Zee Entertainment: Merger with Sony is the only hero in this daily soap

The current volatility in the stock stems from the uncertainty that has arisen over the timeline of the completion of its merger with Sony, analysts say

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Subhash Chandra’s Zee Entertainment Enterprise Ltd (ZEEL) has been on a downward trajectory since October 2022, and the negative trend has become more pronounced since December.

ZEEL’s problems multiplied manifold when IndusInd Bank filed for initiating insolvency proceedings against the broadcaster in the Mumbai branch of the National Company Law Appellate Tribunal (NCLAT) on February 22.

ZEEL was the guarantor of IndusInd Bank’s Rs 150-crore loan to Essel Group’s Siti Networks. It failed to honour the Debt Service Reserve Account Guarantee Agreement (DSRA). The shortfall amounted to Rs 83 crore.

This news led the stock to tank over 13 percent on February 23 and since then the counter has been volatile, with daily swings ranging as high as 10 percent.

On February 27, too, the stock lost around 10 percent in the early morning session at Rs 176.65, which was also the day’s low before it retraced and recovered some ground.

Analysts at the securities firm Geojit Financial Services wrote: “Owing to existing provisions in place, the impact on its books from this development remains negligible”.

Positive bias 

Although the stock has been declining over the past few months, analysts believe it has more to do with an overall bearish trend in Indian equity markets.

Before the beginning of the insolvency saga,  market players had been quite positive on the counter, largely on the back of its impending merger with Sony Pictures Networks India.

According to Mutual Fund holdings data, released every month by the Association of Mutual Funds in India (AMFI), MFs have been increasing their holdings in ZEEL over the past few months.

The data shows that their holdings as a percentage of share capital stood at 22.62 percent at the end of September 2022. At the end of October, they went up to 24.98 percent, in November to 26.24 percent, in December to 27.19 percent and in January, the total stake held by different mutual funds across their schemes stood at 27.42 percent.

According to Bloomberg, out of the 25 analysts who track the stock, 21 have a “buy” rating on the stock while two have a “hold” and a single analyst has a “sell” rating on ZEEL.

What’s rocking the boat? 

Despite the positive bias, the stock has been unable to arrest its decline. According to market experts, the whole premise of the ‘bullishness’ on the stock hinges on the company’s merger with Sony. That is the only catalyst which can pull back the stock.

Jinesh Joshi, research analyst at Prabhudas Lilladher Pvt Ltd, told Moneycontrol: “The current volatility in the stock is due to the uncertainty in the merger timeline with Sony that has cropped up in view of the NCLAT proceedings.”

Investors are getting jittery because of the negative news flow around the merger.

Karan Taurani, Senior Vice President at Elara Capital, said: “The stock is coming down consistently because of the uncertainty about the merger with Sony and the fear that it might eventually get called off.”

Now since NCLAT has issued a stay on the insolvency proceedings, both Joshi and Taurani do not see any chance of the merger being called off.

Joshi expects the final order against the insolvency to come by March 29 and he believes the merger will be most likely complete after that.

This is the only but very big positive for the stock from the medium- to long-term perspective.

What should investors do? 

ZEEL, by itself, has not been able to perform over the past few quarters. Its revenue is declining, margins are narrowing as content creation and marketing costs rise and a series of exceptional losses and provisions have eaten into its profitability.

Despite a decline in operational performance, the whole ZEEL story is only hinging on the merger. If this merger fails to materialise, experts are looking at a downside of over 30 percent from current levels.

Joshi advises investors who can take the risk of waiting for more clarity coming on the insolvency part to hold onto their positions. He expects the merger to go through but maintains the time-line could be a bit uncertain.

“We expect near-term profitability challenges as network share is flattish at ~16 percent; losses in digital venture are widening (Rs 794 crore in 9MFY23 compared to Rs 558 crore in 9MFY22) and content and production cost continues to stay at elevated levels,” Joshi added.

In light of the ongoing challenges, he has cut his target multiple to 21x (earlier 22x) but retains a ‘buy’ rating with a revised target price of Rs 277 (earlier Rs309) in the belief that the merger with Sony can result in significant revenue/cost synergies in the long term.

The merger with Sony seems the only silver lining, backed by cost/revenue synergies and the potential to overtake Disney as the number one broadcaster in India. This will also support valuation multiples.

“TV as a medium will continue to co-exist with digital, in the medium term and synergies with Sony on linear TV and OTT (Over The Top) will drive overall scale/efficiency for the merged entity, as both companies have minimal overlap on genre,” Taurani said.

Taurani added: “The stock is currently trading at very inexpensive valuations of 7x – 10x PE (assuming the merger goes through) with 7x PE will be excluding the Zee5 and Sony Liv losses and 10x PE will be including the losses of Zee5 and Sony Liv.”

He sees the stock as compelling play at these valuations and does not see any more setbacks.

He advises investors to approach the stock from a medium-term perspective as in the near term he expects volatility to continue in view of the various news flows regarding the liability claims against ZEEL. Any order against the company in these cases holds the possibility of the merger being called off but for now the merger is very much on cards and will get executed in the coming future, he said.

ZEEL closed 6.4 percent down at Rs 182.95 on February 27 at The National Stock Exchange. The stock has shed ~21 percent over the past year and is down 15 percent in the past month.

Disclaimer: The views and investment tips of investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.