 MNCSkyVision INDONESIA 1,601 1,694 241 43.4 16.2 11.9 68.8 37.3 BeijingGehuaCATV CHINA 1,177 910 334 46.9 5.8 5.2 24.9 22.7 Median 7.6 7.1 17.1 15.7 HathwayCable* INDIA 676 733 211 16.6 8.7 22.3 DENNetworks* INDIA 566 554 235 7.3 9.2 21.8 Source:*AttributablemultiplesonFY16iiestimates(steadyͲstate;buildinginfullbenefitsfromphaseI&IIofdigitisation).#Forcomparison, wehaveplacedDecͲ12andMarͲ13yrͲendmultiplesunderFY13andsoon. [email protected] 93 Institutional Equities Hathway Cable – REDUCE Financial summary Incomestatementsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Strong growth in Revenues 8,827 10,121 11,676 17,847 23,486 revenue driven by direct billing to the end- Ebitda 1,501 1,676 2,037 3,982 5,194 customer Depreciationandamortisation (1,276) (1,443) (1,416) (1,709) (2,298) Ebit 225 233 620 2,273 2,897 Higher ARPU and drop in NonͲoperatingincome 255 165 150 150 200 LCOs’ profit to drive the MSO’s profitability Financialexpense (452) (520) (675) (940) (1,072) PBT 27 (121) 96 1,483 2,025 Exceptionals (144) (116) 0 0 0 ReportedPBT (117) (238) 96 1,483 2,025 Taxexpense (127) (153) (19) (297) (405) PAT (243) (391) 76 1,186 1,620 Minorities,Associatesetc. (70) (101) (6) (177) (242) AttributablePAT (313) (492) 70 1,010 1,378 Ratioanalysis Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Persharedata(Rs) PreͲexceptionalEPS (3.2) (4.3) 0.5 7.1 9.6 DPS 0.0 0.0 0.0 0.0 0.0 BVPS 59.6 56.2 56.7 63.8 73.4 Growthratios(%) Revenues 20.4 14.7 15.4 52.8 31.6 Strong growth in Ebitda 19.6 11.7 21.5 95.5 30.4 revenue driven by direct EPS (53.9) 33.2 (111.5) 1343.0 36.5 billing to the end- customer Profitabilityratios(%) Ebitdamargin 17.0 16.6 17.4 22.3 22.1 Ebitmargin 2.5 2.3 5.3 12.7 12.3 Taxrate (108.5) (64.5) 20.0 20.0 20.0 Netprofitmargin (2.8) (3.9) 0.7 6.6 6.9 Returnratios(%) Return ratio remains ROE (5.3) (7.4) 0.9 11.7 14.1 poor due to a large ROCE 3.3 2.8 5.1 13.6 15.3 legacy asset base Solvencyratios(x) NetdebtͲequity 0.2 0.4 0.6 0.8 0.5 NetdebttoEbitda 1.0 1.8 2.3 1.9 1.1 Interestcoverage 0.5 0.4 0.9 2.4 2.7 Source:Companydata,IIFLResearch [email protected] 94 Institutional Equities Hathway Cable – REDUCE Balancesheetsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Cash&cashequivalents 2,204 1,081 1,487 685 2,600 Inventories 47 55 63 97 127 Receivable days to Receivables 2,529 2,492 3,039 5,379 7,721 remain elevated as cable Other current assets 1,869 1,946 2,346 2,746 3,346 would continue post paid model Creditors 3,160 3,492 4,028 6,157 8,103 Othercurrentliabilities 136 110 130 150 170 Netcurrentassets 3,354 1,973 2,777 2,599 5,522 Fixedassets 6,779 7,974 9,888 13,253 11,951 Intangibles 4,037 4,191 3,551 3,551 3,551 Investments 47 53 53 53 53 OtherlongͲtermassets 00 0 00 Totalnetassets 14,217 14,191 16,269 19,456 21,077 Borrowing to increase to Borrowings 3,751 4,095 6,095 8,095 8,095 fund digitisation OtherlongͲtermliabilities 1,948 2,068 2,076 2,254 2,497 Shareholdersequity 8,518 8,028 8,097 9,107 10,485 Totalliabilities 14,217 14,191 16,268 19,456 21,077 Cashflowsummary(Rsm) Y/e31Mar,Consolidated FY11A FY12A FY13ii FY14ii FY15ii Ebit 225 233 620 2,273 2,897 Taxpaid (116) (140) (19) (297) (405) Depreciationandamortization 1,276 1,443 1,416 1,709 2,298 Networkingcapitalchange (1,303) 258 (399) (624) (1,008) Otheroperatingitems 454 0 0 00 Operatingcashflowbefore 535 1,794 1,619 3,061 3,781 interest Financialexpense (452) (520) (675) (940) (1,072) NonͲoperatingincome 255 165 150 150 200 Operatingcashflowafterinterest 338 1,440 1,094 2,272 2,909 Capital expenditure (2,322) (2,791) (2,690) (5,075) (996) Expect a sharp drop in capex post digitisation LongͲterminvestments 2,370 1,710 0 00 Others 0 0 0 0 0 Investment in HD STB Freecashflow 386 358 (1,596) (2,803) 1,914 poses an upside risks to Equity raising 0 0 0 0 0 capex numbers Borrowings (856) 344 2,000 2,000 0 Dividend 0 0 0 0 0 Netchgincashandequivalents (471) 703 404 (803) 1,914 Source:Companydata,IIFLResearch [email protected] 95 Institutional Equities Hathway Cable – REDUCE This page is left blank intentionally [email protected] 96 Institutional Equities CMP Rs224 Den Networks Not Rated Target 12m NR Market cap (US$ m) 550 Driving consolidation Enterprise value (US$ m) 538 Bloomberg DEN IN Den Network (Den) is the largest multi-system operator in Sector MEDIA India with subscriber reach of 11m and a presence in 84 cities. Incorporated in 2007, Den is relatively a young company that pioneered the consolidation of small Feb 06 2013 independent cable operators (ICOs) across India. Its seamless execution during phase I and preparedness for phase II are positives. However, progress on critical revenue 52Wk High/Low (Rs) 239/78 share negotiations with LCOs remains sluggish. The potential Shares o/s (m) 134 negative impact on profitability of LCOs and non-ownership of Daily volume (US$ m) 2 last mile make us sceptical about Den achieving the Dividend yield FY13ii (%) 0.0 suggested revenue share. Den’s stock price factors in Free float (%) 46.8 seamless execution of all four phases of digitisation, leaving little on the table. Shareholding pattern (%) Promoter 53.2 Pioneered cable consolidation: Despite Den’s late entry in the business, it has emerged as the largest MSO in the country. It FII 13.7 achieved this through acquisition of majority stakes (~51% in most DII 2.4 cases) and integration of more than 80 cable operators. Since its Others 30.7 reach is largely built through acquisitions, its economic ownership in subscriber base is closer to 55-60%. Den is indicating this would Price performance (%) increase on digitisation as it invests its own as well as its partner’s 1M 3M 1Y share of digitisation-related capex. Its 55% subscriber reach is Den Networks 13.2 21.2 172.8 covered by the first two phases of digitisation. Absolute (US$) 17.3 24.6 160.0 Gains from digitisation overestimated: Digitisation is likely to lead Rel. to Sensex 13.8 16.4 161.1 to increase in tariffs and redistribution of subscription revenue in CAGR (%) 3 yrs 5 yrs favour of the MSOs and broadcasters. This is expected to lead to ~5x EPS NA NA jump in revenue of the MSOs and leave them with healthy margins of 20-25%. We are building in only the first two phases as we see Stock movement immense challenges in effective implementation of the remaining two Shares ('000)Volume (LHS) (Rs) phases. Based on these assumptions, Den could generate attributable Price (RHS) Ebitda of Rs4.5-5bn in steady state. We see risks to the magnitude 4,000 250 and timing of step-jump in revenue due to digitisation. 