initiating coverage - den networks ltd

7/31/2019 Initiating Coverage - Den Networks Ltd

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Den Networks Ltd.

BUY

1 of 19 - Monday 13 th August, 2012 This document is for private circulation, and must be read in conjunction with the disclaimer on the last page.

Target Price 210 CMP 124 FY14 PE 17.6x

Index Details We initiate coverage on Den Networks Ltd (DEN) as a BUY with aDCF valuation based Price Objective of 210. At CMP of 124, thestock is trading at 21.5x and 17.6x its estimated earnings for FY13& FY14 respectively, representing a potential upside of ~70% overa period of 18 months. Being the only profitable MSO with amarket share of 12% and a subscriber base of 11mn, DEN is wellpoised to benefit from the ongoing digitization wave in the cableindustry. We expect revenues to grow multifold as the LCO will nolonger be able to under report the subscriber base. We expectrevenues and earnings to reach to 1,280.9 crore and 93.4 crorein FY14 from 714.3 and 14.6 crore in FY12 respectively.

Digitization- The game changerDigitization is expected to be the turning point for the struggling cable industry. Thecable industry has been characterized by drastic under reporting of subscribersleading to substantial revenue losses not only to the broadcasters & MSOs (MultiSystem Operators) but also the GoI (Government of India) in the form of losttaxation. With Digitization gradually replacing the analog distribution system, theentire universe of subscribers will now be uniquely recognized leading to a multifold

jump in the paying subscribers for MSOs. This would lead to a quantum jump in therevenues for the MSOs and broadcasters, besides paving the way for the launch of higher value added services like premium content, high definition offerings andbroadband services.

DEN well poised to benefit from digitizationDEN is expected to be one of the biggest beneficiaries of this Digitization. Althoughthe full impact of the revenue benefit would be felt FY15 onward, nevertheless in theinterim, the impact on revenue and profitability is expected to be substantial. Postdigitization, DEN s entire ~11 mn subscriber base (as against the reported number of ~1.4 mn) is expected to start contributing to the revenues. We expect DEN ssubscription revenues t o grow multifold to ` 853.8 crore by FY14 from ` 262.34 crorein FY12.

Sensex 17,633

Nifty 5,348

BSE 100 5,341

Industry Cable TV

Scrip Details Mkt Cap ( ` cr) 1,638

BVPS ( ` ) 61

O/s Shares (Cr) 13.3

Av Vol (Lacs) 0.4

52 Week H/L 130/35Div Yield (%) 0

FVPS ( ` ) 10.0

Shareholding Pattern

Shareholde rs %

Promoters 53.8

DIIs 2.5

FIIs 8.5

Public 35.2

Total 100

Den Networks. vs. Sensex

Key Financials ( in Cr)Y/E Mar NetRevenue EBITDA PAT EPS

EPS Growth(%)

RONW(%)

ROCE(%)

P/E(x)

EV/EBITDA(x)

2011 606.6 136.1 37.5 2.8 28.4 4.8 13.1 43.5 11.72012 714.3 134.0 14.6 1.1 -61.1 1.8 11.3 112.9 11.92013E 936.4 259.1 76.7 5.8 426.1 8.7 20.3 21.5 6.22014E 1280.9 308.6 93.4 7.0 21.8 9.6 21.3 17.6 5.2


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- 2 of 19 - Monday 13 th August, 2012

This document is for private circulation, and must be read in conjunction with the disclaimer on the last page.

Distribution JV Media Pro to facilitate better negotiation powerIn its initiative to grow through partnership, Den Network and STAR India Ltd formedSTAR DEN, a strategic 50-50 Joint Venture (JV) for the distribution of TV channels

and services in India. To further reinforce STAR DENs visibility and ensure a better negotiation power aided by a strong bouquet of channels, the company formed a JVwith Zee Turner Ltd in May 2011 called Media Pro Enterprise India Private Limited.DEN is a participant in this JV through its 50 percent stake in STAR DEN.

