Zee investors could score big from sports exit

Move will lead to higher operating-profit margins

The Zee Entertainment stock touched a two-year high on Tuesday after the company indicated that it was in advanced stage of talks for the sale of its sports business. The company also said that it was exploring various strategic options for entering in new businesses or restructuring existing ones to maximise shareholder returns.

In recent times, the stock has rallied and outperformed its peers. It seems the Street was anticipating such an announcement. If the company manages to sell its sports business at a decent valuation, it will have a favourable impact on the financials.

The sports bouquet comprises five channels, including two in the high definition (HD) format. The Ten Sports network has broadcast rights for key cricket boards and international championships in golf and wrestling. At a turnover of Rs 630 crore for FY16, sports accounts for 11 per cent of the company’s overall revenues. However, at operating level, the business reported a loss of about Rs 34 crore in FY16.

Interestingly, this segment helped the company improve its operating profit in the June quarter. On revenue of Rs 170 crore (up 12 per cent year-on-year), the sports business reported an operational profit of Rs 17.1 crore, beating expectations of a loss. Analysts expect the company’s improving graph on the sports front to continue. Morgan Stanley analysts say the company’s sports business over the past five quarters has performed better than market expectations and its own forecast.

The company acquired Ten Sports in three tranches between 2007 and 2012, paying about Rs 900 crore. Coupled with accumulated losses at the operating level of Rs 756 crore, it has spent about Rs 1,660 crore on the segment. Given the money it has spent, the company has not garnered the commensurate subscription revenues from this genre. The issue is that the segment requires higher upfront spend for good content to generate enough eyeballs and revenues which Zee has not done. While doing away with the sports bouquet may weaken its bargaining position with content distributors (cable and direct-to-home players), Vivekanand Subbaraman of Ambit Capital says that these fears are unfounded given sub-par cricket viewership of Zee’s sports channels.

On the other hand, the argument in favour of the deal, which is estimated to be at Rs 2,000 crore, is the improvement in margins and higher focus on regional content.

Subbaraman says exit from the sports segment will free up the management and provide financial cushion for investments in regional markets (a key growth area for Zee) — the company has marginal presence in Tamil genre and is absent from Malayalam genre. Its focus on building regional channels (organic and inorganic—acquisition of Odia channel Sarthak earlier this year) and higher rural penetration has helped it improve its share of advertising revenue. Overall margins could see an improvement to the tune of about 400 basis points over the next year or so from the current 25 per cent. While most analysts are bullish on the stock, given the recent run-up, valuations are on the expensive side. The exit from the sports segment is already factored in the current stock price. What needs to be seen is how the company will fare in its acquisition strategy and make more inroads into regional content.