Why the Zee-Sony deal is a win-win for all

The Zee Entertainment-Sony Entertainment merger deal comes as no surprise. Zee has been up for grabs for the past two years after the promoters fell into bad times because of the misadventures in the infrastructure sector. It has been clear for some time that Zee Entertainment cannot stand on its own; it needs capital.

With the promoters in distress, in August 2019, the company sold 11 per cent to Invesco Oppenheimer for Rs 400 a share. That took the fund’s total holding close to 18 percent. Prior to Invesco acquiring Oppenheimer Asset Management globally, Oppenheimer Developing Markets Fund held close to 7 percent in the company for many years.

Zee has been in talks with many players, including Sony Pictures, for the past two years. However, a deal never fructified, thanks to valuation differences and issues of management and control.

Why Zee accepted the deal

The call by Invesco to oust the existing management and reconstitute the board pushed the Zee promoters to accept the deal, which was seen as an offer for an honourable exit, said a person familiar with the deal.

Although Invesco Oppenheimer had called for the ouster of CEO Punit Goenka earlier, they did not want to be disruptive about managing the business, said the source.

“This deal is, in fact, driven by Invesco Oppenheimer. It is benign for both sides,” he said.

With Sony Pictures likely to hold a majority stake (52 percent) in the new entity, the board will be reconstituted and the necessary checks and balances will be put in place to avoid any resurfacing of governance issues.

The Zee promoter’s ‘skin-in-the-game’, with Punit Goenka continuing as CEO for five years, was necessary to ensure that the deal goes through without any regulatory challenges, said the source.

SugarBox maybe only blot on Goenka

Goenka is seen as an effective captain, who has run a tight ship, putting a strong leash on costs, while galvanising the organisation to tap new growth areas as well as in fixing legacy governance issues.

Over the past decade, Zee has seen a steady growth, with viewership share rising from low-teens to close to 20 percent in FY19. It was mainly driven by investments in the regional movie genre. In the last two years, however, that number has gone down to 17 percent as management attention has been divided.

Apart from steering the company towards profitable growth opportunities during his tenure, Goenka has also taken measures to bring greater level of transparency to reinstate trust among stakeholders, said analysts.

An analyst from Prabhudas Lilladher said in his report: “Zee 4.0 initiated by him, with a clear focus on strengthening corporate governance and disclosure levels was a step in the right direction. Measures like publishing balance sheets on a quarterly basis, disclosing revenue and Ebitda of Zee5 and providing the breakdown of content inventory and advances brought in the much-needed transparency.”

Barring some questionable investments, like the one in SugarBox, for which the company paid Rs 522 crore, analysts feel the senior management, led by Goenka, has been effectively driving growth.

“In a service business, the culture of the organisation is very important. Zee has been the best-run media company in India with a strong focus on profitability and capital efficiency. A new management would have put the business at risk,” said a prominent fund manager who described the deal as the best outcome possible.

“Unless you are in some sort of a punishment mode, there was no case for firing Punit. That would have been like throwing the baby with the bathwater,” he added.

OTT business an area to watch

It may be a tad early to comment on how businesses may pan out, post acquisition. While the ad scene for the year looks up and the merged entity will consolidate its position in broadcasting, how the OTT part of the business plays out will have to be watched. While the OTT business offers a high growth potential, it is also a cash- guzzler. In Q1FY22, it clocked revenues of Rs 111 crore but with high operating costs of Rs 315 crore, the EBITDA was in the red by Rs 203 crore.

In terms of overall numbers, Sony Pictures clocked Rs 582 crore in profit after tax for FY21, down from Rs 896 crore the previous year, chiefly because of the pandemic. If that number can be recouped by FY23, the combined profit for Zee and Sony could be roughly Rs 2,500 crore, based on analyst forecast. A 10 percent growth in profit for the following year could take that number to Rs 2,750 crore.

Value creation for investors

Over the past decade, the Zee stock has traded at an average one-year forward multiple of roughly 26x, but, over the past couple of years, it had seen a de-rating because of governance issues and stress caused by the promoters’ pledged shares.

After the huge surge in stock price over the past week, the stock has come back to multiples it has commanded historically. But here is the stock math: Assuming that the new entity commands an earnings multiple of 25x, the overall market-cap of the new entity should around Rs 68,750 crore (25x P/e *Rs 2,750 of PAT for FY24).

Considering Zee shareholders will hold a 47 percent share in the new entity, the marketcap will be Rs 32,312 crore. Based on Wednesday’s price of Rs 333, the stock commands a marketcap of Rs 32,400 crore, pricing in historical valuation for the new entity.

“Zee’s valuations have been constrained by governance concerns and structural risks. The market has ascribed a negative value to Zee5 due to a lack of confidence in the management,” a September 14 report by Kotak Institutional Equities said.

From a price perspective, Invesco, with its activist action, just managed to create huge value for savvy individual and institutional investors that have returned to the stock since September 14. But it is ironic that Invesco will have to wait it out to make a return on its own investment.

The deep value trade in Zee is over. With governance issues behind, and with a stronger competitive position in the broadcasting space, a good movie distribution business, and a finger in the high-growth OTT pie, Zee now has a long runway ahead for growth.

The future course will be determined by the growth trajectory Goenka and the new promoters chart for the company.