3,000 200 150 2,000 Valuations – stretched even in the best case: Den trades at 6.9x 100 1,000 50 EV/Ebitda, considering best-case estimates for FY17. This looks 0 0 expensive, given that post complete digitisation, growth would come off sharply and is likely to be closer to 4-5%, in line with growth in Jul 12 ARPU on an all-India basis. Additionally, risks exist to the underlying Oct 12 Feb 11 Sep 11 Feb 13 Dec 11 Mar 12 May 11 assumptions. Financial summary (Rs m) Y/e 31 Mar, Consolidated FY11A FY12A FY13ii FY14ii FY15ii Revenues (Rs m) 10,218 11,295 10,028 15,723 20,426 Ebitda margins (%) 8.8 7.3 21.3 27.3 24.6 Pre exceptional PAT (Rs m) 375 143 722 1,370 1,385 Reported PAT (Rs m) 375 143 722 1,370 1,385 Pre exceptional EPS (Rs) 2.9 1.1 5.5 10.5 10.6 Bijal Shah Growth (%) 24.7 (61.9) 405.7 89.7 1.1 [email protected] IIFL vs consensus (%) 13.9 47.0 (2.6) 91 22 4646 4645 PER (x) 77.8 204.6 40.4 21.3 21.1 ROE (%) 5.0 1.8 8.6 14.5 12.8 Jaykumar Doshi Net debt/equity (x) (0.2) (0.1) 0.4 0.8 0.5 [email protected] EV/Ebitda (x) 42.6 47.6 20.4 11.1 9.0 91 22 4646 4668 Price/book (x) 3.8 3.6 3.3 2.9 2.5 www.iiflcap.com Source: Company, IIFL Research. Price as at close of business on 05 February 2013. 9797 Institutional Equities Den Networks – Not Rated Company snapshot Den Networks is one of the largest MSOs in India. The company offers analogue and digital cable TV services across more than 84 cities. Den has a subscriber reach of about 11m, supported by 98 analogue head-ends, 17 digital head-ends. The company services a large part of its subscriber through several subsidiaries and joint ventures in which it holds varying economic interest. Besides cable, Den also provides broadband Internet services. However, the size of its broadband business is negligible. The company owns 25% stake in Media Pro, the distribution joint venture of Star and Zee. Background Mr. Sameer Manchanda founded Den Networks in July 2007. Since its inception, the company has acquired controlling stake in ~78 MSOs and expanded its reach to 11m subscribers. In Jan 2008, Den Networks entered into a 50:50 joint venture (Star-Den) with Star network for joint distribution of channels of Star group (excl. sports genre), Disney group, Times group and select channels of Network 18. Later, in July 2011, Star-Den formed a 50:50 distribution joint venture (Media Pro) with Zee-Turner for joint distribution of channels. Accordingly, Den Network owns 25% in Media Pro. DEN has presence in more than 80 cities in India Delhi Ghaziabad Jaipur Lucknow Faridabad Kanpur Jodhpur Meerut Allahabad Varanasi Vadodra Rajkot Surat Nasik Kolkata Kalyan - Dombivli Navi Mumbai Mumbai Pune Legend Mysore Bangalore Metros 1 Million + Cities Other DEN Cities Source: Company, IIFL Research Management Name Designation Remarks / management description Sameer Founder & MD Mr. Manchanda is a Chartered Accountant with 29 years experience in the Television Manchanda industry. He has served as director of several media companies. He is also co founder of IBN18 and was its joint MD from 2005 10. S.N. Sharma CEO Mr. Sharma has been CEO of Den since inception (2007). He has 23 years experience in the media sector and has worked with Den and Indusind Media in the past. Rajesh Kaushal CFO Mr. Kaushal, a Chartered Accountant with 13+ years experience has been CEO of Den since inception (2007). [email protected] 98 Institutional Equities Den Networks – Not Rated Den – the largest MSO in India Den — a network of joint ventures Den acquired stake in and Den’s 11m subscriber reach is serviced by close to hundred joint integrated ~80 MSO over ventures in which the company holds varying economic interest the past five years (more than 50% stake in most cases). Unlike Hathway, Den’s direct reach is miniscule and does not have a primary subscriber base. Den enjoys a strong presence in central and northern India and it provides services in ~84 cities including Delhi, Mumbai, Pune and Bangalore. Out of Den’s 11m reach, 2m subscribers are in phase I Den is the youngest MSO cities and 4m subscribers are in phase II. The balance 5m having largest subscriber reach subscribers are spread across regions coming under phase III and phase IV of digitisation. Figure 5.1: About 55% of Den's subscribers fall in phase I and phase II cities Phase III 32% Phase IV 14% Phase II 36% Phase I 18% Source: Company, IIFL research Good execution in phase I, market share largely maintained Den has a presence in three cities – Delhi, Mumbai and Kolkata – out of four cities covered in first phase of digitisation. Its aggregate subscriber reach in these markets is ~2m. Deployment of STBs has significantly scaled up with seeding of 1.6m STBs in 9MFY13 compared with 0.3m during full-year FY12, which allowed the company to retain its market share. In phase I cities, its digital subscriber count is ~2m. Figure 5.2: DEN has seeded ~2m STBs in phase I Kolkata*, 250,000 Chennai, 0 Delhi, 1,200,000 Mumbai, 400,000 Source: Company, IIFL research. * DEN expects its digital subscriber reach in Kolkata to be ~400k on completion [email protected] 99 Institutional Equities Den Networks – Not Rated Building back-end, revenues to start from 1QFY14 After completion of seeding of STBs and discontinuation of analogue signals, Den is putting together other pieces essential to realise the benefits of digitisation. The company indicated that customer acquisition forms, preparation of subscriber database and package selection would be competed by end-FY13. It has started raising provisional invoices to the LCO on a net basis (excluding LCO’s revenue share). Direct billing to customers is likely to start from 1QFY14. Simultaneously, agreements with LCOs for revised revenue share would be executed. Over 4m of Den’s subscriber Gearing up for phase II of digitisation are covered in by phase II Den is present in ~24 out of 38 cities covered in phase II of digitisation. Some of the key cities include Pune, Bangalore, Navi Mumbai and Jaipur. Its estimated subscriber reach covered in phase II of digitisation is 4m. With a digitised subscriber base of 0.5m in phase II cities and STB inventory of 1.5m, Den is well placed for seamless execution in phase II as well. Figure 5.3: Den expects to deploy ~3.5m STBs in phase II To be Already digitised digital 87% 13% Source: Company, IIFL research Funding is not a constraint for phase II Den has attractive STB Den requires an additional Rs2.5-3bn for digitisation of its 4m strong financing deal with vendors subscriber base in phase II. At present, the company has a cash with payment spread over 5 balance is Rs1.7bn. Net gearing of 43% leaves headroom for raising years more debt. The management indicated that the company has an option to avail vendor financing