Valuation At a CMP of ` 124, the stock is trading at 21.5x and 17.6x estimated earnings for FY13and FY14 respecti vely. MSOs are expected to be the biggest beneficiaries of digitization as revenues will no longer be under decla red by the MSOs. We believeDEN with a market share of 11% and a subscriber revenue base of ~11 mn is wellequipped to meet the digitization deadlines for Phase I and Phase II cities. We initiate

coverage on Den Networks Limited as a BUY with a price objective of ` 210representing an upside potential of ~70% over the next 18 months.


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Key Investment Highlights

Digitization- The game changer

Digitization is expected to be the turning point for the struggling cable industry. Thecable industry has been characterized by drastic under reporting of subscribersleading to substantial revenue losses not only to the broadcasters & MSOs (MultiSystem Operators) but also the GoI (Government of India) in the form of lost taxation.With Digitization gradually replacing the analog distribution system, the entire universeof subscribers will now be uniquely recognized leading to a multifold jump in thepaying subscribers for MSOs. This would lead to a quantum jump in the revenues for the MSOs and broadcasters, besides paving the way for the launch of higher valueadded services like premium content, high definition offerings and broadbandservices.

Under declaration of revenues to be eliminatedCurrently, the analog market is highly unorganized with over 1000 MSOs and 60,000LCOs (Local Cable Operators) servicing the 146 mn strong Indian TV households. Asper the existing structure of broadcasting, t he content is passed on to the LCOs by theMSOs via cable who further distribute s the channels to the consumers. This results inthe LCO having singular access to the consumer and the analog system ensures thatthere is no way for the MSO to have a clear understanding on the number of subscribers who are enjoying its services. This has resulted in a significant under reporting of the total subscriber base leading to severe revenue leakages for not onlythe broadcasters and MSOs but also the exchequer. The extent of this under reportingis so large that out of the total market size of ` 18,000 crore, revenues to the extent of only 15% are actually realized.

MSOs to benefit from gr owth in television households and

increased C&S penetration

138146

188

73%

76%

89%

70%72%74%76%78%80%82%84%86%88%90%

020406080

100120140160180200

2010 2011 2016E

m n

h o u s e

h o

l d s

Television households (mn)

Paid C&S Penetration of TV households % (mn) (RHS)

Source: FICCI KPMG 2012, Ventura Research


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Key Highlights of TRAI Tariff Order & Interconnection Regulations forDigital Addressable Cable TV Systems

Basic TierSince, the consumer is required to pay for Free to Air (FTA) channels, concept of Basic Service Tier (BST) has been introduced. The BST is priced at ` 100 max (+ taxes) per month.

However, it is not compulsory for the consumers to subscribe the BST and the consumer can select hisown 100 FTA channels in the BST.

Minimum Pay TV package A pay channel package will cost atleast ` 150 per month.

Minimum 500 channelsMSOs must carry a minimum of 500 channels from 1 st January, 2013.

Uniform Carriage FeesMSOs can declare their own carriage fees for any channel that the MSO has not asked the broadcaster for.

Carriage fees cannot be increased for two years.

No demanded placementBroadcasters cannot insist on placement of their channel in a particular slot.

MSO LCO Revenue ShareIn case mutual negotiations for revenue share between the MSO & LCO fail, the revenue share shall be

55:45 (MSO : LCO) for BST or FTA channels.65:35 (MSO : LCO) for Pay channels & their bouquets

Compulsory a-la-carte by broadcastersEvery broadcaster must offer all its channels to MSOs on a -la-carte basis.

The broadcaster cannot compel any MSO to include its channels in any package or scheme offered bythe MSO.

Source: Industry, Ventura Research


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Come digitization and control shifts from LCO to MSO

However with the onset of the new Digitization Bill, a radical change in the way theC&S industry operates will take place. This will lead to the MSO gaining increasing

control over the network and the use of smart technology (Set Top Box equipped witha Conditional Access Card at the customers end & SMS Subscriber ManagementSystem) will ensure that all revenue leakages are plugged. However, the full impact of this is expected to be felt only from FY16 onwards once the seeding of the entireecosystem with STBs (Set Top Box) is completed (in line with road map laid down byTRAI).

