The stock of Zee Entertainment Enterprises (Zee) zoomed by 15.71 per cent last week, driven by positive sentiment following the unconditional approval of NCLT for the Zee-Sony Pictures Networks India (SPNI) merger. So, is it finally light at the end of the tunnel for Zee shareholders? It most likely appears so, unless Sony decides not to go ahead with the merger.

Held out as a merger of equals, with Zee shareholders owning around 47 per cent of the company and SPNI 53 per cent (the higher stake due to pre-merger cash infusion by Sony into SPNI to fund growth initiatives), the deal can now close in another 2-3 months’ time. Originally announced in September 2021, the deal has taken substantially longer than anticipated to come to final stages as a few controversies surrounding Zee promoters had created speed bumps along the way

A successful closure will make the combined Zee-SPNI entity the second largest player in the Indian TV industry in terms of revenue. According to a recent report by Elara Capital, current ZEE-SPNI market share is estimated at 19.4 per cent, second to Disney Star India.

The combined entity will be able to reap synergies across revenue and cost lines. A combined pool of content of both companies will be able to provide a much better experience to streaming/OTT  subscribers and can boost subscriber growth and ARPU. On the television side, this will give the merged entity more clout in bargaining with advertisers and distributors. Cost savings too can be realised across multiple line items, which is typical when companies merge. These factors, combined with the macro factor of excellent growth prospects for media and entertainment sector in India given favourable demographics and rising affluence, make a good case to be optimistic on the prospects for Zee-SPNI.

So, what should investors do in this context?

Risk versus reward

Zee currently trades at a one-year forward PE of 26.5 times (Bloomberg estimates) and EV/EBITDA of 15.6 times. Neither cheap nor expensive. However a thing to note here is that profits are impacted by investments in content and streaming businesses — initiatives that will take a few years to pay off. For example, in FY23, Zee’s digital business segment reported revenue of ₹755 crore and EBITDA loss of ₹1,105 crore. This gives a perspective on investments required for scaling up the digital business. Such investments are likely to continue for the next few years as well, as media companies plan for a linear TV to digital transition. Investing in streaming is an imperative to stay competitive. The payoffs for such investments are more backend-loaded.

While consensus estimates for the combined entity are not available, Elara Capital estimates Zee-SPNI combined net profits for FY25 at ₹2,121 crore. This implies a FY25 PE of 26 times for the combined entity (based on Zee current market cap and 47-53 merger ratio). Adjusted for impact of streaming investments, the valuation looks reasonable for a media company with long-term structural positives.

The near-term risk to consider, though, is what if the merger does not conclude? We consider the probability of this to be low, but important to note that it is not zero. Zee promoter Punit Goenka has stated that the merger will go through whether or not he is the CEO of the merged entity. This implies that if the Zee promoters do not get any relief from SEBI banning them from holding any director or KMP position in listed entities, they are unlikely to stand in the way of the merger. It is in their interest to co-operate too, not stand in in the way of the merger, given the numerous benefits it entails for the company and its other shareholders who own 96 per cent of the company. Promoters own a mere four per cent stake in Zee.

So, now the ball is largely in Sony’s court. While they have given scant indications of their intentions, it is entirely in Sony’s interest too to complete the merger, in view of the synergies it entails. Given Sony’s wide domestic and international experience in the media and entertainment sector, they do not require the experience of Zee promoters to run the combined entity.

The risk-reward, in our view, is favourable. If the merger does not go through, the stock can revert to the around ₹200 levels. If it goes through, valuation re-rating and earnings driven-growth is on the cards for one of the largest entertainment and media companies in India. In bl.portfolio edition dated July 30, 2022, we had recommended a buy on Zee when it was trading at ₹247, for investors with a long-term perspective. Investors who had bought on our recommendation can continue to hold the stock.    

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