facilities of up to five years. Accordingly, funding is not a concern for the company to execute phase II. Figure 5.4: DEN is well placed to fund phase II of digitisation Cash requirement for Phase II Subscriber reach (mn subs) 4 Already digitised (mn subs) 0.5 STBs required (mn) 3.5 STB inventory (mn) 1.3 Balance STBs required (mn) 2.3 Subsidy per STB (Rs) 1,000 Total funds required (subsidy) Rs m 2,250 Net Debt/Equity 0.4 Source: Company, IIFL research [email protected] 100 Institutional Equities Den Networks – Not Rated Structural changes in business Hitherto, MSOs received less than 20% of the subscription fees paid by the consumer. Hence MSOs relied heavily on carriage fees (~50% of revenue) to meet operating costs. Carriage revenue was higher than the content cost paid to broadcasters. Digitisation envisages a six-fold increase in MSOs subscription revenue (excluding LCOs’ share). Content cost is also set to increase as broadcasters receive their due share of subscription fees. This arrangement suggests that Den would earn 20-25% Ebitda margins on its expanded cable revenue. We estimate Den’s Ebitda to grow at a Cagr of 30% over FY13-16ii and expect it to report profit of Rs1.3bn in FY16ii. Several JV partners would transform into distributors Den’s economic ownership JVs with regional MSOs form the backbone of Den’s subscriber reach. in its 11m strong subscriber The company owns 51%+ stake in almost all its 78+ JVs. The base is close to 55% inability of these JV partners to contribute their share of capex for digitisation is further tilting control of operations in favour of the company. Den makes full investments for digitisation, should the JV partner fails to contribute its share. The management indicates that in such cases, the status of JV partner is reduced to a distributor. As distributors, these entities would earn 5% commission on the net subscription revenue (less LCO’s share). The company indicated that It expect to utilize about 90% of the digitised subscriber base in phase 1 falls in this digitisation as an category. However, we are not sure if agreements to this effect have opportunity to hike its stake been signed with the respective JV partners. Figure 5.5: Den a network of JVs Subscribers LCO Regional MSOs LCO Subscription revenue and Joint carriage Venture revenue shared with JV partners LCO LCO Source: Company, IIFL Research [email protected] 101 Institutional Equities Den Networks – Not Rated Figure 5.6: Several JVs would become redundant post digitisation Subscribers Case 1: JV partner invests for digitisation LCO • JV continues to function as in analog environment Case 2: JV Partner does not Regional MSOs invest • JV becomes somewhat redundant and JV LCO partner receives 1) 5% of subscription revenue Joint Venture (less LCO’s share) as distribution commission and 2) some carriage LCO share OR • Den’s stake in JV increase to factor in its investment for digitisation LCO Source: Company, IIFL Research Subscription revenue set to leapfrog The uptick in revenues is Den’s subscription revenue at Rs3bn (FY12) with a reach to 11m expected 6 months after subscribers translates into monthly subscription of digitisation ~Rs23/subscriber. Its 55% subscribers are covered in the first two phases of digitisation. Post digitisation, Den would directly bill the end-customer. Accordingly, the entire revenue paid by the subscriber would accrue to the company. We are building in billing to the end- consumer with a lag of six months for phase I and nine months for phase II (vis-à-vis the digitisation timeline). We estimate an initial ARPU of Rs200/month growing at 10% on completion of phase I and II and 5% in FY16ii. Figure 5.7: Subscription accounted for 45% of cable revenue in FY12 Carriage revenue 55% Subscription revenue 45% Source: Company, IIFL research [email protected] 102 Institutional Equities Den Networks – Not Rated Figure 5.8: Phase I & II digitisation is likely to drive ~5x jump in DEN's blended ARPU Analog (LHS) Digital (LHS) Analog ARPU (RHS) Digital ARPU (RHS) Blended ARPU (RHS) 12 250 (mn subs) (Rs/m) 200 9 150 6 100 3 50 0 0 FY12ii FY13ii FY14ii FY15ii Source: Company, IIFL research Carriage revenue set to decline Carriage revenues have Carriage and placement fees contributed 55% to Den’s cable already started coming off revenue in FY12. These fees are paid by the broadcasters to the for digitised markets MSOs primarily for carrying their channels on cable network. These fees saw a sharp growth in past few years as the number of channels increased significantly without a corresponding increase in the channel-carrying capacity of the analogue system. As the digital system addresses this capacity constraint, carriage fees are expected to gradually come down. We estimate ~30% Cagr decline in carriage revenue over FY13-16ii. Figure 5.9: Carriage revenue is likely to drop 30% over next 3 years Carriage revenue (LHS) Carriage revenue as % of Cable revenue (RHS) 5,000 60.0 (Rs m) (%) 4,000 50.0 40.0 3,000 30.0 2,000 20.0 1,000 10.0 0 0.0 FY12 FY13ii FY14ii FY15ii FY16ii Source: Company, IIFL research, STB deployment bumps up top line Subsidy on STB deployment Den collects ~Rs800 from the customer for every STB deployed as works out to Rs1,000/box against the cost of the STB of ~Rs1,600. It recognises this income as subscription revenue in the corresponding quarter and expenses the associated commission of Rs250-300/STB. Digitisation has led to acceleration in STB deployment, which would boost revenue in FY13 and FY14. Activation revenue is expected to contribute 18%.3/17.3% to total cable revenue in FY13ii/FY14ii. [email protected] 103 Institutional Equities Den Networks – Not Rated Figure 5.10: Cable revenues in FY13 14 would be boosted by activation income (Rs m) Activation revenue (LHS) (%) Activation revenue as % of Cable revenue (RHS) 3,000 24.0 2,500 20.0 2,000 16.0 1,500 12.0 1,000 8.0 500 4.0 0 0.0 FY12 FY13ii FY14ii Source: Company, IFL research LCO’s revenue share likely to settle at 40% Negotiations with LCOs on Following digitisation, the function of billing the end customers would revenues share are far from transfer from the LCOs to MSOs. MSOs would recognise the entire over subscription fee as revenue and pay a revenue share to the LCO. Den expects revenue share agreements with LCOs to be signed at ~40%, as against TRAI’s minimum mandated revenue share of 35%. The management has indicated that direct billing to Phase I customer would start only by 1QFY14. Accordingly, the company would start incurring this cost from 1QFY14. Content cost set to rise Broadcasters and MSOs are Presently, content cost paid by