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Heavy investments continue

* Zee Entertainment (Zee)’s consolidated EBITDA declined 34% YoY (a beat) as its revenue growth (of 8% YoY) was offset by higher content and Zee5 spends. Ad revenue dropped 4% YoY due to weak market and the impact of IPL, offset by 18% YoY subscription revenue growth on the back of NTO 3.0 and digital subscription growth in 1QFY24.

* We largely retain our revenue/EBITDA estimates for FY24/FY25 building in recovery in the ad market and continued investments. While the current valuations do not appear to justify the strong potential of the merged entity, aided by its strong competitive position in both linear and digital segments, NCLT’s judgment on merger and its completion would remain a key monitorable. Reiterate BUY with a TP of INR280, based on 26x FY25E EPS.

EBITDA declines 34% YoY due to higher opex

* Zee’s consolidated revenue grew 7.5% YoY to INR19.8b (in line) driven by subscription revenue growth as ad revenue growth was muted in 1QFY24.

* Ad revenue declined 4% YoY to INR9.4b (in line) due to muted ad spends during the early part of the quarter and the impact of IPL.

* Subscription revenue grew 17.6% YoY to INR9.1b (in line) driven by NTO 3.0 and ZEE5.

* Revenue from sales and services jumped 38.5% YoY to INR1.4b driven by Theatrical revenue from movie releases

* Zee’s total opex grew 13.6% YoY to INR18.3b, due to higher programming and technology costs and continued investments in Zee5.

* EBITDA fell 34% YoY to INR1.5b (beat). EBITDA margin contracted 500bp YoY to 7.8% (vs. 4.7% est.) as revenue growth was offset by higher opex.

* Zee5’s revenue came in at INR1.9b (+21% YoY), while operating loss widened to INR3.4b. Adjusted for Zee5, linear TV business’ revenue/ EBITDA grew 6% each to INR17.9b/INR5b with an EBITDA margin of 28%.

* Zee reported an exceptional loss of INR706m, which was related to employee and legal expenses pertaining to the proposed Scheme of Arrangement.

* Adjusted for the exceptional item, PAT declined 57% YoY to INR496m (vs. INR162m estimated) during the quarter.

Highlights from the management commentary

* NCLT has reserved its order w.r.t merger and is expected to announce the judgment on 10th Aug’23. The company does not foresee any major impact of MD’s disqualification on merger process.

* Ad revenue, which posted a moderate growth early on, is now showing improvement on exit basis. Management expects a strong recovery from 3QFY24 onwards with the onset of festive season.

* Subscription revenue growth on net basis to remain moderate given the incremental marketing costs incurred by the company.

* Sequential rise in operating loss for Zee5 during 1QFY24 was due to lower revenue, which led to operating deleverage.

Valuation and view

* The gradual recovery in ad revenue with improving spends from FMCG segment appears to be a silver lining. Recovery could be seen from 2HFY24 onwards with the onset of the festive season.

* Outlook on subscription revenue, however, is expected to improve with the implementation of NTO 3.0.

* The continued investments within the digital (Zee5) segment could drag profitability, given the segment remains in an investment mode.

* The merged entity with a revenue scale of ~INR160b and EBITDA margin of 18% as of FY23 is trading at 10x EV/EBITDA on FY23 basis. We believe that the valuations of the merged entity do not capture the strong opportunity ahead. However, any certainty around merger timelines would remain a key monitorable.

* The potential re-rating of the stock will be governed by: a) a recovery in the ad market, and b) completion of the Sony merger deal, given the strong market position for the merged entity and its growth opportunity.

* Valuing the stock at 26x FY25E EPS, we arrive at a TP of INR280. We maintain our BUY rating.

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