Once each phase of digitization is implemented, each user in the network will beidentifiable to the MSO, consequently driving away the prevailing under declarationand resulting in a multifold increase in revenues for the MSOs. The MSO will controlthe infrastructure and the role of a LCO will be limited to the extent of a collection andservicing agent of a MSO.

Roadmap to Digitization

Phase Geographies Covered No of C&SHouseholds

Deadline

I Delhi, Mumbai, Kolkata and Chennai ~12 mn 31-Oct-12

II All cities with population > 10 lacs 30-40 mn 31-Mar-13III All urban areas (municipal areas) ~ 20 mn 30-Sep-14IV Rest of India ~ 20 mn 31-Dec-14

Source: Den Networks, Ventura Research

MSO & Broadcasters Share to grow multifold post digitization

Stake-holder revenue share Pre-digitization Post 2016

Consumer ARPU 100% 100%LCO 65-70% 35-50%Distributor 5% 0.5%MSO 15-20% 25-30%Broadcaster 10-15% 30-35%



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Enhanced channel carrying capacity to result in greater choice toconsumers

As of 2011, there are more than 600 channels broadcasted in India. The prevailinganalog regime has a capacity of carrying only ~90 channels and the customers do nothave the liberty to choose the channels. Thus, customers are forced to view thechannels the MSO broadcast and the broadcasters have to pay the MSO placementand carriage fees for relaying their content. However, under digitization this is all set tochange.

Under digitization the MSO s are required to carry 500 channels by January 13. Thiswill not only provide the consumers access to a larger number of channels but theconsumers will also be able to experience other value added services like video ondemand, video recording facility, a la carte facility and high ARPU High Definition (HD)services.

and lower carriage fees charged to broadcasters

As explained above due to channel carrying capacity constraints, broadcasters arerequired to pay carriage fees to the MSOs in order to place their channel on theMSOs network. Also placement fees are paid by the broadcasters to have their

channel carried in a higher sequence to ensure better visibility.

Carriage and placement fees presently contribute ~50% of the total revenues for theMSOs. Post digitization as the channel carrying capacity of the MSOs will increase,there will not be any demand supply mismatch and hence the broadcasters andMSOs are expecting a decline in carriage fee. Also, since channels of the same genrewill be placed together in the digitized network, placement fees are also expected toreduce providing the broadcasters a level playing field.

No of channels in India

5 11 1329

55 66 75

130170

200

263308

363

461

552

623

0

100

200

300

400

500

600

700



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However, there is no consensus of opinion with regards to the movement of carriagefee in the near term. We believe that even a significant decline in carriage fees will notimpact the MSOs as the gain from the subscription revenues will be far more than thedecline.

ARPU s to expand post complete rollout of digitization

Over the past few years APRUs have remained largely suppressed due to highcompetition among the MSOs and the unorganized nature of the industry. Evenduring the phased implementation of digitization, we do not expect a major surge in

ARPUs as MSOs and DTH operators are on an expansion spree for capturing thesame target audience resulting in competitive pricing. However, post completion of digitization , we expect ARPUs to improve aided by value added services andintroduction of niche content and increased HD offerings . We expect ARPUs for theindustry to stabilize to around ` 220-225 by FY15 from the current ` 170-180.

DEN well positioned to benefit from digitizationDEN is expected to be one of the biggest beneficiaries of this Digitization. Althoughthe full impact of the revenue benefit would be felt FY15 onward, nevertheless in theinterim, the impact on revenue and profitability is expected to be substantial. Postdigit ization, DENs entire ~11 mn subscriber base (as against the reported number of ~1.4 mn) is expected to start contributing to the revenues. We expect DEN ssubscription revenues t o grow multifold to ` 853.8 crore by FY14 from ` 262.34 crore inFY12.

