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ZEE - Sony merger – Turning into a dominant media player

* ZEE announced completion of the due diligence and final contours of the deal. SONY and ZEE’s promoters will hold 51%/4% in the merged entity, while the rest will be held by the public.

* There will be a fresh capital infusion of INR113b (USD1.6b) by Sony, including the INR11b as non-compete fee to ZEE’s promoters, which will be utilized to increase its stake to 4% from 2% in the merged entity.

* The merged entity is valued ~17x FY20 EV/EBITDA and 22x P/E. On a SoTP basis, the merged entity’s linear business is estimated to be valued at 11-12x EV/EBITDA, with a negative value for the OTT business.

* The combined entity will be a leader in the broadcasting space, with a strong war chest for intensifying its OTT foray and an investment similar to that made by Netflix on its India content.

* The deal addresses past corporate governance and Balance Sheet issues. A strategic partner like Sony will have the ability to leverage large scale opportunities in the Indian Media space.

* We upgrade ZEE to Buy from Neutral with a revised TP of INR425. Roadblocks in the fruition of the deal could be key risks.

Deal contours

* Fund infusion: SPNI, via a rights issue of INR79.5b, and ZEE’s promoters, through a new share issue of INR11b, will infuse INR90.5b in the combined entity. This, along with the existing cash on the books of the merged entity, will form the USD1.575b (INR113.4b) growth capital to be infused in the merged entity.

* SPNI to fund ZEE promoters’ 2% additional stake for INR11b (INR300/share): Sony, via its subsidiary, will pay a non-compete fee of INR11b to ZEE’s promoters, which will be used to infuse primary equity capital into SPNI, thereby increasing their stake by 2.11% to 3.99%.

* Increase in ZEE promoter’s stake to 20% may be market linked: ZEE has agreed to limit its stake to 20% in the combined entity. The press release clarified that the deal does not provide the promoters any pre-emptive or other rights to acquire equity of the combined entity from Sony, the combined company, or any other party. This was a key bugbear for Invesco.

* SPNI/ZEE to hold 50.9%/3.99% stake: Sony through its subsidiaries will indirectly hold majority stake (50.86%) in the combined entity. ZEE’s promoters will hold 3.99% and public shareholding will stand at 45.15%.

* This will be on the basis of: a) A 10:1 stock split, along with a bonus issue to SPNI’s shareholders. b) Overall equity infusion of INR90.5b by both companies. c) Share swap of 85:100 for ZEE’s shareholders and 133:10 for BEPL’s shareholders.

* At ZEE’s current market capitalization, this implies a post-money enterprise value of INR523.6b for the merged entity.

* The leadership of the combined entity will be driven by ZEE’s current MD and CEO Mr. Punit Goenka. The majority of the board of directors of the combined company will be nominated by Sony and will include SPNI’s current Managing Director and CEO, Mr. N.P. Singh. On closure of the deal, Mr. Singh will assume the role of Chairman, Sony Pictures India (a division of SPE).

Deal process

* Regulatory and shareholder/creditor approvals will now be sought and may take 3-4 quarters to fructify.

* Shareholders and creditor approval: ZEE needs to secure the consent of threefourth of its shareholders for the deal to be passed. (https://www.mca.gov.in/MinistryV2/mergers+and+acquisitions.html).

* Invesco holds a 20% stake, so securing their approval will be crucial.

* MIB and CCI approval: A couple of mergers in the Radio industry took over two years to fructify. So, this deal could take some time. CCI’s approval should take lesser time.

What’s in it for each company’s stakeholders?

ZEE

* While ZEE had a healthy Balance Sheet and market position, the merged entity will have a better market standing (revenue and cost synergies), given its scale and ability to intensify its OTT foray. The combined entity will have revenue of INR140-150b and EBITDA generating capability of 35% in the linear business, i.e. ~INR50b.

* It will have a wider portfolio across genres, including general entertainment, movies, and sports. SPNI, a unit of Japan’s Sony Corporation, operates 26 channels, including sports, while ZEE has 49 channels. The company over time could use its leverage to boost its competitive position and synergies.

* As per our estimate, both ZEE and Sony’s current combined OTT spend would be a sizeable ~INR30b annually. This could be far better utilized as a merged entity to ensure a steady flow of movie content and other genres.

* The new entity will have an independent board elected by Sony. Given ZEE’s history of various related party transactions and non-core investments, this deal may address most concerns.

Sony

* Sony gets two things. a.) A business at a reasonable price. ZEE is currently valued below 20x, a far cry from its peak valuation. b) Better management leadership to drive the broadcasting business, considering ZEE’s industry leading performance over the years.

* Promoter: This allows the promoter to improve their shareholding and address corporate governance concerns. It also provides a strong partner to invest in new opportunities in the changing Media landscape.

OTT opportunity and merged entity’s capabilities

* The OTT opportunity is evident from the 29m unique OTT subscribers paying for 53m OTT video subscriptions as of CY20. The same is doubling annually. Around 1,200 hours of original content is created annually for OTT platforms at a cost of INR10.2b across 220 titles, excluding acquired movie rights. The overall video subscription market was valued ~INR43b in CY20. This is now nearly 15% of the TV broadcasting market and is expected to double in two years.

* The merged entity’s ability to spend INR30b annually is similar to Netflix’s INR30b India content investment over the last two years. As per our estimates, the combine MAU of ZEE5 and SonyLIV is about 140m compared to ~192m for Hotstar’s entertainment content. Thus, the merged entity could certainly have a strong wherewithal to compete in the market.

Valuation and view

* The merged entity will get a strong board, along with senior management (current MD: Mr. Goenka) that has a very strong operational background. There is a possible upside from the merged entity’s higher competitive position in the market and synergy gains, given that both the companies have a significant potential to improve profitability. The stock is still trading below 20x, including SPNI. Improving corporate governance and operational performance could significantly aid in the long run. But the deal may take 3-4 quarters to fructify, given the long haul of structural changes to the business, board, and leadership, which may take time to drive incremental earnings.

* At ZEE’s current m-cap, this implies a post-money enterprise value of INR524b for the merged entity, implying an EV/EBITDA of 17x on a FY20 basis and a P/E of 22x. Considering the stable state 35% EBITDA margin for the linear broadcasting business, the OTT business garners negative value. This could be in for a big change given the merged entity’s strong war chest and ability to invest in content to drive growth. We upgrade our rating to Buy with a revised TP of INR425/share (at 25x Sep’23E EPS).

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