Sony-Zee merger, endgame unfavorable: Karan Taurani, Elara Capital

Sony India terminated the merger agreement with Zee Entertainment Enterprisers (Z IN) on 22 January 2024, seeking a termination fee of USD 90mn on account of alleged breaches of merger cooperation agreement (MCA) terms by Z, invoking arbitration and seeking interim relief against Z. Z has denied all such assertions by Sony regarding the alleged breach of the MCA, including the latter’s demand of termination fee. Z is evaluating all available legal options to contest Sony India’s claims.

Stiff competition from digital media and RIL/Disney merger

We believe the above termination may hit both the parties as both are facing stiff competition from digital media as also potential threat from the merger of RIL-Disney, near term. Z has reported muted growth/profitability performance in the past two years, as revenue growth has converged (flat in FY20-23) and EBITDA margin dipped to 10.7% (6MFY24), due to: 1) losses in the OTT segment and 2) lower growth in linear TV segment.

On the brink of multiple legal proceedings

Z had also signed a contract with Disney for sub franchise of sports rights (ICC tournaments) in linear TV. We had estimated related annual losses of ~INR 15.2bn in FY25E and beyond, given: 1) hefty content cost, 2) lower sports ad revenue and 3) cricket content being available free on OTT. Z may now not fulfil this commitment (cash balance of mere INR 6bn, versus potential contractual obligation of INR 40 bn per year) as it was entered into given its strategic-synergistic contiguity with Z-Sony merger. Also, Z could see a hit from related penalty/legal proceedings due to 1) battle with Sony over the non-compete fee, 2) ongoing legal proceedings by various creditors of the Essel group (Axis Finance, IDBI Bank etc.) and 3) dishonouring of contract with Disney.

Valuation: Downgrade to Sell; TP pared to INR 170

Z may see a sharp de-rating in P/E valuation of its broadcasting business to at least 10x one-year forward or lower, due to the unfinished merger, as: 1) linear TV growth has converged sharply, 2) Z may not have any potential to scale-up OTT offering in a highly fragmented market, 3) lower profitability – EBITDA margin, ex-Sports losses, could converge to 14% and 4) any further write-offs on the inventory side or matters pertaining to related parties’ creditors or not honouring the sports contract with Disney (ICC tournaments – Z could have potentially paid half of the USD 3bn value for TV rights). Merger with Sony was the key valuation driver to move up in the past two years. But given the termination, we downgrade Z to Sell with March 2025E TP pared to INR 170 from INR 340. But if the Disney contract is honoured, TP may move to INR 130, citing losses in the sports segment. We value the broadcasting business at 10x one-year forward P/E and OTT at 3.0x one-year forward EV/sales. Possibility of any other strategic/financial partner buying majority stake in Zee could provide respite to valuation multiples.