OTT concerns to remain an overhang for Zee Entertainment; stock falls

The company’s operating profit for FY18 grew at a muted 8% to Rs 20.8 billion
The Zee Entertainment stock fell nearly 10 per cent intra-day on worries that its over-the-top (OTT) application Zee5 will weigh on margins. 

Analysts at Morgan Stanley, in a report, indicated that intense competition in the OTT space — especially from deep pocketed international players Amazon and Netflix, as well as domestic players such as Reliance Jio — would require Zee to spend on high quality content, thus impacting margins. 

They expect margins of the company to fall by 3-5 percentage points and expect the company (Zee5) to break even by 2023, at the earliest. 

The stock, however, recovered and closed with losses for the day at just under three per cent. 

The recovery came after the management indicated that overall margins for the company would be at least 30 per cent, and that Zee5 would be able to break even over the next 3-5 years. 

The company’s operating profit for FY18 grew at a muted 8 per cent to Rs 20.8 billion, on account of lower revenues (sale of sports business) as well as higher advertising, sales promotion, and distribution costs. 

Margins, however, expanded by 115 basis points to 31.1 per cent due to lower media content costs. 

In addition to the performance of Zee5, the Street will look at the growth in the core broadcasting services, especially advertising revenues that accounts for 63 per cent of the overall revenues. 

Given the strong volume growth trends in consumer companies and higher spending in the future, analysts expect advertising growth for Zee Entertainment to be robust in the second quarter of FY19. 

However, what could put advertising growth (14 per cent in FY18) at risk is the shift of advertising spends to digital platforms. If the share of digital advertising increases from 17 per cent to 31 per cent over the medium term, Zee’s traditional and the biggest revenue stream could be under stress. 

Given the large investments required in building and sustaining content, revenue gains from digital advertising may not offset the higher investments in content. 

Analysts, however, say the trends could play out over the medium term so near-term pressures are unfounded. Further, the limited local content offered by players like Netflix may not lead to a change in viewer behaviour. 

At the current price, the stock is trading at 28 times its FY19 earnings estimates and investors could look at buying the stock on further correction.

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