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Cost controls bear fruit; ad revenue recovery vital for re-rating

* Zee Entertainment’s (Zee) revenue continued the declining trend as 2QFY25 revenue fell 18% YoY (5% miss) on softer advertising revenue (- 8% YoY, 1% miss) and lower revenue from other sales and services (-77% YoY on a high base (2QFY24 boosted by Gadar 2 release).

* However, Zee’s strong control over costs and a further reduction in Zee5 losses led to 18%/15% QoQ jump in EBITDA/adj. PAT (21%/35% beat).

* The management indicated that advertising revenue saw pick-up in Sep’24, which should continue in 3Q with the onset of the festive season. However, a strong and sustainable pick-up in rural consumption is required to maintain healthy ad revenue momentum beyond 3Q.

* Zee aspires to deliver a CAGR of 8-10% in total revenue with its current portfolio and improve EBITDA margins to an industry-leading range of 18- 20%. We believe a steady recovery in ad revenue remains key to meeting these aspirations and potential re-rating.

* We lower our FY25/FY26 revenue estimates by 5-7% due to weaker growth in domestic ad revenue and cut our EBITDA estimates by 3-10% largely on weaker revenue growth.

* We build in a CAGR of 4%/21%/33% in revenue/EBITDA/PAT over FY24- 27.

* Zee’s valuations have turned attractive. However, we await the outcome of ongoing litigation for ICC rights with Star before we turn more constructive. We reiterate our neutral rating with a TP of INR145.

Effective cost control drives EBITDA beat

* Zee’s consolidated revenue declined 6% QoQ (-18% YoY) to INR20b (~5% miss) due to softer ad revenue and weaker other sales and services.

* Ad revenue declined 8% YoY to INR9b (-1% QoQ, 7% miss), as macro ad environment remained soft in the domestic business (-9% YoY).

* Subscription revenue grew 9% YoY to INR9.7b (-2% QoQ, in line), driven by a pick-up in TV subscription revenue after NTO 3.0 & ZEE5.

* Revenues from other sales and services plunged 77% YoY to INR1.3b as the base quarter benefitted from the release of Gadar 2.

* However, Zee maintained strong cost controls as total operating expenses declined further 10% QoQ (-20% YoY) to INR16.8b (8% lower), mainly driven by lower programming/content costs (down 26%/240bp YoY).

* As a result, EBITDA was up 18% QoQ (down ~4% YoY) at INR3.2b (21% beat) as margins improved further 330bp QoQ (240bp YoY) to 16% (350bp beat).

* Zee5 revenue recovered 6% QoQ to INR2.4b (down 11% YoY), driven by healthy trends in usage and engagement metrics. EBITDA losses reduced further to INR1.6b (vs. INR1.8b loss QoQ and INR2.5b loss YoY).

* Adjusted for Zee5, Zee’s linear TV business revenue/EBITDA declined 19%/18% YoY.

* The company reported an exceptional gain of INR109m pertaining to the settlement of SITI Network’s past receivables.

* Adj. PAT stood at INR1.9b (vs. INR1.7b YoY, 35% beat), aided by higher EBITDA, higher other income and lower depreciation.

* 1HFY25 revenue declined 7% YoY, while EBITDA/PAT grew by 22%/60% YoY, largely on continued cost rationalization.

* For 2H, the implied growth rate is ~3% for revenue (vs. 7% YoY decline in 1H) and ~40% YoY for EBITDA (vs. 22% YoY in 1H).

* For 1HFY25, Zee generated OCF of INR4.5b, led by EBITDA and control over WC.

* With INR540m of capex and interest costs, Zee generated FCF of INR3.9b. This led to an increase in net cash position to INR16.3b.

* WC days remained stable QoQ/YoY at 303.

Highlights from the management commentary

* Recovery in ad revenue: Zee management indicated that ad revenue started to pick up in Sep’24 and should further recover in 3Q with the onset of the festive season. However, the management believes that a sustainable strong recovery in rural consumption remains key to long-term growth in ad revenue.

* Drivers for further margin expansion: A large part of cost rationalization has already happened and the company has reinstated salary hikes from Sep’24. Going ahead, the management expects margin improvement to 18-20% to be driven by a pick-up in revenue growth.

* Guidance: The management expects a CAGR of 8-10% in total revenue with the current portfolio and expects to improve margins further to 18-20%.

* Music: Zee Music remains a key asset and the company will continue to invest in it. There was some slowdown due to lower film production.

* Competitive intensity: Zee management highlighted that the company competed with Disney and Viacom separately in the past and it does not expect things to change materially on the competitive front after the merger. Further, the management noted that Disney-Viacom’s merged entity’s strategy is sports focused, while Zee remains focused on entertainment and has no plans of venturing into sports aggressively.

Valuation and view

* Zee aspires to deliver a CAGR of 8-10% in total revenue with its current portfolio and improve EBITDA margins to an industry-leading range of 18-20%. We believe that a sustainable recovery in ad revenue remains key to meeting these aspirations and potential re-rating.

* We lower our FY25/FY26 revenue estimates by 5-7% due to weaker domestic ad revenue growth and cut our EBITDA estimates by 3-10% largely on weaker revenue growth.

* We now build in a CAGR of 4%/21%/33% in revenue/EBITDA/PAT over FY24-27. ? Zee’s valuations have turned attractive. However, we await the outcome of the ongoing litigation for ICC rights with Star before we turn more constructive on Zee. We retain our neutral rating with a TP of INR145.

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