Easing investor concerns, valuations to support Zee stock in medium-term

Merger synergies, traction in OTT, and margins key for gains in medium term

The Sony Pictures Networks India and Zee Entertainment Enterprises (ZEEL) deal is being viewed positively by the Street. Cash infusion, control of the ZEEL board by Sony, and multiple synergies could reflect on the stock of the merged entity in the medium term.

While the regulatory and shareholder approval process is expected to take around eight months, the culmination in a deal, with most terms broadly in line with the September announcement, removes uncertainty about the merger. Further governance concerns and promoter control over the merged entity seem to have been addressed.

In the deal announced earlier, Zee promoters’ 3.99 per cent stake in ZEEL could potentially go up to 20 per cent without any preconditions attached to it. Options available to promoters were open-ended and could have happened through open-market purchases or a preferential issue.

While ZEEL’s founder-promoters will have 3.99 per cent even in the new deal, concerns over mode of stake increase have been put to rest. The announcement highlighted that the deal does not provide the promoters (founders) of ZEEL any pre-emptive or other rights to acquire equity of the combined company from Sony Group, the combined company or any other party. This means that founder-promoters of ZEEL will have to increase stake up to 20 per cent on market-based pricing.

While Punit Goenka will continue as its managing director, brokerage firm Credit Suisse believes the agreement addresses concerns over governance, with Sony appointing a majority of directors to the board of the merged entity and promoters not getting preferential rights on the stake increase. Sony will have 50.86 per cent stake after the merger.

The other concern for investors had been the overlap of interests of promoters (Subhash Chandra) and the new merged entity. Sony will pay promoter entity Essel Mauritius Rs 1,101 crore as part of a non-compete agreement.

Zee promoter (Chandra) has indicated that Essel Group will make investments in the digital arena. However, ZEEL in a previous call pointed out that there may not be a clash since Zee is in digital entertainment, while the family-owned entities will be looking at other digital properties.

While these are deal-related concerns, over the medium term, the ability of the merged entity (valued at Rs 53,000 crore) to extract synergies, scale up its over-the-top (OTT) offering, and improve margins will be a key driver of valuations. The Zee management has highlighted that the merged entity is expected to get 6-8 per cent synergies (largely on the revenue side) in the first year of operations. 

Karan Taurani of Elara Securities expects the combined entity, which has a 75-channel bouquet and 26-per cent viewership share, to grow its advertising revenues by 13 per cent over the FY22-24 period on a low base and on synergies, given the content variety across genres. Barring the overlap in Hindi general entertainment category (GEC), the merger is complementary, with Zee strong in regional content and movies, while Sony has a strong portfolio in Hindi GEC, kids, and sports.

Sony Music and movies are not part of the deal and thus, could compete with the merged entity. Taurani expects operating profit margins — which are in the 23-26 per cent range for the two entities — to improve by 230 basis points to 26 per cent by 2023-24 for the merged entity on the back of cost benefits in manpower and sales/general administration expenses. 

The bigger challenge for the combined entity will be its ability to counter competitive pressures in the OTT space. While sports content will be a major addition to the combined offering, there could be a surge in costs as rivals, such as Disney+ Hotstar, Amazon Prime, and Netflix, turn aggressive both on the content side, as well as on customer acquisition.

The cash infusion from Sony of $1.5 billion and ZEEL’s $170-million cash will help fortify the balance sheet and invest in content. There is also scope for improvement on pricing as Zee5 and SonyLIV are at a discount to Disney+ Hotstar.

While the stock ended marginally lower in trade on Wednesday, Siddhartha Khemka, head-retail research, Motilal Oswal Financial Services, says it is attractively valued. Despite the rally in the last few weeks, the stock is trading below 20x one-year forward earnings estimates. What could help in the long run are improving corporate governance and operational performance, he adds.