A big bang merger called PVR INOX

“Based on the share-swap arrangement, INOX valuation has been pegged at Rs 6,400 crore (EV per screen of Rs 10 crore) whereas PVR is currently trading at a valuation of Rs 11,000 crore (EV per screen of Rs 12 crore)”, a report from Elara Capital said.

After the merger, INOX promoters will own a 16.7 percent stake, while PVR promoters will have a 10.6 percent stake in the combined entity.

Scale brings muscle

PVR currently operates 871 screens, spread over 181 properties across 73 cities in India. INOX, on the other hand, operates 675 screens through 160 properties in 72 cities. The merger of the two largest players will create 1,546 screens in the merged entity, spread across 341 properties in 109 cities.

“It provides substantial bargaining power over the entire ecosystem, including customers, real-estate developers, content producers, technology service providers, the state exchequer and employees,” a report from JM Financial said.

According to a report from Nirmal Bang Institutional Equities, the merged entity has tied up a large part of the retail real estate pipeline, with each having more than 1,000 screens lined up over the next 5-10 years. This could be the biggest competitive advantage for the merged entity. Also, the merged entity has the best real-estate locations in all major urban centres in India. This can help it raise rates even higher.

There will be synergies in revenue as well as costs. “On the revenue front, we believe the biggest synergy benefit will be in the form of higher pricing power in advertising for INOL, whose advertising revenue per screen was 35 percent below PVR’s in FY20. We now see it narrowing far quickly,” the report said.

On the cost side, corporate costs are expected to fall but there may not be much incremental operational cost cuts since operations were already lean for both the companies, post the pandemic. The merged entity can bring in more savings on the rentals part as it will have better negotiating power with the mall operators.

Encouraging trends, post pandemic

Post the relaxations in pandemic-induced restrictions, both PVR and INOX have seen a strong reopening, aided by big-ticket releases from Bollywood, Hollywood and also the regional industry.

According to a report from global brokerage, CLSA, the average ticket prices have risen and even F&B (food & beverage) spending per head has gone up, compared to the pre-COVID levels. The CLSA report also points out another encouraging trend -- in December 2021, both PVR and INOX had achieved almost 90 percent of their December 2019 revenues.

OTT threat

Historically, the management has been dismissive of the threat posed by OTT platforms. However, for the first time, it acknowledged the threat and the need to create scale to fight the onslaught.

“Despite the huge opportunity for growth in screen additions, the management has acknowledged the threat posed by OTT platforms to occupancies and screen-level profitability metrics,” a report from Motilal Oswal said.

However, CLSA believes that over-the-top (OTT) streaming services in India present limited risk to multiplexes as even during the lockdowns, only 40 films went directly to OTT.

Both theatres and OTT will co-exist. “The OTT challenge, in our view, is a storm in a tea cup. While we are cognizant of the threat, we think it is exaggerated as the economics of taking a movie directly to OTT for a reasonable budget movie that will find a theatrical release is not compelling,” a report from Nirmal Bang Institutional Equities said.

In case a movie goes directly to OTT, it is likely to get a modest 15-20 percent return on the cost of production. On the other hand, if it’s a theatrical release first, the OTT revenue gets enhanced if the movie is a reasonable success.

Risks from CCI

“This is the biggest risk to the deal”, the Nirmal Bang report said. This apprehension stems from the fact that in a much smaller deal between PVR and DT Cinemas in 2016, some screens had to be divested for the deal to be cleared by the CCI.

“We believe PVR INOX may need to shed screens in key metros like Delhi and Mumbai, if this rule is applied again by CCI. We also gather that the deal may benefit from ‘exemptions available to transactions involving small targets from notification to CCI,” the report added.

It expects INOX Leisure’s total FY22 revenue to be below Rs 1,000 crore (due to COVID-19), which is also the threshold, and, hence, CCI rules may not come into play. “But, we think this is a grey area and it is subject to interpretation,” the report concluded.

The verdict: will it be a blockbuster?

The Street’s verdict on the merger is clear and positive with most of the brokerages maintaining a ‘buy’ rating on both the stocks.

“With the PVR INOX merger a positive, offering compelling revenue and cost synergy and consolidating the sector with strong growth ahead, we retain our BUY ratings on both PVR and INOX,” CLSA recommended.

Nirmal Bang estimates a target price of Rs 2,383 for PVR and Rs 594 for INOX while giving a ‘buy’ rating to both the stocks. The target price represents a 30 percent and 26 percent upside for the respective stocks.

“The upside could be larger as we believe valuation multiples could expand as we are looking at an entity which can deliver ~Rs 1,800 crore in EBITDA by FY24, if there are no hiccups”, the Nirmal Bang report concluded.

JM Financial believes that the merged entity would be a stronger one and could command a premium, given the possibilities of synergies driving earnings upgrade.

“A 15x target multiple on the combined EBITDA would yield a March 2023 target price of Rs 2,300 per share for the post-merger PVR stock and Rs 690 for INOX. In such a scenario, we see a 47 percent upside on INOX and 28 percent upside on PVR, compared to the closing price of March 25”, it concluded in its report.

However, Motilal Oswal is cautious on the stocks. “We value PVR at 12x FY24 EBITDA to arrive at our target price of Rs 1,600 per share. We maintain our Neutral rating,” it said in its report. The rich valuation it commanded historically was led by strong growth and the screen- addition opportunity does provide an ability to continue its strong growth. “However, OTT platforms pose a risk of shrinking the exclusive period, softening occupancies, and lower screen economics”.

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