How the Sony Pictures deal can add value for Zee Entertainment investors

The Zee Entertainment (Zee Ent) stock is up almost 30 per cent in the trading today, after it announced a merger (non-binding) with Sony Pictures (SPNI). The Zee Ent-SPNI deal positions the combined company well for a streaming future, as it pools the large volumes of content and production operations, digital assets and industry experience of two of India’s leading media companies. This announcement follows the trend seen in the international media space such as the recently announced $80-billion (equity value) merger between Warner Media and Discovery Inc and the acquisition of 21st Century Fox (media empire of Rupert Murdoch) by Disney for $71 billion in 2019.

Ever since streaming (as the way to consume entertainment) started becoming a dominant theme, the mantra for success has shifted in favour of ‘content+ scale’ is king versus the earlier ‘content is king’. This is because the streaming business model depends not on advertisement revenue, but more on having a large number of subscribers and keeping them locked-in for many years, preferably forever. The pay-off for the streaming business is more back-loaded as operating leverage kicks in once the subscriber base reaches a certain scale.

The Zee Ent-SPNI deal is subject to completion of due diligence, signing of a binding agreement and regulatory approvals. As per the in-principle approval for the merger, current Zee Ent shareholders will own around 47 per cent of the combined company, while SPNI shareholders will own 53 per cent. The agreement also includes SPNI shareholders infusing cash into SPNI prior to the merger to provide for growth capital of around Rs 12,000 crore for the combined company. This likely implies there will not be capital raise required in future to fund growth in the streaming business. The new company will be publicly listed.

Whether SPNI will merge into the listed Zee Ent or whether Zee Ent and SPNI will merge into a new company is not clear. However this will not matter much for Zee Ent shareholders as either way they will end up owning 47 per cent of a company that will be well primed to compete well in the Indian entertainment industry given the combined content spanning GEC (national and regional), movies and sports.

Upside left for stock

While the financial details/ valuation for the detail are still not out, at the current price, Zee Ent is trading at an equity value of about Rs 30,500 crore. This implies equity value of around Rs 65,000 crore for the combined company. However, it is highly probable that the valuation this deal would assign to combined company would be higher, given the synergies. Assuming SPNI is assigned similar earnings multiples as Zee Ent, there is still value in the Zee Ent. stock for long-term investors. This is for two reasons – one, Zee Ent was an underappreciated stock in the Indian markets. We had given a buy recommendation on Zee in our July 18 Portfolio edition when the stock was trading at Rs 209, and at a very cheap PE of 13 times one year forward earnings. There was good value to be unlocked in the shares. The events of the last 2 weeks have resulted in that playing out.

Even after the 80 per cent run up in recent weeks, the stock is trading now at one year forward PE of around 20 times. This is not overly expensive for a company which still has a strong presence in the traditional television space and is also well positioned to capitalize on streaming business opportunities. Two, as mentioned above, in a streaming world ‘content +scale’ is king. Given this, the whole is greater than sum of the parts in this Zee plus SPNI combo. This deal will enhance the valuation for streaming business.

In a world where streaming businesses get substantially higher valuation multiples than traditional television businesses, this deal provides case for further increase in valuation multiples.

However, investors should note that the structural positives may not make the stock immune to any corrections related to broader market volatility. Hence, a long-term horizon is needed.

Why Zee Entertainment stock is a good buy

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