Evolution of ARPU as digitization evolves

ARPU (INR Per Month) 2011 2012 2013E 2014E 2015E 2016EDigital 160 170 180 201 226 253

Analog 160 165 170 170 171 171DTH 160 170 180 201 226 253IPTV 160 170 180 201 226 253



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Adequate inventory of STBs to result in timely roll out for Phase I

DEN with ~2 mn subscribers enjoys a sizeable market share of 16% in the Phase Icities (Mumbai 12%) . Having already seeded 0.8 mn STBs as of June 12 in the PhaseI cities and with adequate inventory and STB orders placed for 2.5 mn nos, we do notforesee any roadblocks in DEN meeting the deadline for Phase I which ends onOctober 31, 2012.

The Phase II rollout is also progressing well and once Phase I is completedconcentrated effort on implementation in Phase II is expected to lead to acceleratedseeding. From the current ~1.4 mn nos, paying subscribers are expected to go to 3.9mn by the end of FY14.

Delays in roll out not ruled out

However the pan India rollout is not expected to be without hiccups. Given that theLok Sabha elections are to be held in 2014 there could be tweaking of the deadline for Phase III and IV leading to extending the roll out time. As a matter of caution we havefactored in a three month delay in implementation of Phase II deadline and a yearsdelay each in Phase III and Phase IV deadlines respectively.

STB seeding status as on 1st June12

Hathway DEN Digicable WWILEstimated Subscribers 2,270,000 2,000,000 2,000,000 2,500,000Total STBs Seeded 909,917 429,738 497,650 433,119Percentage Achievement (%) 40.1 21.5 24.9 17.3

Source: Ventura Research, MIB

Growth in Subscription Revenues Operating margins Cable Business

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

0

200

400

600

800

1000

1200

1400

FY11 FY12 FY13E FY14E FY15E

R s

i n c r o r e

Sub sc rip tio n Revenue % of t ot al rev enue (RHS)

19.8%

18.5%

26.9%

23.7%

28.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%


Source: Den Networks, Ventura Research Estimates Source: Den Networks, Ventura Research Estimates


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DTH Players Not a Threat

Despite having a presence in ~42 mn Households since inception (2003), we do notexpect DTH to completely replace the existing analog distribution system. MSOsbeing deeply penetrated in the Phase I and Phase II regions will restrict the churn toDTH operators and w ith accelerated rollout of digitization, we expect the MSOs tofurther consolidate their position. MSOs clearly outperform DTH on various other parameters as enumerated below.

DTH vis--vis Cable

No of STBs to be seeded by Den

2.9

1.1

2.3 2.3

0

0.5

1

1.5

22.5

3

3.5

FY13E FY14E FY15E FY16E

i n M i l l i o n s

Source: Den Netowrks, Ventura Research

Parameters DTH Cable

License Fees 10% of DTH revenues No license fees

Major Investment Annual lease payments for transponders to trasnmit channels

One time investment for a headend

ChannelsLimited channel carrying capacityof ~300 channels

High channel carrying capacity of ~500 channels

Broadband services No broadband servicesBroadband services can beprovided along with cable

Access to the end consumerOnly direct subscribers i.e. primaryaccess

More of secondary subscribers

Revenue Sharing No revenue sharing with LCO Revenue sharing with LCO

Ad Spend Huge ad spendsNo huge ad spends since MSO'sare well established

Service quality Rains can disrupt signals Consistent signals



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In our opinion, DTH players will experience higher seeding in Phase III and Phase IVregions. However for them to make inroads into Phase I and II will be a tall task giventhe fact that we have not witnessed significant churn amongst cable subscribers toDTH services. And with completion of phase I already on anvil the going will only get

tougher for them. Carriage fees to rationalize, but multifold jump in subscribers toneutralize impact on revenues

The limited carrying capacity (90 to 100 channels) of the set top boxes provided awindfall to the MSOs with broadcasters paying carriage and placement fees to ensurethat they featured in the bouquet of offerings to subscribers. However with regulationrequiring that MSOs offer minimum 500 channels, the premium on placement fee areexpected to moderate and the carriage and placement income is expected to comedown.