MSOs to broadcasters is low since a entering into separate large portion of subscription fees paid by the consumer is retained by content contract for digital the LCO. On digitisation, broadcasters are expected to get their and analogue markets rightful share of subscription revenue. MSOs and broadcasters are now entering into separate contracts for digital and analogue subscribers. Content cost for the digitized subscriber base is likely to be significantly higher. Den estimates that content costs would eventually stabilise at around 33% of the subscription revenue, though in the first year following digitisation, it may be lower. We are building in an increase in content cost from second year of digitisation. Figure 5.11: DEN's content costs is set to double over FY12 16ii even as its carriage revenue drops 25% (Rs m) Content Cost Carriage revenue 5,000 4,000 3,000 2,000 1,000 0 FY12 FY13ii FY14ii FY15ii FY16ii Source: Company, IIFL research [email protected] 104 Institutional Equities Den Networks – Not Rated Digitisation-related expenses to drive other costs Digitisation would require Digitisation would entail new costs pertaining to subscriber setting up full-fledged management. These include costs associated with billing, and subscriber management maintenance of subscriber database and the customer care centre. system The management expects these costs to be around 3% of the subscription revenue initially. As the subscriber base increases, it should gradually come down. Additionally, Den would also incur ~5% commission on subscription revenue (less LCO’s share) to JV partners who convert to distributors post digitisation. The other key cost line items, which include employee costs and administrative expense, are expected to grow broadly in line with inflation. Ebitda set to grow at ~25% Cagr over FY13-16ii Step jump in revenues to Economics for digitised universe for MSOs are expected to be far drive Ebitda growth superior compared with their current profitability. The full impact of the first two phases of digitisation would be evident only in FY16 as revenue and cost trends would take a while to stabilise. On a steady- state basis, MSOs are expected to make 20-22% Ebitda margin on the increased revenue base. We expect Den’s Ebitda to increase from Rs2.1bn in FY13ii to Rs4.7bn in FY16ii. Figure 5.12: DEN's Ebitda margin are likely to stabilize around 22% on completion of first two phases (Rs m) Ebitda (LHS) Ebitda margin (RHS) (%) 6,000 30.0 5,000 25.0 4,000 20.0 3,000 15.0 2,000 10.0 1,000 5.0 0 0.0 FY12 FY13ii FY14ii FY15ii FY16ii Source: Company, IIFL research Revenue recognition and depreciation for STBs aggressive Accounting treatment of In India, STBs are provided to customers at a subsidised price. Den activation revenues bumps treats the upfront activation amount paid by customers as up reported Ebitda subscription revenue in the quarter of STB deployment. The STB is capitalised and depreciated over eight years. Accordingly, on deployment of an STB, company’s revenue and Ebitda would be boosted by Rs500-600/STB. STB deployment has picked up and is likely to remain elevated until completion of phase II of digitisation. Accordingly, activation fees would provide a sharp boost to reported Ebitda in FY13 and FY14. As we are not building in phase III and IV of digitisation at present, the impact of STB deployment significantly reduces from FY15 onwards. [email protected] 105 Institutional Equities Den Networks – Not Rated Figure 5.13: Ebitda breakup: Activation revenue would boost Ebitda in the initial yrs (Rs m) Cable Activation 6,000 5,000 4,000 3,000 2,000 1,000 0 FY13ii FY14ii FY15ii FY16ii Source: Company, IIFL research Figure 5.14: MSOs’ accounting policy is aggressive as compared with DTH players Set top box accounting Den Hathway Dish TV Cost of STB or CPE* (Rs) 1,600 1,600 2,600 Cash from customer (net of 550 550 1,300 dealer commission) (Rs) Entire amount is Entire amount is Recognized as recognized as recognized as lease rental Revenue recognition activation revenue activation over a 5 year on STB revenue on STB period deployment deployment Net revenue per STB or CPE 550 550 260 deployed in first year Straight line over Straight line over Straight line Depreciation 8 yrs 8 yrs over 5 yrs Depreciation per STB/CPE 200 200 520 Source: Company, IIFL Research * Consumer premises equipment in case of DTH players Den’s economic interest in Ebitda lower Subsidiaries and joint venture companies account for almost all of Den’s reach. Accordingly, a large part of Ebitda is attributable to minority shareholders of these entities. We do not have adequate details to calculate attributable Ebitda accurately. Furthermore, we are unsure of the exact distribution of profit between Den and its JV partners, where the entire investment related to digitisation has been made by Den. In the absence of such details, we assume only 50% of the JV partners would make their share of investment. In such a scenario Den’s attributable Ebitda would be 20-25% lower than the headline numbers. We estimate steady-state profit of ~Rs1.3bn Transition of Den’s business model from largely analogue to digital would take over a couple of years. Accordingly, we believe FY16 profit would be fairly representative of company’s earnings capacity. We are building in phase I and II of digitisation and revenue share for broadcasters and customers, as guided by the management. Den would generate attributable Ebitda of Rs4.7bn in FY16 and attributable profit of Rs1.3bn. [email protected] 106 Institutional Equities Den Networks – Not Rated Figure 5.15: On effective implementation of digitisation phase I & II, DEN would generate a steady state Ebitda of Rs4.7bn in FY16ii FY13ii FY14ii FY15ii FY16ii Assumptions Subscriber break up Wt. subscribers Analog (mn) 10.5 8.1 5.2 5.2 Wt. Average digital subs (mn) 0.5 3.0 6.0 6.0 Total subs 11.0 11.1 11.2 11.2 ARPU (Rs/month) Analog subs 22.0 20.3 16.9 16.9 Digitised subs 200 200 218 229 Subscription revenue (Rs m) Analog subscription revenue 2,772 1,979 1,054 1,065 Digital subscription revenue 1,202 7,209 15,682 16,466 Revenue Subscription revenue 3,974 9,188 16,736 17,530 Carriage revenue 3,844 3,383 2,875 2,732 Activation revenue 1,750 2,625 225 225 Media Pro & others 460 528 590 659 Total revenue 10,028 15,723 20,426 21,146 Expenses Content Costs 2,500 3,051 4,307 4,886 As% of Subscription revenue 62.9 33.2 25.7 27.9 Sub Mgmt Exp (@2.5%) 30 180 392 412 LCO's share (@~37%) 445 2,667 5,802 6,092 Distributor expenses (@5%) 34 204 445 467 Employee expenses 807 884 969 1,063 Other Op. & Adm exp 3,672 3,987 2,962 2,952 Media Pro & others 