Multiplex is a very tough business with high capex and high fixed opex (operating expenses). Even in a fast-growing market like India, multiplexes have been struggling to generate free cash flows. The business model in its current form is that of a glorified QSR (quick service restaurant) since more than 80 percent of the profits come from the sale of high-priced food and beverages.
The movie screening business is breakeven at best. Advertising revenues are limited to local area advertisers and some standard government ads. Footfall is completely dependent on the quality of new releases, and the multiplexes have no control over that. Most importantly, they have been losing out to international OTT (over-the-top) behemoths in terms of the release of new content.
Therefore, this merger of PVR and INOX Leisure should be seen as a last resort defensive step to drive cost efficiencies. It would also give them some might to push the studios to go in for theatre releases. However, it would be interesting to see how the merged entity creates a compatible culture.
For instance, INOX follows a strict vegetarian menu. While these are operational details that would get worked out, the merged entity would now pray that viewers throng the theatres in large numbers so that average occupancy increases beyond 35 percent and then pay for the food and beverages to make the business model work.
Any kind of surprise M&A activity, especially by consumer brands, is typically immediately cheered by market participants and there is a spike in buying interest. However, in this case, we believe that the merged entity will have to work hard to repair its balance sheet and convince the lenders that it can generate enough free cash flows to sustain the debt taken during lockdowns.
Also read - PVR, INOX announce merger, Ajay Bijli will be MD of combined entity
Our expectation is that during the period that the merger takes effect and for a year thereafter the market valuation will stay in a narrow range. Those who believe that the merged entity will create a strong business can buy the shares for the long term. However, the short-term traders looking for a quick upside may be disappointed.
Also read - Top 10 trading picks for next 3-4 weeks as market loses momentum
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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