Discussions with various stake holders clearly points to the fact that the carriage andplacement fee could collapse by as much as 50%. While the management of DENbelieves that the revenues from this source would only correct post complete rolloutwe have chosen to be conservative in our forecast. Carriage fees which have so far contributed 47% to the consolidated revenues are expected to decline to 23% goingahead. We have factored a drop in carriage fees to ` 294 crore in FY14 from ` 327.9crore in FY12. Given the expected multifold increase in subscription revenues, thedrop in carriage revenues will have a minimal impact on total revenues.

Carriage Revenues to fall

0%

10%

20%

30%

40%

50%

60%

0

50

100

150

200

250300

350


R s

i n c r o r e

Carriag e Rev enue % o f t ot al rev enue (RHS)



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Digitization to spur consolidation in the industry

Digitization has turned out to be a key driver for consolidation in most developedmarkets. Citing the example of United States which was highly unorganized in the pre

digitization scenario, the market is now dominated by top 5 players. We believe such aconsolidation drive can take place in India as well leading to the emergence of a feworganized and well capitalized players over the next few years.

Consolidation will also enable MSOs to have a better bargaining power withbroadcasters resulting in improved margins and thus better returns to the investors.DEN being one of the major players which has grown the inorganic way is best placedto benefit from consolidation.

Trends in International Markets

Country Pre-consolidation Post Consolidation

US 50 large playersTop 2 MSO's -Comcast (22% Market share)and Time Warner (21.9 % Market share)

Japan 686 players Top 3 Players- J:COM (30% Market Share)

Taiwan 600+ players Top Player-TBC (47% Market Share)

Korea 1000 playersTop 2 Players- CJ Hellovision (21% marketshare) and T-Broad (20% market share)


Operating margins International Players

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

CY07 CY08 CY09 CY10 CY11

E B I T D A %

Comcast Time Warner Dish Network Direct TV

Source: Bloomberg, Ventura Research


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Financial performanceRevenues for the cable business were higher by 20.7% yoy to ` 190.1 crore led byincreased subscription and carriage revenues whereas operating profits rose by76.8% yoy to Rs. 46.2 crore. Earnings from the cable business before ESOPexpenses almost doubled to Rs. 12.2 crore from Rs. 6.7 crore in Q1FY12.

Consolidated revenues are not comparable with past periods due to the change inaccounting policy at Media Pro which has started reporting revenues on a net basis(Gross Revenues Cost of Distribution Rights). Consolidated revenues were reportedat Rs. 194.9 crore whereas operating profits stood at Rs. 38.5 crore as compared toRs. 17.9 crore in Q1FY12. Earnings rose multifold from Rs. 1.8 crore in Q1FY12 toRs. 12.2 crore in Q1FY13.

Quarterly Financial PerformanceParticulars Q1FY13 Q1FY12 FY12 FY11

Net Sales 194.9 282.9 1139.3 1041.9

Growth % -31.1 9.3

Total Expenditure 156.4 265 1043 931.1

EBIDTA 38.5 17.9 96.3 110.8

EBDITA Margin % 19.8 6.3 8.5 10.6

Depreciation 15.6 12.3 53.8 45.6

EBIT (EX OI) 22.9 5.6 42.5 65.2

Other Income 5.7 3.8 14.8 16.2

EBIT 28.6 9.4 57.3 81.4

Margin % 14.7 3.3 5.0 7.8

Interest 10.0 5.1 27 19.2

Exceptional items 0 0 0 -0.5

PBT 18.6 4.3 30.3 61.7

Margin % 9.5 1.5 2.7 5.9

Provision for Tax 4.5 1.5 10.8 17.4PAT 14.1 2.8 19.5 44.3Minority Interest &Others 2 1 5.4 6.8

PAT (after MI) 12.1 1.8 14.1 37.5

PAT Margin (%) 6.2 0.6 1.2 3.6Source: Den Networks, Ventura Research


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Financial outlook

DEN is expected to be one of the biggest beneficiaries of the digitization leading to a

quantum jump in its revenues and profitability. Despite factoring a delay of threemonths in the Phase II deadline and a years delay each in the Phase III and Phase IVdeadline respectively, we expect the paying subscriber base to reach 3.9 mn by FY14from the current 1.4 mn. On the back of the increased paying subscribers revenuesare expected to almost double to ` 1,280.9 crore by FY14 from ` 714.3 core in FY12,while earnings are expected to leapfrog to ` 93.4 crore from ` 14.6 crore in FY12despite higher depreciation from newly seeded STBs and interest cost. However thefull benefit of digitization will be felt only FY15 onwards.

