Here’s why this brokerage firm downgraded Zee Entertainment

Zee in focus: After over two years of discussions, Japan’s Sony has terminated its merger cooperation agreement (MCA) with Zee and has requested a termination fee of $90 million, alleging a breach of the MCA by Zee. 

In response, Zee has indicated that it will evaluate all available options, including potential legal action. Notably, Punit Goenka, Zee's MD and CEO, has reportedly agreed to step down, a key point of contention between the two parties. 

Here’s why Motilal Oswal downgraded the stock

When the merger was initially announced in December 2021, the stock was upgraded to buy based on the belief that it would create a robust entity, benefiting Zee in three crucial ways, which included enhancing the product portfolio with 75 channels across various genres and languages, securing a dominant revenue market share of over 35 per cent, expansion in the OTT space, with the combined Zee-Sony entity positioned to carve a niche in a market dominated by major players and improving the perception of the company's governance through Sony's majority shareholding and board composition.

Given the collapse of the merger, Zee may find it challenging to make progress on these fronts individually. 

The company's performance has been lackluster over the last four years, with a 14 per cent decline in ad revenue from FY20 to FY23 and a continuous loss of market share over the past 4-5 years. 

In the evolving OTT landscape, Zee5 could face challenges competing with established players like Disney, Netflix, Amazon Prime and Network18 led by Reliance Industries.

Can Zee bounce back?

The recovery of earnings in the near term is not anticipated, analysts said. Zee has not disclosed whether it will pursue the merger amid the litigation with Sony, which could impede operational improvements, or explore mergers with other players. 

Reports suggest that Disney is considering a potential exit from India, while discussions with RIL have taken place previously. The company's future path remains uncertain, and the long-term outlook is unclear.

The linear TV business maintains a robust 30 per cent EBITDA margin, outperforming the consolidated EBITDA margin in the low teens. 

However, uncertainty looms over the growth and profitability of the OTT business, with an annualised EBITDA loss of Rs 1200 crore (14 per cent of overall revenue) post-merger termination. 

The merger could have bolstered the competitive position by creating a linear TV business with an EBITDA of Rs 4,000-4,500 crore. 

The stock's valuation remains uncertain, with potential scenarios suggesting a range between Rs 230 and Rs 167 per share. 

Consequently, Motilal Oswal has downgraded the stock to ‘Neutral’ with a target price of 200 per share.

As of 10:24 am, shares of Zee were locked in lower-circuit of 10 per cent at Rs 208.60 per share.