400 460 515 577 Total expenses 7,888 11,434 15,392 16,449 Ebitda 2,140 4,289 5,034 4,697 Ebitda Margin (%) 21.3 27.3 24.6 22.2 Depreciation 567 1,051 1,633 1,633 Other income 250 175 200 225 Interest expense 453 811 973 746 PBT 1,370 2,602 2,628 2,544 Tax 411 780 788 763 PAT 959 1,821 1,840 1,781 Less: Minority interest 237 451 455 439 Attributable PAT 722 1,370 1,385 1,341 Source: Company, IIFL Research [email protected] 107 Institutional Equities Den Networks – Not Rated Valuations stretched even in the best case Transition phase and limited details make valuation exercise difficult The business model of the MSOs is in a transition phase as we progress from largely analogue to the digital system. At present, there are several unknowns: revenue share, content cost, timeline, and effective implementation of digitisation. An accurate estimation of the cash-generating capacity of the MSOs’ business is fairly difficult, given these uncertainties. This is further complicated by the limited availability of information with respect to certain financial items. At present, we are largely going by the industry’s estimates on probable economics in a digitised environment. In view of fluid earnings estimates, we start the valuation exercise by attempting to understand what the market price is building in and assess the upside and downside risks. Market price builds in blue-sky scenario The table below indicates that Den’s market price already factors in seamless execution of all the four phases. Assuming a delay of six months in implementation and time lag of six months in realisation of the benefits, these estimates are unlikely to be realised before FY17. The following discussion explains why most of the above assumptions are at risk. Den trades at 6.9x FY17ii estimates in the best-case scenario. This looks expensive to use, given that following complete digitisation of India, growth would come-off sharply and will likely be closer to 4-5%, in line with growth in ARPU on an all- India basis. Note that current all-India ARPU is ~Rs150/month compared with our FY17 assumption of Rs250/month (both gross taxes). Multiple risks to these assumptions • Revenue share at risk: Our industry interactions suggest that revenue share negotiations are still far from conclusion. Digital subscription packages would require the LCOs to take at least 30% price increase even as the relevant content would be reduced. At the same time, the indicative revenue share implies that LCOs’ profitability would drop by at least 40%. This proposition looks inherently flawed to us. • Limited progress on other important steps: Discontinuation of the analogue signal is just the first step of the process. Other tasks such as creating a subscriber database and selling of packages, which are required to be accomplished in order to achieve higher revenue share are progressing slowly, at best. Note that, this after four months of digitisation in the most affluent cities in India. • Challenges in the remaining phases of digitisation: Firstly, Phase I digitisation is not as much a success as perceived since two out of the four cities sill remain in the analogue mode. The complexity of the implementation challenges would grow as later stages are much larger in scope. [email protected] 108 Institutional Equities Den Networks – Not Rated Figure 5.16: Valuations build in blue sky scenario Assumptions Phase I & II All 4 phases Comments Subscriber Reach break down (mn) Phase I & II 6.0 6.0 Phase III & IV 5.0 5.0 Total 11.0 11.0 Digital Builds in growth of 10%/5% in FY15/FY16; gross Subscriber base (in FY16) (mn subs) 6.0 11.0 ARPU of Rs270/month Due to large subscriber base in Phase III & IV we ARPU (Rs/month) 230 210 forecast lower blended ARPU Analogue Subscriber base (in FY16) (mn subs) 5 0 ARPU (Rs/month) 20 0 Revenues (Rs m) Digital subscription 16,560 27,720 Analogue subscription 1,200 0 Carriage 2,700 2,400 Building a 35 40% drop in digitised market Others (incl Media Pro) 650 650 Total 21,110 30,770 Additional expense for digital cable LCO's share 6,624 11,088 ~40% as per management's guidance Content cost 4,140 6,930 ~25 30% as per management's guidance Distribution comm 248 416 ~5% of MSO’s subscription revenue share Other costs 414 693 ~2.5% of digital subscription revenue Total 11,426 19,127 Analogue content cost 770 0 Our estimate Other operating costs 4,650 4,650 Our estimate Gross profit (Rs m) 8,914 11,643 Cable business gross profit Rs87/sub/month Ebitda (Rs m) 4,264 6,993 Ebitda margin 20.2 22.7 Less: minority interest in Ebitda 1,066 1,748 IIFL estimate Attributable Ebitda (Rs m) 3,198 5,245 CMP (Rs) 220 220 Current Market cap (Rs m) 28,708 28,708 Higher debt in second case due to capex on phase Attributable debt 4,500 7,500 III and IV of digitisation Enterprise value 33,208 36,208 EV/Ebitda (x) 10.4 6.9 Source: Company, IIFL Research [email protected] 109 Institutional Equities Den Networks – Not Rated Financial summary Income statement summary (Rs m) Y/e 31 Mar, Consolidated FY11A FY12A FY13ii FY14ii FY15ii 10,218 11,295 10,028 15,723 20,426 Drop in revenue in Revenues FY13ii is due to change Ebitda 901 822 2,140 4,289 5,034 in accounting pertaining to Media Pro Depreciation and amortisation (456) (538) (567) (1,051) (1,633) Ebit 445 284 1,573 3,237 3,401 We build in a 6 months lag for uptick in Non operating income 363 271 250 175 200 revenues and 12 months for costs Financial expense (191) (269) (453) (811) (973) PBT 617 286 1,370 2,602 2,628 Sharp jump in Exceptionals 0 0 0 0 0 depreciation on account 617 286 1,370 2,602 2,628 of deployment of STBs Reported PBT Tax expense (174) (100) (411) (780) (788) PAT 443 186 959 1,821 1,840 Minorities, Associates etc. (68) (43) (237) (451) (455) Attributable PAT 375 143 722 1,370 1,385 Ratio analysis Y/e 31 Mar, Consolidated FY11A FY12A FY13ii FY14ii FY15ii Per share data (Rs) Pre exceptional EPS 2.9 1.1 5.5 10.5 10.6 DPS 0.0 0.0 0.0 0.0 0.0 BVPS 59.4 61.7 67.2 77.6 88.2 Growth ratios (%) Revenues 12.2 10.5 (11.2) 56.8 29.9 Ebitda 8.8 (8.7) 160.2 100.4 17.4 EPS 24.7 (61.9) 405.7 89.7 1.1 Profitability ratios (%) The drop in Ebitda Ebitda margin 8.8 7.3 21.3 27.3 24.6 margins in FY15 is due Ebit margin 4.4 2.5 15.7 20.6 16.7 to lag in content cost increase Tax rate 28.2 35.1 30.0 30.0 30.0 Net profit margin 4.3 1.6 9.6 11.6 9.0 Return ratios (%) ROE 5.0 1.8 8.6 14.5 12.8 ROCE 8.4 5.2 14.5 20.5 18.2 Solvency ratios (x) Net debt-equity (0.2) (0.1) 0.4 0.8 0.5 Net debt to Ebitda (1.4) (0.8) 1.7 1.8 1.1 Interest coverage 2.3 1.1 3.5 4.0 3.5 Source: Company data, IIFL Research [email protected] 110 Institutional Equities Den Networks – Not