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Music topline affected by transition of a few OTTs to paywall

Saregama’s 2Q EBIT of INR 526mn missed JMFe by 17.4% due to weaker-than-expected revenue in all three reporting segments. Music segment revenue missed JMFe by 12.3% as it expanded only 4% YoY vs. 15%+ growth in each of the previous 9 quarters. The growth slowdown was attributable to the flagship music licensing business, which, our calculations suggest, grew only in low single digits YoY. Essentially, the transition by three music OTT players - Gaana, Resso and Hungama - to paid subscriptions (behind paywall) led to their minimum guarantees going away. We see the impact as transitory in nature as the development can significantly lift streaming platform revenue for the company over the medium to long term. While music retail volume was very strong at 21.2% YoY, realisation continued to come off due to growing share of Carvaan Mobile (where realisation is significantly below INR 2k). Films/TV Serials and Events segment revenue missed our estimate by 34% and ~98% due to the uneven nature of the businesses. Having said that, the Music licensing and Films/TV Serials segment revenues are likely to report a sharp bump-up in 2H on the back of a strong line-up of new music/films content in 2H and synergy benefits from the recently acquired Pocket Aces business. From a medium-term perspective, the management suggested that Consol. revenue could grow 27-28% YoY

* Revenue weakness led to earnings miss in 2Q: Saregama’s consol. revenue declined 6.8% YoY (+5.5% QoQ) to INR 1.72bn, a miss on JMFe by 22.5%. Films & TV Serials and Events businesses revenues shrank 1%/98%, respectively, whereas the Music segment revenue grew 4% due to lower-than-estimated growth in the music licensing business. Increase in Music revenue share led to gross margin expanding to 76.4% from 71.1% in 2Q last year. Despite the revenue slowdown, EBIT margin expanded c.340bps YoY to 30.5% (ahead of JMFe by 190bps) due to sharp decline in A&P (-26.9% YoY) and other expenses (-9.3% YoY). Adj. EBITDA margin in 2QFY24 stood at 41.8% compared to 37.8%/38.1% in 2QFY23/1QFY24 and was above 32-33% guidance. Other income (net of finance expenses) in 2Q stood at INR 130mn, below JMFe of INR 170mn. Overall, PAT grew 8.4% YoY to INR 481mn, below JMFe by c.20% mainly due to revenue weakness.

* Impact of music OTT’s transition to paywall transitory in nature: The transition of music streaming platforms to paywall means 1) music labels will eventually move away from the concept of minimum guarantees with streaming platforms (only three platforms follow this model now) and 2) end consumers initially moving to free platforms like Youtube and then eventually getting nudged to paid subscriptions. While this could have near-term impact on revenue, over a slightly longer period, the transition is likely to lead to a sharp improvement in yields per stream for music labels. As per Saregama management estimates, this could lead to 150-300% improvement in revenue from music labels. We, therefore, expect the current impact of transition to be transitory for music labels.

* Cut EPS estimates, retain ‘BUY’ with TP of INR 450: We expect Saregama’s music licensing revenue to deliver at least 20% CAGR over FY23-26E basis its new content acquisition strategy, while acknowledging that the actual growth delivery could be significantly higher if recent developments (Pocket Aces acquisition and Music OTTs’ transition to paywall) plays out as envisaged by the management. While margin EBIT will likely correct to ~24% in FY24 vs. 27.2% in FY23 due to expensing out of new investments and consolidation of Pocket Aces, we expect a recovery thereafter driven by scale benefits and factor in a 40bps improvement over FY24-26E. We reduce earnings estimates over FY24-26 by 5-12% as we factor in lower other income on account of cash utilisation towards the Pocket Aces acquisition that we also consolidate in our model now. We retain ‘BUY’ on Saregama with a DCF-based Sep’24 TP of INR 450 (assuming a WACC of 12% and Tg of 5%).

* Pocket Aces acquisition: The management suggested that the acquisition will help it get direct access to 95mn+ digital subscribers (most of whom fall in the 12-35 age group) of Pocket Aces across various digital platforms such as Instagram, Youtube, etc. The target also manages 120+ digital influencers and actors and has exposure to brands targeting the younger audience. The acquisition, therefore, will significantly enhance Saregama’s capability to market and monetise its new content. Saregama expects combined revenue of the two companies to grow at 27-28% YoY over the medium term with adj. EBITDA margin of 32-33%, despite the fact that Pocket Aces is currently loss-making (break-even expected in FY25).

* Carvaan: The management mentioned that volume growth in the retail music business was driven by Carvaan Mobile devices whose average realisation per unit sold is significantly below INR 2,000. This, in turn, led to a sharp decline in overall business realisation. The business is now contributing to small profits vs. being break-even earlier.

* Overall guidance: The management expects to deliver Consol. revenue of 22-23% in FY24 (Pocket Aces contribution to materialise from Nov’23) despite a weak 1H. While it expects the Events business to see some traction in 3Q (following events in Australia and New Zealand), it expects Films/Web Series business to see a sharp bump-up in 4Q that will eventually lead to 25% YoY growth in FY24. The flagship Music licensing business is likely to see a sharp uptick in 4Q on the back of a strong line-up of new music content in 2H and synergy benefits from the recently acquired Pocket Aces business. The management continues to guide for adj. EBITDA margin of 32-33% in FY24 despite consolidation of the loss-making Pocket Aces business and likely increase in revenue share of low margin Films/TV Serials segment in 4Q.

* Artist management vertical: The management currently has three artists on a 360-degree monetisation basis in the artist management vertical that it launched in 2Q. The company will invest in creating songs and music videos for these for these artists and also take care for the marketing cost. Saregama, in return, will initially make money from music that they will create, and once they become established artists the company will monetise them by promoting them on live circuits. Besides this, the management is also working with around a dozen artists (who are moderately established) for their live events (but with no investments) on a commission basis.

* Tech Investments: The company is planning to invest further in predictive AI and Gen AI. It is developing in-house tools that can train on its music library of 150k+ songs to generate newer content. It is also about to launch its own music learning app that will teach music fans how to sing or play musical instruments by leveraging AI capabilities.

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