United we stand, divided we fall! That seems to be the message coming across from the country’s top two multiplexes – PVR and Inox, as they announced plans for an all-stock merger on Sunday. The pandemic dealt a double blow to the multiplex industry – besides crippling operations for almost two years, it also catapulted OTT as a significant long-term competitive threat to multiplexes.
In fact, the press release by PVR and Inox, post the merger announcement, refers to the combined entity ‘countering adversities posed by various OTT platforms.’ This, in fact, has been a problem that multiplexes across the world have been grappling with. In western economies, the big-budget producers/distributors — Disney, Warner Bros, Comcast (NBC Universal) and Netflix — also have their own streaming service. Thus, producers have been grappling with trying to identify the optimal model in terms of difference in time period between theatrical and OTT release.
Warner Bros tested out an experiment in 2021 dubbed the ‘Project Popcorn’, wherein in all of the studio’s theatrical releases were simultaneously released on its OTT platform as well. The same dilemma holds good for producers in India as well. While it may be to a lesser extent now, the trend may be permanent. Thus this merger of the two multiplex biggies will allow them to wrest back some clout while negotiating with producers/distributors.
Swap in favour of Inox
In the first day of trading post announcement of the deal, the stock of PVR was up 3.53 per cent, while that of INOX was up 11.75 per cent. The outperformance of INOX was in reaction to the proposed swap ratio for the merger — three shares of PVR for every 10 shares of INOX. Based on today’s closing price, 3 shares of PVR (₹1,886/share) is worth ₹5,658; 10 shares of INOX (₹525/share) is worth ₹5,250. Thus if the deal were to conclude as expected (which depends on getting shareholder and regulatory approvals), then investors have a better arbitrage opportunity in staking their bets on INOX for a stake in the combined entity. Investors, however, need to note that if the share price of PVR falls, the INOX shares too will fall and vice-versa.
Valuation on the higher side
PVR currently is trading at FY23 EV/EBITDA (Bloomberg consensus) of around 13.4 times and PE of 56 times. INOX trades at FY23 EV/EBITDA and PE of 13.8 and 47 times respectively. Adding up the numbers of the independent entities as they are now — to get a perspective on the combined entity (adjusted for swap ratio) — implies a FY23 EV/EBITDA and PE of 13.8 and 54 times.
In reality, however, the valuation multiples will be cheaper than what the combined entity numbers indicate now, as it would be able to tap synergies across revenue lines — ticketing revenue, food and beverages, and in- theatre advertising. There will be cost synergies too. The combined entity will have better leveraging power with producers/distributors, food and beverage suppliers and advertisers. It will also have scope for reducing rental/leasing costs, besides savings in marketing and other expenses.
It remains to be seen to what extent the current valuation multiples will be tempered based on better profitability of the combined entity. However, even if one were to assume 10 per cent increase in EBITDA and 15 per cent increase in net profit from synergy benefits, then its FY23 EV/EBITDA would be around 12.6 times and PE would be 47 times. This, of course, will change based on how much synergies the combined entity can tap.
Whether this valuation is cheap, depends on the eye of the beholder. The industry faces structural competition from OTT and evolving consumer behaviours. On the other hand, favourable demographics and increasing affluence in the Indian economy are positives. Given these, whether these valuations are justified will depend on how the industry evolves over the next few years in terms of delivery and consumption of content. This will be the key monitorable for long-term investors.
Regulatory approval is key
While the deal is highly likely to get shareholder approval, and both company managements/boards expect requisite regulatory approval as well, investors need to track the soundbites leading up to getting regulatory approvals. The combined entity will operate 1,546 screens, across 341 properties over 109 cities. Based on analyst reports, the combined entity will have a near 50 per cent share of total multiplex screens in the country. While this is a blockbuster for PVR and INOX with many positives for its shareholders and hardly any negatives, whether other stakeholders like Bollywood view it the same way needs a wait and watch. For example in 2009, Bollywood went on a strike against multiplexes in a revenue-sharing dispute that resulted in no new releases in multiplexes for few weeks, till a common ground was found. The increased clout of the merged entitymay be scrutinised.