Zee Telefilms: A strained script?

Recommendation:Hold

S. Vaidya Nathan

The Zee Telefilms stock has shed around 54 per cent in the last couple of months.

With its plan for a massive ADR/GDR offering and forays into regional markets, the company's revenue and per share earnings stream may get strained in the short term. Shareholders could stay invested, use any sharp uptrend to trim exposures and contemplate re-entry at lower levels, says S. Vaidya Nathan.

THESE are rather strange settings for the Zee Telefilms stock. In the last couple of months, the price has declined from a post-stock-split high of Rs. 1,555 (in mid-February) to around Rs. 720 now. A decline of around 54 per cent is something unusual for a stock that has seen 100-fold gains since January 1998.

The selling in the last two months has been accompanied by sizeable volumes which suggests that some institutional investors may be cutting exposure in the stock. To some extent, it may be attributed to profit-booking which had to happen at some point. Another factor may well be the need to cut exposures in a liquid stock such as Zee Telefilms to meet cash calls in scrips that had been ramped up and which are down now. The emergence of alternative media stocks and decline in the specific operator interest may also be behind the downtrend. But some company-specific factors also seem to be at work.

Plethora of plans

The company is in the midst of announcing plans for a range of businesses. Apart from Zee Learning Centre, two English channels and an e-connect service, the promoter and Chairman, Mr. Subash Chandra, has unveiled plans for a range of business activities over the next six months to one year.

These activities range from movie production, buy-out of cable-operators, bidding for the next two World Cup cricket telecast rights, digitisation of 9-18 channels this year and increasing the international presence by launching ``a global product in October focussing on original medicines, food, and other aspects of the Indus Valley Civilisation''. The company expects to capture 60 per cent of the Indian viewership in the next few months.

But the overall thrust of the plans seems to portend considerable uncertainties over the level of profitability and cash flow strengths. The company has not had the best of cash flows even in 1998-99 when it posted good earnings growth. While the numerous announcements are par for the course for Zee Telefilms, they also raise the question of whether the company overreaching itself in its pursuit of growth? Is it taking on too many things at one go when it is yet to complete its consolidation exercise? There is reason for concern on this front though some of the proposed activities may be necessary to beat the competition.

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Apart from the plans specific to Zee Telefilms, there is also the satellite telephony project which involves sizeable outlays. If Zee Telefilms were to even partly bankroll this project, it could affect the valuation of the stock; there have been no firm indications on this.

The ADR overhang?

The company has secured shareholder approval for an ADR/GDR offering of up to $1.50 billions. Mr. Subash Chandra has indicated that despite the recent downtrend on Nasdaq, the offer would be made in June.

According to the board announcement, the offer is to consolidate the company's leadership position in the media industry by enhancing existing business lines and developing related ones, particularly in the Internet/new media sector. The size of the offer would be either $1.50 billions or 40 million shares. The latter would translate into a price of around Rs. 1,636 per share. The rupee value of this mobilisation (if the company manages to get this price) would be around Rs. 6,550 crores.

is this plan viewed as being extremely ambitious? But, then, Zee Telefilms has always been ambitious and that is how it has grown to what it is today. But by any yardstick, the $1.50-billion tag for the ADR is big.

The company has couched the objectives of the offering in general terms. Acquisitions in the global market which may require this level of resources do not seem likely. More so, given Zee's focus on India and the programming targeted at Indian audiences. In this backdrop, the ADR offering appears to have been viewed with some scepticism.

Notably, since the announcement of the ADR offering at a board meeting on February 28, the stock has been on a relentless downtrend. In fact, the entire decline from the highs happened after this announcement. And the decline in the Zee Telefilms' stock price has been more pronounced than the broad market. The latter, as represented by the Business Line Index of 250 stocks is down 21 per cent since February 28, while the Zee stock dropped close to 53 per cent.

Is this a case of institutional investors taking a dim view of the company's grandiose ADR plans? Incidentally, retail holdings are less than 5 per cent in the company and much of the stake is held by the promoters and institutional investors. The only plausible explanation for the downtrend may well be selling by some institutional investors thinking that at around Rs. 1,500, the stock was overvalued and/or felt that the ADR plan was a case of the company over-stretching its operations.

Plans spiked?

But what has happened is that the market, by pricing the stock down, may have spiked the company's plans. If it is to stick to the cap of 40 million shares, the company may be able to raise only around $750 millions. If the company opts for the higher limit of $1.50 billions, it may lead to a sharp rise in the equity base, from around Rs. 39 crores to Rs. 120 crores. If it does make such a huge offering, the stock valuation may be affected in the absence of transparency regarding the plans to use the proceeds.

This move has to be viewed in the light of the doubling of the equity base following the merger of Zee Multimedia Worldwide with the company. Zee Multimedia, a closely-held company of the promoters, was in charge of Zee's operations in some overseas markets. The swap ratio for this merger was also not exactly transparent as it moved from 1.60:1 (1.60 shares of Zee Telefilms for every share of Zee Telefilms) to 1:1.

Though this may, prima facie, seem favourable to Zee Telefilms shareholders, questions over the valuation of Zee Multimedia still loom large. More so, since no detail about the financials and the nuts and bolts of the Zee Multimedia business has been made public. There was also some expansion of equity (around 4 per cent) because of the acquisition of the stake held by Rupert Murdoch in the joint ventures. It is in this backdrop that the ADR announcement came. And it has also been supported only by broad statements which offer little insights to the shareholders and other investors.

Acquisition game

While the ADR is yet to happen, the company has moved into the acquisition mode in India. It recently launched a couple of regional language channels as part of a broader strategy. While in the East and the North, it has no competition of note, that is not so in the South. In each of the four markets, there are at least two established channels. By taking the acquisition route, Zee Telefilms is pursuing a growth strategy that would place it in a position of strength and gain it valuable time.

The company has decided to take a controlling 51 per cent stake at a price of around Rs. 200 crores in Asianet (which operates the Asianet Malayalam channel). Though Asianet's financials and cash flows may not be on a par with Zee's, its brand equity in Kerala and the Gulf may make the acquisition a good launch-pad for Zee. This may give it the room to move into other southern markets and also extend the leveraging of its programming business. Though Zee is not directly taking charge of the operations now, it may extend its tentacles over a period, especially to leverage the Asianet connection.

More modest growth rates

Given its myriad investment plans which entail equity expansion, the company's earnings would have to grow at a much faster rate than in the past to justify the stock valuations. But that may increasingly become difficult as the company faces enhanced competition in its mainline business of Hindi channels and programming.

Though the detailed earnings announcement for 1999-2000 is yet to be made, the market response may be lukewarm going by the indications of the top management at the EGM on April 10. The profit from local operations is expected to rise by 26 per cent, that from international subsidiaries by 46 per cent, revenue from TV software exports by 37 per cent and advertising and booking revenues by 33 per cent.

These growth rates (in what was a good year in terms of overall adspend in the economy) may not be adequate to support the valuation levels of the stock, and higher growth rates may not be easy to come by. Even with the share sharply marked down, some downside from the present levels may be in store. Similar trends also seem likely in the homestretch to the ADR offer. Shareholders may, however, stay invested, use any sharp upside to trim exposures and contemplate re-entry at lower levels.

Suitability

Zee Telefilms is suitable for investors with an appetite for high risk. Even during normal times, the stock has one of the highest levels of volatility among the Nifty/Junior Nifty stocks.