Dish TV India

Merger synergies will be key to re‐rating

March 22, 2018 We met the management of DISH TV to get an update on the impending merger with Videocon D2H and potential synergies that could arise from it. Our discussion Jinesh Joshi [email protected] centred on the breakdown of synergy benefits, competitive scenario in the DTH

+91‐22‐66322238 market amid abeyance of fresh auctions by DD Free Dish, license fee liability conundrum and general impact of the new tariff order by TRAI.

Update Management guided for synergy benefits of Rs5.1bn and Rs7.6bn in FY19 and FY20 respectively due to scale advantage that will emerge from negotiating content Rating Not Rated deals and sourcing set top boxes. Aligning back end operations and admin cost Visit Price Rs66 rationalization will be another area of cost savings post‐merger. Even if the Target Price NA synergies fructify to the extent of 50%, EBITDA could get a boost in FY20 (merged Implied Upside NA entity pro‐forma EBITDA stood at ~Rs20bn in FY17). Apart from synergy benefits, Sensex 33,136 new tariff order, if implemented, could act as another sweetener as it will improve Nifty 10,155 the bargaining power of distributors. However, with a split verdict announced by (Prices as on March 21, 2018) Madras High court the order still remains in a limbo.

Trading data Nonetheless, competition from DD Free Dish, as government has allowed renewal Market Cap. (Rs bn) 70.8 of slots by paying a pro‐rata fee, will continue to hurt DTH players in the near term Shares o/s (m) 1,066.0 until some alternative model is devised. License fee liability, in case, if it arises 3M Avg. Daily value (Rs m) 552.9 Major shareholders could be another overhang. However, we believe, the scale that the merged entity Promoters 64.43% will achieve (subscriber market share in the region of 45‐50% post‐merger) will be Foreign 18.48% difficult to match. Thus, valuations at an EV of 6.5x FY20 EBITDA (assuming 50% Domestic Inst. 8.38% discount in synergies and a stagnant merged entity base EBITDA figure of FY17) Public & Other 8.71% appear compelling. Stock Performance (%) 1M 6M 12M Absolute (8.6) (13.1) (38.1) Key financials (Y/e March) 2014 2015 2016 2017 Relative (6.0) (13.2) (49.1) Revenues (Rs m) 25,090 26,880 30,599 30,144 How we differ from Consensus Growth (%) 15.8 7.1 13.8 (1.5) EPS (Rs) PL Cons. % Diff. EBITDA (Rs m) 4,947 7,331 10,249 9,729 2019 NA 0.85 NA PAT (Rs m) (1,576) 31 6,924 1,093 2020 NA 1.90 NA EPS (Rs) (1.5) 0.0 6.5 1.0 Growth (%) NA NA NA (84.2) Price Performance (RIC: DSTV.BO, BB: DITV IN) Net DPS (Rs) ‐ ‐ ‐ ‐ (Rs) 120 Profitability & Valuation 2014 2015 2016 2017 100 EBITDA margin (%) 19.7 27.3 33.5 32.3 80 RoE (%) ‐ ‐ ‐ 5.1 60 RoCE (%) (1.9) 16.1 35.8 22.0 40 EV / sales (x) 3.0 2.5 2.6 2.5 20 EV / EBITDA (x) 15.5 9.2 7.8 7.7 0 PE (x) NA NA 10.3 65.5 P / BV (x) NA NA 18.8 14.6 Jul/17 Jan/18

Sep/17 Net dividend yield (%) ‐ ‐ ‐ ‐ Nov/17 Mar/17 Mar/18 May/17 Source: Bloomberg Source: Company Data; PL Research

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Dish TV India

Key takeaways from our meeting

Merger Synergies

Management stayed put with its synergy guidance of Rs5.1bn in FY19 and Rs7.6bn in FY20. Out of the Rs5.1bn savings expected in FY19, Rs1.1bn will be from sourcing set top boxes at better prices due to scale advantage. The combined entity will have net subscribers of ~30 mn with net adds in the region of ~1.5‐2 mn per annum. Post‐ merger, the new entity will be able to negotiate better with vendors of set top boxes due to increase in volumes.

