The Hindu Business Line : PVR: Invest at cut-off

THE initial public offer of PVR Ltd, the largest multiplex operator, is worth an investment from a long-term perspective. Our recommendation is not linked to gains on listing. We take a positive view on the potential of the multiplex business in India as there are few other outdoor entertainment options for the rising affluent consumer class. At first glance, the valuation appears stiff. The past financial performance, however, may not be relevant at this stage, as the scale of expansion of the top players in this space over the next two-three years is likely to alter the nature and scale of their operations significantly. As multiplexes are at a nascent stage, the valuation is likely to be out of sync with fundamentals in these early years, much like the retail sector.

Shringar Cinemas is now the only pure-play listed player, but will soon be joined by PVR and Inox Leisure. These three are likely to be the serious contenders in this space and will battle it out at prime locations over the next few years.

Investors seeking an exposure to this sector can consider holding more than one stock. PVR's larger scale, strong foothold in the North and a good performance track record are reasons to add the stock to the portfolio. Investors would have to wait for a while before they begin to reap the gains.

Risks to recommendation

Fortunes of the multiplex business are closely linked to the number of films that are successful at the box office. This brings in an element of unpredictability to revenues and earnings growth.

With all major players expanding at the same time, an overlap in the catchment areas in certain cities is inevitable. This could lead to concentration of power in the hands of the distributors in these territories, which could increase film-hiring costs and exert pressure on margins across companies. PVR's margins, though at a healthy 18-20 per cent, are lower than that of Inox and may be harder hit in such a situation unless margins improve significantly.

Inox is also set to tap the equity market soon. If its offer is more attractively priced, PVR's stock price could dip.

Gaining a national footprint

The Rs 70-crore PVR Ltd is the largest multiplex operator with 10 cinemas and 39 screens mainly in Delhi and the NCR (National Capital Region). It plans to open 18 cinemas with 82 screens by FY-08 and is likely to retain its leadership position in terms of size, even as its peers expand.

The offer would fund the setting up of 12 multiplexes over the next two years. Five of these would come up in the lucrative, but highly competitive, Mumbai market, and the rest in Delhi, Gurgaon, Indore, Lucknow, Hyderabad and Chennai. It is to set up two low-cost digital theatres in Latur and Aurangabad (in Maharashtra).

The expansion is likely to strengthen its foothold in the North, where PVR has a first-mover advantage. Other players have also, by and large, avoided building a presence in this region due to PVR's dominant presence. The company is, therefore, well-placed to tap the immense purchasing power in Delhi, Gurgaon and Ludhiana.

Competing for footfalls

The foray into Mumbai would mean taking the competition head on. PVR's proposed multiplexes at Juhu, Mulund and Ghatkopar would face competition from multiplexes of Shringar and Adlabs, which would be located within a five-km radius. But the density of population in Mumbai can probably accommodate two or three multiplexes in the same catchment.

We do not perceive under-cutting on the ticket price front. PVR has initiated flexible ticket pricing and sells tickets at lower prices from Monday to Thursday. Flexible pricing and lower ticket prices have helped occupancy rates and ramped up box office revenues.

The choice of films is, however, more likely to be a determinant of customer's preference for multiplexes. Multiplexes that promise quality films and a wider range to appeal to all audiences will attract more footfalls. With the presence of more multiplexes in a territory, the film distributor's power vis-à-vis exhibitors or a multiplex is likely to increase. This could lead to higher payments to distributors and margin pressure.

Earnings outlook

We expect PVR to deliver a strong revenue growth on the back of its massive expansion drive. While higher hiring costs can be a damper, margins, in the near term, are likely to improve.

PVR's margins, currently at about 20 per cent, are significantly lower than that of Inox, as the company has not fully availed itself of entertainment tax exemptions; entertainment tax accounts for 25 per cent of its ticket sales, while it is only about 4 per cent of Inox's ticket price.

PVR has, however, applied for entertainment tax exemptions for several of its new properties, which would have positive impact on margins. Advertisements, which are a high-margin revenue source, accounted for 12 per cent of PVR's incomes in FY-05. As PVR gains scale, the share of advertising is also likely to rise, thereby improving margins.

PVR's profits have grown at a CAGR (compound annual growth rate) of 35 per cent since 2001. It is likely to maintain this growth momentum, though interest and depreciation costs in the initial years might act as a drag on earnings.

Offer details: Seventy-seven lakh shares are on offer. PVR plans to raise about Rs 130 crore through this offer. Post-offer, the promoters would have 40 per cent stake, while ICICI Venture would hold 22 per cent. A small portion of the proceeds would go towards an equity investment in its subsidiaries, CR Retail and PVR Pictures. The price band is Rs 200-240. The lead managers are ICICI Securities and Kotak Mahindra Capital. The offer closes on December 14.