Mumbai: Sony India terminated the merger agreement with Zee Entertainment Enterprisers on 22 January 2024, seeking a termination fee of $ 90mn on account of alleged breaches of merger cooperation agreement (MCA) terms by Zee, invoking arbitration and seeking interim relief against Zee. Zee has denied all such assertions by Sony regarding the alleged breach of the MCA, including the latter’s demand of termination fee. Zee is evaluating all available legal options to contest Sony India’s claims.
Stiff competition from digital media and RIL/Disney merger
We believe the above termination may hit both the parties as both are facing stiff competition from digital media as also potential threat from the merger of RIL-Disney, near term. Zee has reported muted growth/profitability performance in the past two years, as revenue growth has converged (flat in FY20-23) and EBITDA margin dipped to 10.7 per cent (6MFY24), due to: 1) losses in the OTT segment and 2) lower growth in linear TV segment.
On the brink of multiple legal proceedings
Zee had also signed a contract with Disney for sub franchise of sports rights (ICC tournaments) in linear TV. We had estimated related annual losses of ~Rs 15.2bn in FY25E and beyond, given: 1) hefty content cost, 2) lower sports ad revenue and 3) cricket content being available free on OTT. Zee may now not fulfil this commitment (cash balance of mere Rs 6bn, versus potential contractual obligation of Rs 40 bn per year) as it was entered into given its strategic-synergistic contiguity with Zee-Sony merger. Also, Zee could see a hit from related penalty/legal proceedings due to 1) battle with Sony over the non-compete fee, 2) ongoing legal proceedings by various creditors of the Essel group (Axis Finance, IDBI Bank etc.) and 3) dishonouring of contract with Disney.
Valuation: Downgrade to sell; TP pared to RS 170
Zee may see a sharp de-rating in P/E valuation of its broadcasting business to at least 10x one-year forward or lower, due to the unfinished merger, as: 1) linear TV growth has converged sharply, 2) Zee may not have any potential to scale-up OTT offering in a highly fragmented market, 3) lower profitability – EBITDA margin, ex-Sports losses, could converge to 14 per cent and 4) any further write-offs on the inventory side or matters pertaining to related parties’ creditors or not honouring the sports contract with Disney (ICC tournaments – Zee could have potentially paid half of the $ 3bn value for TV rights). Merger with Sony was the key valuation driver to move up in the past two years. But given the termination, we downgrade Zee to Sell with March 2025E TP pared to Rs 170 from Rs 340. But if the Disney contract is honoured, TP may move to Rs 130, citing losses in the sports segment. We value the broadcasting business at 10x one-year forward P/E and OTT at 3.0x one-year forward EV/sales. Possibility of any other strategic/financial partner buying majority stake in Zee could provide respite to valuation multiples.
The credit of this article goes to Elara Capital SVP Karan Taurani.