Valuation

At a CMP of ` 124, the stock is trading at 21.5x and 17.6x estimated earnings for FY13and FY14 respectively. We initiate coverage on DEN Networks Limited as a BUY witha price objective of ` 210 representing an upside potential of ~70% over the next 18months. We have valued Den Networks on a single stage DCF, given the sustainablecash flows of the business post the complete digitization of the cable industry.

Revenue and EBITDA% trend PAT Trend

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

0

200

400

600

800

1000

1200

14001600

1800


R s

i n c r o r e

Revenue EBITDA % (RHS)

0

20

40

60

80

100

120

140

160

180

200


R s

i n c r o r e

Source: Den Networks, Ventura Research Source: Den Networks, Ventura Research


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Particulars (Rs crore) FY13E FY14E FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22EPAT 93.8 113.4 208.6 204.9 216.1 272.4 320.9 363.2 385.9 405.0Depreciation 92.7 108.2 137.2 166.1 169.3 172.5 175.7 178.9 182.1 185.3Interest (1-t) 31.0 36.9 42.7 46.6 36.9 22.2 12.5 0.0 0.0 0.0

Capex -436.0 -194.0 -362.0 -362.0 -40.0 -40.0 -40.0 -40.0 -40.0 -40.0

Inc in Non Cash Working Capital 16.1 -36.9 -43.2 -34.2 -11.6 -26.2 -24.5 -19.2 -14.9 -12.8Free Cash Flow -202.4 27.6 -16.7 21.4 370.8 401.0 444.6 483.0 513.1 537.6Years 1 2 3 4 5 6 7 8 9 10

Discount Factor 0.88 0.78 0.69 0.61 0.54 0.48 0.42 0.37 0.33 0.29

PV of Free Cash Flow -179.0 21.6 -11.5 13.1 200.6 191.8 188.1 180.7 169.8 157.3Cumulative Cash Flow -179.0 -157.5 -169.0 -155.9 44.7 236.5 424.7 605.4 775.2 932.5

Discounted Cash Flow Model

2% 3% 4% 5% 6%12.1 209.6 225.3 245 270 30312.6 195 209 225 247 27413.1 183 195 210 228 25113.6 170 181 194 209 22914.1 160 169 180 193 210

Perpetuity Growth Rate

W A C C

TP (Rs)

Sensitivity Analysis

Terminal Year (n) FY22 Risk Free Rate 8.1%WACC (%) 4% Market Risk Premium 8.0%Terminal Value 6,160 Beta 0.8Discounted Terminal Value 1,803 Cost of Equity 14.5%Present Value of firm till Terminal Year 932 Cost of Debt 9.8%Total Discounted Value of Firm 2,735 Post Tax Cost of Debt 13.0%Less Current net debt of the firm -52 Debt (Rs crore) 258Present Value of Equity 2,787 Enterprise Value (Rs crore) 2,735No of equity shares (crore) 13.3Fair value of Equity Shares 209.6 WACC 13.1%

DCF Valuation (Rs crore) WACC


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P/E

0

100

200

300

400

500

600

Mar-10 Mar-11 Mar-12 Mar-13

CMP 30X 45X 60X 75X 90X


P/B

0

50

100

150

200

250

300


CMP 1.25X 1.75X 2.25X 2.75X 3.5X


EV/EBITDA

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000


EV 4X 9X 14X 19X 23X

Source: Den Networks , Ventura Research


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AppendixWorking of the Analog mode of cable distribution

Working of the DTH mode of cable distribution



initiating coverage - den networks ltd

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