The Hindu Business Line : Saregama India: Invest

SHAREHOLDERS can consider investing in the rights offer of Saregama India, as there could be scope for gains from the offer price of Rs 45. Saregama's turnaround story is still in a fledgling state.

The stock trades at about Rs 110, and even if there is a sizeable decline in the post-offer period, there could be room for gains. Our recommendation is underpinned by the following factors:

Saregama appears to have put behind it a three-year period of steep losses due to high cost of acquisition of music rights for Hindi films, piracy in the CDs and cassettes market as well as in song-download facilities on the Internet, and stiff royalty payments. The worst may well be over on account of these factors.

Saregama has cut prices sharply for music CDs across genres to combat the threat of piracy, and this has helped it stem the declining trend in sales.

Its cassette sales continues to show a downward trend as the market shifts inexorably to CDs. But its CD sales has shown a healthy rise over the past few years despite a modest decline in the first half of FY-05.

It has also refrained from bidding aggressively for film music rights and opted to selectively pick rights on a revenue sharing basis; earlier it adopted the riskier model of guaranteed payments.

The risk-reward equation is more even handed in the new arrangement the company has started to use.

Following a string of poor showing at the box office and the lack of audience interest in songs of most movies, the prices of music rights have also declined and are no longer exorbitant. Several competing music-vending companies have gone through a difficult phase over the past few years due to factors that have affected Saregama.

As a result, they have also refrained from buying rights, irrespective of the price levels. This, too, has played a role in pushing the prices of film music rights to lower levels. All this, coupled with the revenue sharing model, has helped Saregama stem the rot in its operations.

The company's success in moving to a lower cost structure has aided the turnaround. It has cut its raw material, manpower, promotion, overheads and interest costs sharply over the past two years.

The beneficial effect of the cost reduction is reflected in the FY-05 performance. Revenue growth from the present levels is likely to make a greater contribution to earnings.

Saregama has acquired music rights across genres for several decades now. This remains its key strength. It has also started to put this to effective use by offering flexible downloadable packages at attractive rates, making its archives available on platforms such as iTunes, MSN Music and Sony Connect (iTunes is a raging hit) and also marketing them better to derive fee incomes, which have grown at a healthy clip after declining between 2000 and 2003.

It has also entered into arrangements with several well-known entertainment companies at the global level to distribute their content in the Indian video market. It has thus leveraged its distribution network to create a new revenue stream. At present, home video revenues account for 16 per cent of Saregama's revenues. Despite piracy, the home video market appears poised for healthy growth.

Revenues from this line of business have shown robust growth and could account for a larger share of incomes over the next few years. An expansion in its share could provide greater stability to the revenue base and make a steady contribution to the earnings stream.

The proposed reduction in the debt burden using the proceeds of the rights offer is likely to improve profitability and reduce the financial risks.

Saregama is likely to be prime focus of any interest that global entertainment majors may show in picking up ownership stakes in the music distribution space. We have not factored in gains on account of this factor though this remains a possibility over the long term.

Saregama has scaled down the music marketing business abroad through its subsidiaries. This has led to lower losses. But they continue to be a drag on earnings. One of its subsidiaries is also into production of television content and films.

We view its foray into films as a high-risk venture that could act as a drag of resources without commensurate contribution to profits. Growth prospects in the television content business appear encouraging with its programmes catering to the Sun Network.

With accumulated losses, the balance-sheet still has a long way to go before it acquires a healthy hue. Piracy and a shrinking market in value terms for music marketed in the form of CDs/cassettes are principal hurdles to expansion in margins and growth, and hence, remain key risks to our recommendation.

Offer details: Shareholders would be entitled to four shares for every seven held. The equity base would rise from Rs 9.3 crore to Rs 14.6 crore. The lead manager is ICICI Securities. The rights offer closes on April 22. The offer price of Rs 45 has to be paid on application. The offer document is available on the company's Web site, www.saregama.com, and on SEBI's Web site, www.sebi.gov.in.