Roughly, Rs0.75‐0.8bn of savings will come from interest cost rationalization. Videocon’s current cost of debt is in the range of 13.5% due to lower debt rating. After the merger, interest cost savings will be in the region of 300‐400 bps as the cash flow and BS situation of the merged entity is likely to be much better.

Savings from aligning back end operations will be in the range of Rs0.45‐0.5bn. As an example, DISH TV will be able to negotiate better with call centre vendors as volumes post‐merger will rise. At present, DISH TV has ~16 mn subscribers. Scale advantage that would come from an enlarged subscriber base of ~30 mn of both the entities, will help in reducing rates.

Balance savings will come from admin expense rationalization (warehousing, rents, rates etc) and content deals. The merged entity will benefit to a great extent due to improved bargaining power when it comes to striking content deals with broadcasters. DISH TV’s content cost is in the region of 30% of sales vis‐à‐vis Videocon’s 35‐40%. Since DISH TV negotiates content deals on fixed fee basis, higher reach will enable it to negotiate better with broadcasters.

In FY20, the synergy advantage is likely to be Rs7.6bn. Entire Rs5.1bn will flow through FY20 while an additional Rs2.5bn cost savings will come from synergizing back end services.

Our view on synergy benefits

Merger will give the consolidated entity a huge scale advantage that will drive cost savings when it comes to negotiating content deals and sourcing set top boxes. Assuming a 50% discount (conservative stance just to analyse the quantum of benefits) to management’s guidance, the synergy benefits could be Rs1.6bn (set top box and interest synergy will not impact EBITDA) in FY19 and Rs3.2bn in FY20 at the operating level. Combined EBITDA of both the entities was at ~Rs20bn in FY17; signifying substantial savings could come in after the merger even after assuming a 50% discount in synergies.

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Dish TV India

Competition from DD Free Dish

Post commercialization of DD Free Dish, slots were auctioned to private broadcasters for payment of a carriage fee. Commercialization was thought to be a viable option as DD never had strong content. Hence, excess bandwidth was monetized by auctioning channels to private broadcasters. This move benefitted private broadcasters immensely as they bought slots for a small amount of carriage fee (Rs 60‐80 mn) but raked in huge advertising revenues due to high reach obtained by DD Free Dish. Auctions also relegated incumbent DD channels to an unwanted category as there was rich content available on the platform from alternative broadcasters virtually free. Gain of pit‐full carriage revenue potentially led to a loss of millions in advertising revenues leaving the government in lurch. As a result, government has decided to work on some alternative revenue model and until further notice auctions are suspended.

Our view on competition from DD Free Dish

The DTH market is highly competitive with six players around. However, commercialization of DD Free Dish has created havoc in already overcrowded market as it is a free platform. Suspension of auctions would create a level playing field as customers will switch to pay TV distributors for the lack of content on DD platform. However, government has allowed renewal of slots for a payment of pro‐rata fee until an alternative model is devised. Renewals will keep competitive intensity high and continue to hurt DTH operators in the near term.

Impact of new tariff order

TRAI has released new tariff order to bring in transparency between broadcaster and distributor contracts. Presently, via bundling, broadcasters are pushing in the lower rung channels along with the premium channel to distributors thereby arm twisting them. In the end, customer is loaded with a bundle that has a list of channels against a select few which he/she is interested in.

Ala carte premium channels are either not offered by broadcasters or offered at such a high rate that it becomes unviable for the distributor to buy it. In the current scheme, distributor is at a big dis‐advantage as he has limited bargaining power while customer suffers as he is being sold a bundle of which most channels are unwanted.

The new TRAI order mandates broadcasters to define MRP of each channel. Further, as per the new order all channels should be available on ala carte basis. Bundling is allowed but price of the bundle cannot be less than 85% of the price of all channels in the bundle, if sold ala carte. (There are many other regulations that aim to bring in more transparency between broadcaster and distributor).