Rated Balance sheet summary (Rs m) Y/e 31 Mar, Consolidated FY11A FY12A FY13ii FY14ii FY15ii Cash & cash equivalents 2,795 3,230 422 381 1,126 Inventories 0 0 0 0 0 Receivables 2,947 2,819 2,747 4,738 6,156 Other current assets 2,042 2,339 2,962 3,312 3,662 Creditors 3,700 3,861 2,908 4,216 5,675 Other current liabilities 50 60 60 60 60 Net current assets 4,033 4,467 3,163 4,155 5,208 Fixed assets 2,478 3,321 7,109 11,963 11,275 Intangibles 3,043 3,199 3,173 3,148 3,123 Intangible largely represent Goodwill on Investments 109 0 0 0 0 consolidation of several JVs Other long term assets 247 331 331 331 331 Total net assets 9,911 11,317 13,775 19,596 19,937 Borrowings 1,573 2,582 4,082 8,082 6,582 Debt to rise as capex is front ended and Other long term liabilities 592 690 929 1,385 1,845 revenues would follow with a lag Shareholders equity 7,746 8,046 8,764 10,129 11,510 Total liabilities 9,911 11,317 13,775 19,596 19,937 Cash flow summary (Rs m) Y/e 31 Mar, Consolidated FY11A FY12A FY13ii FY14ii FY15ii 445 284 1,573 3,237 3,401 Ebit Tax paid (174) (100) (411) (780) (788) Depreciation and amortization 456 538 567 1,051 1,633 Net working capital change (256) 1 (1,504) (1,033) (308) Other operating items 329 128 3 4 5 Operating cash flow before 800 852 228 2,479 3,942 interest Financial expense (191) (269) (453) (811) (973) Non operating income 363 271 250 175 200 Operating cash flow after interest 972 853 25 1,843 3,169 Capital expenditure (846) (1,323) (4,329) (5,880) (920) High HD demand poses an upside risks to capex Long term investments (109) 109 0 0 0 Others (395) (210) 0 0 0 Free cash flow (377) (570) (4,304) (4,037) 2,249 Equity raising 0 0 0 0 0 Borrowings (177) 1,009 1,500 4,000 (1,500) Dividend 0 (4) (4) (4) (4) Net chg in cash and equivalents (555) 435 (2,808) (41) 745 Source: Company data, IIFL Research [email protected] 111 Institutional Equities India - Media Annexure 1: HD: A long term positive HD - gaining traction High-definition (HD) technology was introduced to India in 2009. The number of HD channels available in India has gone up from one HD in 2009 to more than 30 channels now. Simultaneously, sales of HD compatible TVs have also picked up and are estimated to account for about ~15-20% of the total TV sales. HD subscriber addition for Dish TV is about 10% of the total gross subscriber additions. Note that, while HD sub adds lag HDTV sales at present, Dish TV’s subscriber growth for HD is more than twice that for SD. We expect this trend to continue on the back of rapid growth in HDTV sales and HD content. Figure6.1: HD’sshareinoverallTVsalesandDishTV’ssubaddsisgainingstrength 20% (%) 16% 12% 8% 4% 0% TVsales DishTVsubaddition Source:Industry,IIFLResearch Figure6.2: LCDstooutstripCRTsinoverallsalesinthecomingyears LCD/LED CRTs 40% 60% Source:Industry,IIFLResearch HD to ride on rapid growth of LCD TVs A big trigger for the fast-track adoption of HD would be the increasing adoption of LCD TVs in India. Steep declines in prices of LCD TVs have made them increasingly popular, and their sales are expected to overtake CRT TVs. LCDs/LEDs dominate the product catalogues of the three largest television manufacturers in India. In these product segments, it is hard to find non-HD models. This reflects that manufacturers are clearly shepherding customers onto HD TVs by phasing out non-HD models. Additionally, the differential between low end LCDs and CRT TVs have come off meaningfully over the past few years. As such, it is inevitable that a surge in sales of LCD TVs will translate into a surge in HD TV adoption. [email protected] 112112 Institutional Equities India - Media Figure 6.3: HD dominates in product offerings for TV manufacturers HDTVs outnumber non-HD offerings in major TV (no.ofproducts) HD/HDͲReady CRT manufacturers’ mid-range LCD line-ups 60 50 40 30 20 10 0 Samsung LG Sony Source:Company,IIFLResearch Figure6.4: PricegapbetweenHDLCDsandCRTTVshavenarrowedoverlastfewyears FullHD/HDͲreadyLED/LCD CRT No.of Typical Price No.of Price Typicalproduct products product (Rs) products (Rs) LowͲend Samsung 7 LA22D404E4R 12,900 14 CS21C370 7,650 LG 8 22CS410 12,750 22 21FG3RG 8,425 Sony 2 KVLͲ22BX350 15,900 0 NA NA MidͲHighlevel Samsung 32 UA32EH5000R 35,000 22 CS29Z40 14,490 LG 40 32LS4600 37,500 10 29FU3AG 16,800 Sony 24 KDLͲ32EX550 42,900 0 NA NA Source:Company,IIFLResearch HD to drive modest upside in ARPUs in the near term: Dish’s current HD packs are priced at Rs385/Rs460/Rs560 per month which is at 25-40% premium to the corresponding SD package. At the current addition rate of 10% of incremental subscribers, HD could lead to a modest 3-4% uptick in our medium term ARPU assumption. That said, we believe that a material upgrade could occur in the assumption of 10% of incremental subscribers adopting HD once inflection point is reached. [email protected] 113 Institutional Equities India - Media Figure6.5: Possibleupside,assuming10%ofnewsubscribersadoptHDatcurrent HDpackagerates,mediumͲtermARPUscouldsee3Ͳ4%upgrade FY12 FY13ii FY14ii FY15ii Subscriptionrevenues(Rsm) 16,639 19,595 23,344 28,503 Averagenetsubscriberbase(m) 9.1 10.1 11.1 12.2 NetARPUs(Rs) 153 162 175 195 CalculationforHD Averagenetsubadditions(m) 1.1 1.0 1.0 NetaverageHDsubͲadditions(10%ofnet 0.11 0.10 0.10 adds)(m) NetHDsubscriberbase(m) 0.3 0.41 0.51 0.61 HDARPUassumption(Rs) 410 430 450 PremiumoverARPUassumption(Rs) 248 255 255 ͲPossibleupsidetosubrevenues(Rsm) 314 642 947 PossibleupsidetoblendedARPUs(%) 1.6 2.8 3.3 Source:Company,IIFLResearch HD adoption in the US - Up from 15% to 75% in five years High-definition (HD) technology was introduced to developed markets in the early 2000s. But it is only in the last five years that HD adoption has seen a sharp uptick, as content offered by broadcasters moved on to HD. HDTV ownership in developed countries has increased sharply over the past few years and penetration of HD capability stands at more than 50% in most developed countries. This rise in penetration has been rapid in the Western world; in the US, for instance, HDTV penetration has increased from <20% in early 2008, to over 75% now. Figure6.6: HDTVpenetrationintheUShasgoneup~4xinthepastfiveyears, withtheincreaseinavailabilityofHDcontent (%) HDTVpenetrationintheUS 90 75 60 45 30 15 0 2007 2008 2009 2010 2011 2012 Source:Industry,IIFLResearch [email protected] 114 Institutional Equities India - Media Annexure 2: Comparison of distribution platforms Figure6.7: AcomparisonofDTHandcablefromasubscriber’sstandpoint Parameter Analogcable Digitalcable DTH Modeofdelivery CoͲaxialcable CoͲaxialcable Satellite Consumerpremiseequipment Notrequired NeedsetͲtopboxes(STB) DishantennaandSTB