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Buy Zee Entertainment Ltd For Target Rs.430

A masterstroke; upgrade to Buy

* Zee and Sony Pictures Networks India (SPNI) have entered into a non-binding term sheet (with a 90-day exclusivity period) for the merger of the two companies. The deal should address investor concerns, and fill the content gaps each of them are currently having.

* Combined entity is valued at Rs502bn (incl. Rs116bn cash from SPNI) based on mergerterms. Zee shareholders would own 49.1% of the merge-co, including a 2% stake transfer by SPNI to Essel Group towards non-compete; Sony will have control over the board.

* Essel Group will maintain its ~4% stake post-merger, with an option to raise it up to 20%. The merger will result in scale (USD2bn revenues), leadership (~25% revenue share), complementary assets, and an USD1.8bn cash pile to ramp up growth.

* As a result, we turn constructive on Zee with the assumption of successful synergies accruing on both revenue and cost fronts. We upgrade to Buy from Hold and raise our Sept’22E TP to Rs430 (11x Sept’23E pro-forma broadcasting EBITDA) from Rs205.

Event: Zee and SPNI have entered into an exclusive, non-binding term sheet for the merger of the two companies. There will be an exclusive negotiating period of 90 days, prior to the formation of a definitive and binding agreement. The parent company of SPNI will invest growth capital of ~USD1.6bn to advance the merged co’s businesses. Post this, Zee shareholders will have a stake of 49.1% (61.25% prior to the aforementioned capital infusion), with ~2% of this being transferred by SPNI to Zee’s promoters. In addition, Zee’s promoters will have the option of increasing their stake to up to 20% without any pre-conditions. The appointment of Mr. Punit Goenka as MD and CEO of the merged entity for a period of five years is an integral part of the deal.

Outlook:

We view this transaction as a big positive as it might resolve a slew of issues relating to corporate governance and investor activism, with the board of directors to be decided by Sony. The merged entity will become the market leader with a comprehensive bouquet of offerings, along with the necessary balance sheet strength to invest in digital businesses and sports rights. SPNI’s emphasis has been on building sports and HSM portfolios, while Zee has been focused on regional, HSM and movie channels. The merged entity will benefit from: 1) increased bargaining power with content producers and distributors; 2) optimization of costs by shutting down tail-end channels, thus, freeing up management bandwidth and costs attached to them; and 3) competitive edge. All these factors should augur well for better valuation. Zee’s underlying broadcasting business has been facing challenges due to the Covid-induced shift toward digital. However, in our view, the merged entity’s comprehensive offerings will place it ahead of competitors on the growth front.

Key risks: 1) integration challenges, 2) cultural differences, 3) delayed regulatory approvals, 4) sustained slowdown in underlying ad revenues and 5) higher than estimated losses from digital business.

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