March 22, 2018 3

Dish TV India

Our view on new tariff order

The new order, if implemented, will improve the bargaining power of distributors. Defining MRP, offering channels on ala carte basis and bundling with a price floor will bring down the content cost of distributors as there will be more clarity on pricing and stuffing of lower rung channels as a part of the bouquet will cease to exist. Since subscribers will be able to pick channels of their choice, channels with poor content will see no demand and cease to exist.

License issue deadlock

DTH players are required to pay a license fee at the rate of 10% of gross revenues. However, over the years, players have toyed with the definition of gross revenue resulting in different rates for different operators. As of 3QFY18, the license fee liability on DISH TV’s books is Rs9.5bn (excluding interest) while that for Videocon (contingent liability) it is Rs5.7bn (excluding interest).

Our view on the license fee issue

Currently, the matter is sub‐judiced and there is no fresh update. However, since Videocon’s liability is off balance sheet it will have to be provided for once the consolidation happens to be in sync with the current policy. If the verdict goes against DISH TV then there will be a cash out go to the said extent.

Other key highlights from our meeting

 ARPU pressure will continue to prevail due to higher share of rural subscribers and low value packs. However, focus on increasing the HD subscriber base (3.4mn out of 16mn) should help.

 Majority of the set top box requirements are imported.

 There is a time lag in content that is being aired on DD Free Dish vis‐à‐vis a paid distribution platform.

 A subscriber is churned out if he/she does not pay for 120 days.

 Content deals are negotiated on fixed fee basis. The term could be annual/quarterly and depends on broadcaster to broadcaster.

 Signal compression standard is witnessing transition from MPEG 2 to MPEG 4. However, this will require a change of set top box as MPEG 2 box cannot decode MPEG 4 signal. This will create an element of additional hardware migration subsidy.

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Dish TV India

Company background

DISH TV launched operations in 2003 and is the first DTH player in India. As of 31st Dec 2017, the company has 25% subscriber (based on gross numbers) market share. Over FY10 to FY17, net subscribers and ARPU has increased at a CAGR of 15.4% and 1.6% to 15.5mn and Rs154 respectively. DISH TV has been able to maintain its content cost in the region of 30% over the last 5 years resulting in an EBITDA CAGR of 14.4% over the same period.

Exhibit 1: Net subscriber base Exhibit 2: ARPU trend

18 200 15.5 172 16 14.5 163 162 150 151 157 154 14 12.9 138 11.4 150 12 10.7 9.6 10 8.5 100 (Rs) (mn) 8 5.7 6 4 50 2 0 0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17

Source: Company Data, PL Research Source: Company Data, PL Research

Transaction summary of merger with Videocon D2H

DISH TV and Videocon have approved a scheme of arrangement to merge their operations. The combined entity will be named as DISH TV Videocon Ltd. DISH TV will issue 857.8 mn shares as a consideration for the proposed transaction. Shareholders of Videocon will get 2.02 shares in the new entity for every share in Videocon.

Post‐merger, DISH TV promoters will own 36%, Videocon principal shareholders 28% (will no longer be classified as promoters) while the rest will be held by minority shareholders. Videocon will have right to nominate two directors on the board, one of whom will be a vice‐chairman and the other deputy managing director.

Final take

Merger of DISH TV Videocon will create a behemoth in the DTH market with the merged entity having subscriber market share in the region of 45‐50%. A pro‐forma snapshot of the both the entities is given below:‐

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Dish TV India

Exhibit 3: Key metrics of the merged entity Particulars (FY17) DISH TV Videocon Total Net subscribers (m) 15.5 12.9 28.4 Revenue (Rs m) 30,144 30,717 60,861 EBITDA (Rs m) 9,728 10,181 19,909

Source: Company Data, PL Research

If we assume the merged entity EBITDA of FY17 to remain stagnant (conservative assumption) and just add the merger synergy figure after applying a discount of 50% then the combined entity is trading at an EV of 6.5x FY20 EBITDA which appears compelling.