Customerschoice Notavailable Available Available Numberofchannels Maximum106 Canoffer1000channels Dependsontranspondercapacity. Atpresent,~280channelsoffered Localisedprogramming Available Available Notavailable Transmissionquality Poor AtparwithDTH Superioraudiovideoquality ValueͲaddedservices Internet Internet,Videoondemand Payperview,topͲupchannels andtopͲupchannels Installationcost Rs0Ͳ200dependingonarea ~Rs750 ~Rs1,500withonemonths’free subscription Subscriptioncost Rs120Ͳ350/monthdepending Rs200Ͳ350/month Rs140Ͳ400/monthdependingon onarea dependingonarea package Source:Company,IIFLResearch Figure6.8: AcomparisonofthebusinessmodelofMSOsandDTHoperator Parameter MSO DTH Relationshipwithsubscribers LargelythroughLCOs.Averysmallpercentageof Directrelationshipwithnointermediary subscriberbase(say5%)maybedirectlyserviced byaMSO LastͲmileacquisitioncost 20Ͳ24xmonthlyrevenues(approxRs3,800Ͳ4,560) Rs2,500(netofreceiptsfromthe subscriber) Analog/digital Over80%isanalog 100%digital Costofdigitisation STBcostRs1,600/piece,ofwhichRs800/pieceis Alreadydigitised recoveredfromsubscriber ARPU Rs150/month–nationalaverage Rs150/month Carriageincome Carriageanimportantrevenuestream–couldbe Carriageincomecontributeslessthan5%of asbigassubscriptionincome totalrevenues Marketsserviced Largelyurban Bothurbanandrural Costofdelivery WouldbehighinfarͲflungareas,asthecostof Low,asitdoesnotrequireputtingupcable layingcableswillbeveryhigh infrastructure Contentcosts Lowonapersubscriberbasis–asLCOsretaina Highascomparedtocable disproportionateshareofsubscriptionfees Source:Industry,IIFLResearch [email protected] 115 Institutional Equities India - Media Annexure 3: Package prices Figure6.9: PackagepricesaresimilaracrossDTHoperators (Rs/month) Lowend MidͲrange HighͲend HD HDChannels DishTV 200 255Ͳ300 380Ͳ400 385Ͳ560 41# TataSky 200 220Ͳ280 410 Package+100 10 AirtelDigitalTV 200 275Ͳ326 405 375Ͳ555 15 Videocond2h 200 265Ͳ320 396 369Ͳ462 22 RelianceBigTV 199 225Ͳ315 402 309Ͳ499 8 SunDirect 160 249Ͳ289 AddͲons Package+~100 9 Hathway* 230 297 358 NA NA DEN * 252 302 353 NA NA *PriceinMumbai#Incl.24upscaledHDchannelsand17trueHDchannels Source:Company,IIFLResearch [email protected] 116 Institutional Equities India - Media Glossary • Pay-TV: Subscription-based television services, provided by both analog and digital cable as well as satellite, and now also through internet television. In India, the pay-TV subscriber base stands at ~133m. • Free-to-air: Television services that do not require subscription or any payment. This allows any person with the suitable equipment to receive the unencrypted signal and view the content. • Terrestrial TV: Mode of broadcasting which does not involve satellite transmission or cables. It typically uses radio waves for transmitting, and antennae or aerials for receiving. • TV homes: Estimated number of television sets in a market. This will not be an exact indicator of TV penetration in the country, as there would be a small percentage of households with multiple televisions. • Pay TV homes: Estimated number of pay-TV subscribers in the country/ market. • Reach: Number of subscribers who are directly/ indirectly availing of pay-TV services from either a cable or a DTH operator. For a cable operator, reach is significantly larger than the number of paying subscribers, as local cable operators significantly under-report their subscriber bases. • Analog and digital channel: A broadcast that is transmitted as an analog signal from the service provider to the subscriber is defined as an analog channel. A broadcast that is digitised at the service provider’s end is referred to as a digital channel. Analog channels cannot be compressed and thus occupy more bandwidth relative to digital channels. The two main digital compression technologies used in television are MPEG2 and MPEG4. Indicatively, an analog channel takes up 7MHz of bandwidth during transmission. Post digitisation and compression, the same resources can be used to transmit more than 20 digital channels. • Analog subscriber: A subscriber receiving an analog signal from the service provider is referred to as an analog subscriber. The analog cable subscriber base in India currently stands at ~80m (~60% of the pay-TV population). The analog cable space suffers from a lack of addressability and hence under-reporting by the LCOs. • Digital subscriber: A subscriber viewing a digital signal from the service provider is referred to as a digital subscriber. DTH has emerged as the main digital platform in the country with ~38m subscribers, significantly larger than the ~15m digital subscribers for cable. • Primary subscriber: A subscriber receiving a signal directly from a service provider, without the intermediation of a local cable operator, is referred to as a primary subscriber. All DTH [email protected] 117 Institutional Equities India - Media subscribers are in effect primary subscribers, but this is a much lower percentage for cable. • Secondary subscribers: Subscribers who receive a broadcast signal through an intermediary such as an LCO. • Customer premise equipment (CPE): Apparatus needed to be installed at a subscriber’s home to enable her to receive a cable/ DTH signal. In case of digital cable, CPE consists of the set-top box costing ~Rs1,600 and a remote. For DTH, the CPE consists of a set-top box, dish, LNB (low-noise block-down converter) and remote. Total cost of CPE for DTH is ~Rs2,700 for SD and ~Rs4,400 for HD. • Multi-system operator (MSO): A cable operator servicing a large number of markets and owning a number of cable systems. • Independent cable operator (ICO): ICOs are merely smaller MSOs. Overall, there are 8,000 MSOs and ICOs in India. • Local cable operator (LCO): Cable operators who operate in specific areas within a town or a city and are restricted geographically. LCOs receive their signal from MSOs and forward them to subscribers. LCOs thus act as franchisees for MSOs. • Digitisation: The process of converting an analog transmission to a digital one. For cable, this requires modification at the service provider’s end and also installation of a set-top box at the subscriber end. • Triple-play: Providing three services—high-speed Internet access, television and telephone. Fibre-optic cables allow two– way communication; some cable companies in India offer triple- play. DTH does not allow any signal to be transmitted from the customer’s equipment, and thus cannot offer triple-play. • HD TV: High-definition television. HDTV has substantially higher resolution compared to standard-definition television. The main metric used to characterise HDTV is frame size