Mumbai: Zee Entertainment Enterprises (Z IN) reported healthy revenue growth, led by increased subscription revenue (8.8 per cent  YoY) given price hikes due to implementation of NTO 3.0 and higher revenue from Zee5. So, expect subscription revenue to grow in the range of 6-7 per cent YoY, near term. Ad revenue was muted as it declined 3 per cent YoY, but this was on the back of ad spends moving away from GECs to properties such as T20 WC, General Elections and IPL. We expect ad revenue momentum to pick up in the near term, helped by: 1) positive impact from the festive season, 2) higher spends by FMCG companies and 3) traction in regional GECs. Ad revenue for Z may grow in the range of 3-5 per cent YoY in the near-to-medium term, as TV medium shows resilience amongst other traditional media genres.

Much needed respite for margin

Z has reported healthy margin improvement of 470bps YoY to 12.7 per cent, largely helped by: 1) better subscription revenue, 2) lower losses in Zee5, 3) lower employee expenses and 4) cost cutting initiatives in technology. EBITDA margin may see further acceleration, helped by better ad growth in the festive season and consistent cost cutting initiatives. Losses in the digital business (Zee5) have come down by 48 per cent, as quarterly loss is now at Rs 1,777mn (reported), versus an average quarterly loss of INR 2,718mn (average of past four quarters). Zee5 continues to report healthy performance with 15 per cent  YoY growth in Q1 revenue, despite cost cutting initiatives. We expect a sharp improvement of 550bps in EBITDA margin to 16.0 per cent by FY27E.

Await FCCB cash deployment plan

We believe raising capital is a mild positive for Z, basis its deployment to generate higher returns. These proceeds from FCCBs (of up to INR 20,000 mn) will come in a phased manner. This will ensure steady cash flow, to: 1) combat increased competitive intensity (merger of RIL/Disney) and 2) use in potential acquisitions, if any.

We believe it is also likely that Z may acquire channels of RIL/Disney, if viewership share or market share in certain genres is high and is not approved by CCI (Competition Commission of India). As per our assessment, RIL/Disney have bigger overlaps in the urban GEC genre, which is Z’s weakness, given the latter’s strength in the regional markets. The cash infusion can also be used to acquire potential digital assets/OTT platforms. We believe there is a high likelihood of the funds being deployed for inorganic purposes, than organic.

Issuance of FCCBs will be treated as a debt instrument for now, until converted into equity shares post maturity or earlier. Assuming that every tranche is of Rs 2bn, there will be an interest expense of Rs 100 mn for Z, which will have a natural forex hedge, as 5-7 per cent of Z’s revenue (Rs 6,000-7,000mn) is international ($ based). So, there may be no hit on earnings for now each time a tranche is raised, as the money may be deployed in liquid funds temporarily, until the final purpose is decided per opportunities. Post deployment, each tranche of Rs 2,000mn will have a negative impact of 1.2 per cent  on Z’s earnings due to interest outgo.

Overall, this could be a win-win for FCCB investors, as they get to pay a coupon rate of 5 per cent and purchase bonds at CMP of Z. This is attractive at 8x forward P/E – core broadcasting segment (basis FY26E). There is a high likelihood of incremental upside over coupon rates for the investors, basis: 1) pick up in TV advertising, 2) margin improvement, and 3) strong growth in the digital segment. Some part of the FCCB proceeds can also be used internally to fund content acquisitions on digital/OTT side, which can drive scale for Zee5 as a platform, and positively impact digital business’ valuations. We do not foresee any major investment in sports by Z in the near term, as all major properties such as IPL, World Cup and BCCI rights, will come up for renewal in the next 3-4years.

The management has largely identified a plan to deploy this cash and allocation towards growth initiatives is a key monitorable, as per our assessment.

Valuation: Reiterate BUY with a higher TP of Rs 210

Z is estimated to report strong earnings CAGR of 17.2 per cent  (FY25E-27E), led by strong margin improvement and better revenue growth. Raising FCCBs in tranches will not hit earnings, but allocation of this capital is a monitorable. The management has guided for an EBITDA margin of 18-20 per cent by FY26, which could provide respite and drive valuation re-rating.

Z (core broadcasting) is currently trading at inexpensive valuation of 8.0x FY26E P/E. We raise earnings estimates by 8.4 per cent/6.9 per cent for FY26E/27E, factoring in better margin performance – Maintain BUY. We roll over to raised Sep’25E SoTP-TP of INR 210 (from INR 180). We value the broadcasting business at 11x (from 10x) one-year forward P/E and OTT at 3.0x (unchanged) one-year forward EV/sales.

The credit of this article goes to Elara Capital SVP Karan Taurani.