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Dish TV India

Income Statement (Rs m) Balance Sheet Abstract (Rs m) Y/e March 2014 2015 2016 2017 Y/e March 2014 2015 2016 2017 Net Revenue 25,090 26,880 30,599 30,144 Shareholders Funds (3,126) (3,134) 3,807 4,906 Raw Material Expenses 142 122 158 158 Total Debt 8,449 480 11,564 5,834 Gross Profit 24,948 26,757 30,441 29,986 Other Liabilities 918 183 (3,725) (4,101) Employee Cost 892 1,018 1,229 1,440 Total Liabilities 6,241 (2,472) 11,646 6,639 Other Expenses 19,109 18,409 18,963 18,817 Net Fixed Assets 17,797 19,510 24,201 27,071 EBITDA 4,947 7,331 10,249 9,729 Goodwill ‐ ‐ ‐ ‐ Depr. & Amortization 5,974 6,138 5,907 6,631 Investments 1,500 2,000 1,500 1,500 Net Interest 1,328 1,754 2,087 2,239 Net Current Assets (14,010) (24,988) (15,796) (23,947) Other Income 778 635 640 475 Cash & Equivalents 3,426 4,286 3,392 2,923 Profit before Tax (1,576) 74 2,895 1,334 Other Current Assets 415 637 725 870 Total Tax 1 42 (4,029) 241 Current Liabilities 21,461 34,167 23,586 30,869 Profit after Tax (1,576) 31 6,924 1,093 Other Assets 954 1,006 1,741 2,016 Ex‐Od items / Min. Int. ‐ ‐ ‐ ‐ Total Assets 6,241 (2,472) 11,646 6,639 Adj. PAT (1,576) 31 6,924 1,093 Avg. Shares O/S (m) 1,065 1,066 1,066 1,066 EPS (Rs.) (1.5) 0.0 6.5 1.0

Cash Flow Abstract (Rs m) Quarterly Financials (Rs m) Y/e March 2014 2015 2016 2017 Y/e March Q4FY17 Q1FY18 Q2FY18 Q3FY18 C/F from Operations 7,055 7,675 11,324 8,204 Net Revenue 7,086 7,389 7,486 7,408 C/F from Investing (2,984) (6,699) (8,091) (6,235) EBITDA 1,906 2,012 2,161 2,005 C/F from Financing (4,610) (362) (3,519) (1,145) % of revenue 26.9 27.2 28.9 27.1 Inc. / Dec. in Cash (539) 614 (286) 824 Depr. & Amortization 1,728 1,822 1,899 1,847 Opening Cash 1,143 581 1,195 909 Net Interest 573 590 611 502 Closing Cash 581 1,195 909 1,733 Other Income 104 98 77 158 FCFF 3,369 (490) 4,956 (1,053) Profit before Tax (291) (302) (272) (186) FCFE 16,349 14,362 14,892 2,738 Total Tax (8) (162) (93) (150) Profit after Tax (283) (139) (179) (36) Adj. PAT (283) (139) (179) (36) Source: Company Data, PL Research. Key Financial Metrics Y/e March 2014 2015 2016 2017 Growth Revenue (%) 15.8 7.1 13.8 (1.5) EBITDA (%) (14.6) 48.2 39.8 (5.1) PAT (%) NA NA NA (84.2) EPS (%) NA NA NA (84.2) Profitability EBITDA Margin (%) 19.7 27.3 33.5 32.3 PAT Margin (%) (6.3) 0.1 22.6 3.6 RoCE (%) (1.9) 16.1 35.8 22.0 RoE (%) NA NA NA 25.1 Balance Sheet Net Debt : Equity NA NA 2.1 0.6 Net Wrkng Cap. (days) (22.0) (12.2) (18.2) (17.2) Valuation PER (x) NA NA 10.3 65.5 P / B (x) NA NA 18.8 14.6 EV / EBITDA (x) 15.5 9.2 7.8 7.7 EV / Sales (x) 3.0 2.5 2.6 2.5 Earnings Quality Eff. Tax Rate (0.0) 57.3 (139.2) 18.1 Other Inc / PBT (49.4) 862.8 22.1 35.6 Eff. Depr. Rate (%) 14.6 12.7 10.3 10.1 FCFE / PAT (10.4) 457.4 2.2 2.5 Source: Company Data, PL Research.

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Dish TV India

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