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Sharp recovery in ads; margin guidance lowered

* Zee Entertainment (ZEEL)’s revenue/EBITDA grew 6.3%/13% YoY, adjusted for a one-time INR5.5b content syndication deal, as ad revenue witnessed sharp recovery (up 6% YoY).

* We revise our EBITDA estimate by 9%/5% for FY21/FY22E, building in faster recovery, but high content investment would keep EBITDA margins lower at 27% (v/s >30% historically) in FY22E. Maintain Neutral.

One-time revenues lead to 27% EBITDA growth

* Consolidated revenues increased 33% YoY to INR27.2b (36% beat), led by recovery in ad revenue and a one-time content syndication deal of INR5.5b (excluding which LTL revenue growth stands at 6.3% YoY).

* Advertisement revenues increased 6% YoY (44% QoQ) to INR13b, led by sharp recovery during the festive season. Domestic subscriptions also grew 6.3% YoY on LTL (adjusted for the reclassification of music revenues).

* On an LTL basis, programming costs grew 11% YoY, adjusted for INR4.7b cost – attributable to a one-time content syndication deal (higher than LTL ad/subs revenue growth). Total opex grew 4% YoY.

* EBITDA, thus, grew 27% YoY to INR7b (40% beat), with margins at 26.2% (- 140bps YoY). Adjusting for the one-time deal related earnings, LTL EBITDA stood at INR6.4b, up 13% YoY (24% beat), with margins at 29.3%.

* The company also reported FV loss of INR839m due to a change in the market price of redeemable preference shares.

* Reported PAT increased 14% YoY to INR4b (15% beat), while adjusted PAT declined 14% YoY to INR4.8b, largely on high FV adjustments.

* Cash and investments rose to INR18b in 3QFY21 (from INR15b in 2QFY21).

* Inventory declined 6% QoQ to INR48b.

Highlights from management commentary

* Ad and subscription growth: Strong revival was seen in ad revenues across categories as economic activity picked up. Subscription growth is expected in the low-to-mid teens post the resolution of NTO 2.0.

* Margin guidance: Incremental investments in a new channel, the Digital business, and the Movie business would lead to margin dilution, and the earlier guidance for a 30% EBITDA margin would be difficult to achieve.

* Plans to scale up Movie biz: It plans to achieve this with 35–40 movie releases a year going ahead. While this would be a low-margin biz, the company aims to make sustainable profits in the long term.

* Increase in receivables: This is not linked to the syndication revenue but the reversal of a low base over the last couple of quarters. The amount from the sale of overseas mutual fund investments has been received, while receivables from related parties have reduced.

Valuation and view

* While revenue recovery has been encouraging, a) high investments in content acquisition in the recent past, b) acceleration in low-margin movie production, and c) investments in the Digital platform are likely to keep margins contained at 27% in FY22, much lower than 32–34% historically (more on this in our recent note).

* On the positive side, it has remained committed to bringing in increased governance and transparency toward investments, although the cleanup is still in process.

* We increase our FY21E/FY22E EBITDA estimates by 9%/5%, led by quicker recovery in ad revenues, and roll forward our estimates to FY23E. We factor in 54%/69% growth in EBITDA/PAT in FY22 on a low base of FY21E. The stock trades at 13x FY22E EPS of INR19. This is a far cry from its historic multiples of >25–30x around three years ago. Any potential re-rating would be governed by a consistent and disciplined investment approach – restricted to the non-core business – and an improving EBITDA/FCF profile.

* For now, we value ZEE at 14x FY23E EPS, with Target Price of INR265. Maintain Neutral

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