The Hindu Business Line : UTV Software: Avoid

A BUSINESS model that now remains more at the level of aspiration than in film production; an uninspiring track record in film production, an in-house channel that could act as a drag on profitability and resources; a relentless decline in operating profit margins over the past five years; and stiff pricing make the initial public offer of UTV Software Communications (UTV) unattractive.

We believe that the company has not placed the sharp decline in profitability in the first half of FY-05 in proper perspective.

The availability of a superior investment option — Balaji Telefilms — in the entertainment content space is also likely to cap the valuation that UTV may command.

The recommendation does not take cognisance of the opportunities to make gains by flipping the stock on listing. In our view, the risks far outweigh the returns linked to fundamentals.

In this backdrop, investors, irrespective of their risk preference, can steer clear of the IPO. UTV, however, merits close tracking as a possible investment candidate at a later date and at lower price levels, if greater clarity emerges on its business model and foray into broadcasting.

UTV aspires to emerge as a one-stop-shop for the entertainment business straddling television content, broadcasting, marketing of advertisement slots on events and programmes on television, production and distribution of movies, dubbing, post-production and creation of ad films. Integrated entertainment companies are common in markets such as the US.

The workability of such a model in the Indian context is yet untested, as different segments of the entertainment business are in the throes of significant change.

UTV's track record over several years in these businesses also does not inspire confidence that it could emerge as an integrated player of strength, which could justify a premium valuation for the stock. Now, it is not a leader in any of the businesses it operates in. It would need to emerge as one in at least two-three of its businesses.

One promising area is marketing of advertisement slots. Its presence in the television content space is of high quality, though it is a distant second to Balaji Telefilms on several parameters.

UTV has a serial on Doordarshan (four days a week) and two on Star Plus (each telecast once a week), which figure high on audience share. Its serials trail those of Balaji Telefilms on cable and satellite and terrestrial channels. This is reflected in its lower profitability levels.

In the first six months of FY-05, there was a steep decline in margins, which may be due to the programming content supplied to Hungama, its fledgling channel targeted at children.

More than half its programming is now devoted to Hungama. In contrast, Balaji Telefilms' content enjoys top slots on popular channels such as Star Plus and regional networks, apart from occupying the top two slots on the Doordarshan network.

UTV has indicated a preference for a higher proportion of commissioned programmes, which are acquired by broadcasters for a fixed price, as they provide a greater degree of stability to revenues and profitability.

But there has been a decline in the share of such programmes in revenues in FY-05. The comforting factor is that its sponsored programme on Doordarshan, which has to be marketed to advertisers by UTV, appears to generate healthy levels of revenues, though sustainability of this trend would be crucial, as audience preferences are fickle, except for a few serials.

Despite these factors, UTV is an entrenched player in the second slot in the television content space with the ability to programme across multiple genres. This business accounts for about 30 per cent of its revenues. Its business of marketing air-time lends stability to revenues and profitability, though margins are lower. It has exhibited strength in this line of business and its plan to have partners across the country could lead to a more robust presence.

A substantial part of the offer proceeds is to be used to bankroll the Hungama channel, which was launched last year. This would be converted to equity at a later stage.

More than 50 per cent of the funding for this channel is to be raised through private equity and/or debt. Even after two/three years, Hungama is unlikely to get into a position of strength to generate ad revenues that could support a 24-hour channel. Cartoon Network and POGO dominate this space.

Despite the focus on offering differentiated content, the audience share is likely to be limited, as prime time viewing at most homes would be dominated by the preference of adults.

The ability and the willingness of cable operators to place Hungama on prime band is likely to be restricted by several established and popular channels in other genres.

In this backdrop, the indication that Hungama would source at least 25 per cent of its content from UTV, and also entrust the latter with rights to market advertisement slots may not mean much for the revenue and earnings stream of the parent company.

If the plans to mobilise more than half the funding requirements for FY-06 from private equity investors/debt come unstuck, UTV's commitments may rise.

Hungama could prove a millstone for UTV in much the same way as Headlines Today acts as a drag on TV Today Network. It could soak resources, raise risk levels and provide a coat of red that could lower the consolidated earnings of UTV. Its other subsidiaries, too, are in the red.

A crucial peg of UTV is its movie production business, which further enhances its risk profile. We do not take a positive view of its track record in movie production. Over a seven-year period, there is yet to be a blockbuster that could provide a substantial upside to earnings once every few years and compensate for the higher risks involved in this business.

It has adopted the co-production route after its debut film that flopped. The most high profile film from UTV's stable — Swades — has not had the kind of success that one would have associated with a big-budget flick movie involving Shah Rukh Khan and Ashutosh Gowarikar.

UTV's move to also now produce movies on its own is likely to stretch resources and make the earnings stream more volatile. It has seven films in the pipeline, of which three are to be produced with partners.

A more corporate tilt to Bollywood is the likely trend and UTV is well-placed to participate in this process.

But it may not deliver value commensurate with the resources and risks.

UTV's other businesses — movie distribution, ad films and dubbing — contribute to less than 10 per cent of revenues. If it manages to translate plans to reality, it could become a player to reckon with in movie distribution.

But this is likely to be a time-consuming process, given the formidable competitors for Hindi films as well as in the southern regional language films.

Its efforts to build a network in the US may also require sizeable financial support before it attains break-even status.

Apart from funding the Hungama channels, the offer proceeds will largely go towards bankrolling movie production and distribution.

Background: UTV is offering 45-lakh shares, and CDP, a strategic financial investor, is making an offer-for-sale of about 25 lakh shares through the book-building route. The price band is Rs 115-130.

The offer opens on February 21 and closes on February 25. The book-running lead manager is Enam Financial. The offer document is available on www.sebi.gov.in, www.utvnet.com and www.enam.com.

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