or the total number of pixels (number of horizontal pixels x number of vertical pixels). For full-HD television, this stands at 1920x1080 (i/p) = ~2m pixels. This is almost 5x compared to standard television, whose display resolution is 720x480 = ~0.35m pixels. For a television to be called HD, it has to support a minimum native resolution of 720p. • HD-Ready: By definition, a HD-Ready TV set is equipped to display a HD signal, but does not necessarily have an in-built digital tuner, unlike a Full-HD TV. However, this is not a significant factor, since HD set-top boxes are equipped with digital tuners. In India, most HD-Ready TVs have a display with 720p vertical pixels, unlike 1080 (i/p) for Full HD. However, in terms of picture quality, there is no material difference for TV sets that are smaller than 70 inches. [email protected] 118 Institutional Equities India - Media This page is left blank intentionally [email protected] 119 Institutional Equities India - Media This page is left blank intentionally [email protected] 120 Institutional Equities India - Media NOTES Institutional Equities India - Media Published in 2013, © India Infoline Ltd 2013 This research report was prepared by India Infoline Limited’s Institutional Equities Research Desk (‘IIFL’), a company authorized to engage in securities activities in India. IIFL is not a registered broker-dealer in the United States and, therefore, is not subject to U.S. rules regarding the preparation of research reports and the independence of research analysts. This research report is provided for distribution to “major U.S. institutional investors” in reliance on the exemption from registration provided by Rule 15a-6 of the U.S. Securities Exchange Act of 1934, as amended (the “Exchange Act”). 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Reduce - Stock expected to return less than the hurdle rate, i.e. return of less than 10%. Distribution of Ratings: Out of 168 stocks rated in the IIFL coverage universe, 93 have BUY ratings, 14 have SELL ratings, 31 have ADD ratings, and 30 have REDUCE ratings. Price Target: Unless otherwise stated in the text of this report, target prices in this report are based on either a discounted cash flow valuation or comparison of valuation ratios with companies seen by the analyst as comparable or a combination of the two methods. The result of this fundamental valuation is adjusted to reflect the analyst’s views on the likely course of investor sentiment. Whichever valuation method is used there is a significant risk that the target price will not be achieved within the expected timeframe. Risk factors include unforeseen changes in competitive pressures or in the level of demand for the company’s products. Such demand variations may result from changes in technology, in the overall level of economic activity or, in some cases, in fashion. Valuations may also be affected by changes in taxation, in exchange rates and, in certain industries, in regulations. Investment in overseas markets and instruments such as ADRs can result in increased risk from factors such as exchange rates, exchange controls, taxation, and political and social conditions. This discussion of valuation methods and risk factors is not comprehensive – further information is available upon request. Zee Entertainment: 3 year price and rating history Date Close Target Rating Date Close Target Rating price price price price (Rs) Price TP/Recochangeddate (Rs) (Rs) (Rs) (Rs) 350 5-Feb-10 256 297 BUY 21-Dec-12 207 238 BUY 300 21-Apr-10 295 330 BUY 24-Jan-13 235 253 BUY 1-Nov-10 276 300 BUY 250 18-Jan-11 114 142 BUY 200 20-Apr-11 135 151 BUY 150 18-Oct-11 113 139 BUY 2-Mar-12 124 144 BUY 100 26-Jun-12 138 155 BUY 50 24-Jul-12 153 165 BUY 0 27-Aug-12 167 193 BUY 11 12 10 12 11 10 11 12 10 13 11 11 12 12 11 10 10 12 10 11 10 12 11 12 12 11 10 10 11 10 12 12 11 13 11 12 10 23-Oct-12 189 197 BUY Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ c 3-Dec-12 195 214 BUY Jul Jul Jul Jan Jan Jan Jun Jun Jun Oct Oct Oct Ͳ Apr Ͳ Apr Ͳ Apr Sep Sep Sep Feb Feb Feb Feb Dec Dec De Aug Aug Aug Nov Nov Nov Mar Mar Mar May May May Institutional Equities India - Media Sun TV: 3 year price and rating history Date Close Target Rating price price (Rs) Price TP/Recochangeddate (Rs) (Rs) 680 10-Feb-10 395 425 ADD 31-May-10 409 450 ADD 580 29-Jul-10 447 476 ADD 29-Oct-10 497 553 ADD 480 26-Nov-10 489 571 ADD 380 14-Sep-11 289 314 ADD 8-Nov-11 289 353 ADD 280 13-Feb-12 341 374 ADD 28-May-12 251 300 ADD 180 26-Sep-12 323 377 ADD 12 11 10 12 11 12 11 10 13 10 12 12 12 11 11 11 10 10 10 11 10 12 12 12 11 11 10 10 11 12 10 11 12 13 12 11 10 24-Jan-13 439 505 ADD Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Jul Jul Jul Jan Jan Jan Jun Jun Jun Oct Oct Oct Apr Apr Apr Sep Sep Feb Feb Sep Feb Feb Dec Dec Dec Aug Aug Aug Nov Nov Nov Mar Mar Mar May May May Dish TV: 3 year price and rating history Date Close Target Rating price price (Rs) Price TP/Recochangeddate (Rs) (Rs) 140 6-Sep-10 55 66 BUY 120 24-Jan-11 61 94 BUY 24-May-11 70 116 BUY 100 20-Jan-12 61 98 BUY 80 17-May-12 55 77 BUY 60 20-Jul-12 71 85 BUY 40 20 0 12 11 10 12 12 11 10 11 13 10 12 12 11 11 10 10 12 11 11 10 10 12 12 11 10 12 11 10 12 11 13 12 11 11 10 10 12 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Jul Jul Jul Jan Jan Jan Jun Jun Jun Oct Oct Oct Apr Apr Apr Sep Feb Sep Sep Feb Feb Feb Dec Dec Dec Aug Aug Aug Nov Nov Nov Mar Mar Mar May May May Hathway Cable: 3 year price and rating history Date Close Target Rating price price (Rs) Price TP/Recochangeddate (Rs) (Rs) 350 26-May-10 187 231 BUY 300 250 200 150 100 50 0 12 11 10 12 11 12 10 11 10 12 12 12 11 11 11 10 10 10 11 10 12 12 12 11 11 10 10 11 12 10 11 13 12 12 11 10 Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Ͳ Jul Jul Jul Jan Jan Jan Jun Jun Jun Oct Oct Oct Apr Apr Apr Sep Sep Feb Sep Feb Feb Dec Dec Dec Aug Aug Aug Nov Nov Nov Mar Mar Mar May May May InstitutionalEquities www.iiflcap.com IIFL - India IIFL - Singapore IIFL - UK IIFL - USA IIFL - Sri Lanka India Infoline Ltd IIFL Securities Pte Ltd, IIFL Wealth (UK) Limited IIFL Inc. IIFL Securities Ceylon (Pvt) Ltd 9th Floor, IIFL Centre, 6 Shenton Way, 45, King William Street, 1114 Avenue of the Americas 27th Floor, East Tower, Kamala City, Senapati Bapat #18-08B, London - EC4R 9AN, 34th Floor, World Trade Centre, Marg, Lower Parel (W), OUE Downtown 2, United Kingdom New York, Echelon Square, Mumbai - 400013 Singapore - 068809 Tel +44 (0) 207-993-6929 NY 10036 Colombo - 1 Tel +91-22-4646-4600 Tel +65-6511 6160 Tel +1-212-221-6800 Tel +94-112-333-000 Fax +91-22-4646-4700 Fax +65-6224 0650 Fax +1-212-221-6818 Fax +94-112-333-383