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Slow ad revenue growth recover

Zee Entertainment Enterprises’ (ZEEL) Q2FY23 print was disappointing yet again on subdued ad revenue growth despite early festive season and rise in viewership share. Also, cost of inflation was higher with rise in content and A&P cost which is keeping EBITDA depressed. ZEE5 EBITDA loss jump Rs1bn YoY to Rs2.8bn is also keeping EBITDA under-pressure. Ad revenue recovery is expected to be more gradual, NTO 2.0 implementation has been pushed to Feb’22, and movie releases are under performing --- nothing is going right for ZEEL at the moment. Further, ZEEL continues to invest aggressively in inventory (particularly movie rights) that has increased by Rs12.7bn (+19.2% YoY) in the past year and restricted FCF generation. Merger progress is on track with consummation anticipated by Mar’23. We cut our EPS estimates by 11-18% over FY23-24 on gradual margin recovery, and reduce target price to Rs265 (from Rs300) valuing the stock at an unchanged P/E multiple of 20x FY24E. Downgrade rating to HOLD (from Buy) on gradual FCF recovery. Key risks: Faster ad / subscription revenue recovery and lower inflation in expenses particularly programming cost.

* Ad revenue facing headwinds. ZEEL’s domestic ad revenue was down 7.7% YoY to Rs9.6bn despite early festival season in Q2FY23 (vs festival season was largely in Q3FY22), and improvement in viewership share for key GECs – Hindi and Tamil. Ad revenue was impacted by discontinuation of FTA channels, and subdued spends by advertisers on higher commodity inflation for FMCG companies. ZEEL expects small growth in ad revenue for FY23 (vs 1.7% dip in H1FY23) with gradual recovery in ad revenue growth. It is working on improving viewership share in Marathi GEC as well.

* Underlying subscription revenue subdued. Domestic subscription revenue rose 2.2% YoY to Rs7.2bn, negatively affected due to impasse in NTO 2.0. TRAI has again extended the timeline to Feb’22 for implementing NTO 2.0, which will be key to watch. Further, discontinuation of FTA channels was expected to help, but that has not happened as yet. Majority of subscription revenue growth is attributed to ZEE5.

* Movie (theatrical release) investment has under-performed. ZEEL said movie release has under-performed the expectation on box office collection; however, it will continue to invest in movie production. It is evaluating on allocating more capital to regional movies compared to Bollywood movies. Apart from movie production, increase in movie rights inventory by Rs4.8bn is a negative surprise, and is leading to rise in inventory

* Higher content cost and A&P spend hurt EBITDA. EBITDA dipped 28% YoY to Rs3bn and EBITDA margin was only 14.7%, impacted by 12.6% rise in programming cost to Rs10bn; and A&P spend jump 29% YoY to Rs3.2bn. ZEEL has been aggressively investing in programming to improve viewership rating, and for ZEE5. Rise in A&P spend was due to more movie releases.

*ZEE5 EBITDA loss at Rs2.8bn. ZEE5 MAU rose 9.1mn to 112mn despite price hike, while DAU increased by 0.1mn to 11.4mn. ZEE5 revenue grew 28% YoY to Rs1.7bn, however, cost rose sharper at 47% YoY. Therefore, EBITDA loss rose to Rs2.8bn from Rs1.7bn in Q2FY22. ZEEL expects losses to rise for few more quarters

* Other highlights. 1) ZEEL has changed amortisation policy for music from 3 years earlier to 10 years. This has Rs320mn of one-time gain in EBITDA; 2) merger with Sony is expected to complete by Mar’23 and stock will remain de-listed for 5-6 weeks. Synergy benefit is expected at ~6% of ZEEL revenue and 3-4% of merged entity revenue; 3) investment in sports will be a critical area of focus of merged entity; 4) unlike previously, ZEEL is not working on cutting cost as it has hurt viewership share in the past, thus, cost measures were ineffective; and 5) inventory will continue to rise as the company is investing in ZEE5, and increasing viewership share. Further, ZEEL has difference in inventory amortisation policy vs Sony. It sees the likelihood of a risk of inventory writedown on merger.

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