Do baby Zee's provide investing opportunity?

One of the key takeaways from 'You can be a stock market genius' by Joel Greenblatt is to look for de-merger/spin-off transactions. These are fertile areas of investigation and can offer lucrative opportunities for individual investor.

Fortified with my pleasant experience of GE shipping de-merger, I spent few days looking at Zee Entertainment de-merger which happened around January. A quick look at two smaller parts - Dish TV, which is direct-to-home satellite TV business and Wire and Wireless, which is the cable business - encouraged me to dig deeper. The initial signs were all according to text book. Specifically:

- The price of de-merged parts has fallen significantly since the de-merger.
Dish TV price has ranged from 143 to 97 and currently trades at 109.
Wire and Wireless price has ranged from 140 to 66 and currently trades at 67.

- Insiders are aligning themselves to profit from market mispricings. For example, wire and wireless was to issue 131 Cr. worth of warrants to promoters (Zee's promoters including Mr. Subash Chandra) convertible @122 Rs. a share. If promoters are willing to buy shares @122, how wrong can one go buying @67?


Well, as I studied the situation more, it appears that my initial enthusiasm was unwarranted.
Cable and Dish are simple business to value. The valuations are entirely dependent on two factors: # of subscribers and ARPU (average revenue per user). Multiply the two and you get sales figure. Slap a suitable multiple (more on this in a moment) and you arrive at valuation.

Conversely, one can start at the valuations and determine the no. of subscribers needed to support that valuation.

Let's reverse engineer the numbers for Dish TV first. The current valuation is 4800 Cr. The investor presentation on the Dish TV site says that they will need to raise another 1000 Cr in next 2 years. So, EV = 5800 Cr. The current # of subscribers is 1.9 M and according to Dish TV's own projections, they will hit 8 M subscribers in 2011. Let's say management projection on this is correct. Management also projects ARPU of 450 INR/month/subscriber. In my opinion, this is very optimistic. The competition with Tata sky and potentially other new entrants (Bharati and Reliance are rumored to get into the act), will keep ARPUs down. Let's assume that they stay steady at the current level of about INR 250.

So, you get 8 M * 250 * 12 = 2400 Cr of sales in Year 2011.
The comparable businesses in US, Direct TV and Dish TV USA, trade at price/sales multiples of 2 and 1.5 respectively. Dish TV (India) is already selling at P/S multiple of > 2 of its projected 2011 sales. In other words, hardly a bargain.


Situation is much better at cable business - Wire and wireless. Its current valuation is 1500 Cr and it needs about 1000 Cr of new investment making its EV 2500 Cr. Wire and Wireless is projecting almost similar subscriber numbers as of DishTV through 2011 - so valuations will work out similar to Dish TV viz. sales of around 2500 Cr in 2011. Comparable business - in this case, comcast US - trades at slightly higher valuations of P/S of about 3.

So, if one were to choose between Dish TV or Wire and Wireless, definitely W&W offers some margin of safety.

Neverthless, I don't think the opportunity is compelling enough because W&W needs to ramp up and prove itself. They have less than million subscribers now. Though digital cable has some tailwind behind it in terms of CAS regulation and better picture quality, its pricing is regulated - supreme court has dictated 5 Rs/channel pricing. It is doubtful whether W&W will have any pricing power. Also, buying up each cable-wallah and stitching together their coalition will probably prove time consuming and costly. You also have to bet that between now and then (when the business turns cash flow positive), new technology won't confuse this picture further.