Thanks, @dd1474, @crazymama, @myprasanna and others for contributing on this thread. I am Just putting out my brief investment thesis on Shemaroo. I have not covered the valuation part and request everybody to take their own view on the valuation. I find the story quite interesting as it has the tailwind of value migration of media consumption moving from physical sources to digital sources. If anybody is interested I can share the evernote compilation of Shemaroo work that I have done (mostly excerpts from ARs and Concall Transcripts with my annotations/observations) Please PM me and I will be glad to share the same.
Business Introduction:
Shemaroo was established in 1962 as book circulating library and over last 55 years it has transformed itself time and again to become a mainstream player in media aggregation and distribution business. It was established by Maroo brothers and is run by its third generation today. It is into three distinct businesses
(a) Content Distribution - focuses on aggregation and distribution of movie rights to broadcasters - Part of traditional media business- constitutes 75-78% of the revenue;
(b) New Media: Caters to distributing content on digital, mobile and over the top platforms- constitutes 16% of the revenue
© Home entertainment - part of traditional media business -constitutes 6-9% of the revenue
Content library- is the most critical component of the business which gets monetized through distributing the content through various modes. Company acquires two types of content rights (1) Perpetual rights - rights for perpetuity (2) Aggregation rights: Typically limited for 5 years, however lately company is trying to acquire rights upto 10 years. It has increased total rights from 2000+ in 2010 to 3600+ in 2016, while the number of titles with perpetual rights have increased from 500+ to 900+ in 2016
Company follows a strategy to generate decent risk adjusted returns and does not participate in higher risk businesses such as pre-release rights or the first cycle rights (first 5 years).It typically acquires content in the second cycle of the film distribution, i.e. five years after the release of the film, when the preference of the viewers is firmly established and economic value of the title can be established with reasonable certainty.
Business Model:
Content Aggregation and distribution: This is a cost plus model where company acquires the bundle of content rights of films from various produces/production houses and then does value addition by improving quality of content, the technical aspects,the legal clearances and packaging it to the TV channels in the manner they find it attractive.It then sells these rights to TV Channels at some mark up to cost. The critical success factor in this business is to identify the compelling content for viewers, acquire the same at reasonable price and create a portfolio of content that balances volume and quality of content that is appealing to the broadcasters. Company ensures that they generate at least 18% pre-tax IRR on the content acquired and distributed through this business. Company books 100% revenue from the sale when the content is sold to broadcasters. On expense side, if it is aggregated content, 90% of the cost of acquisition is booked (rest 10% is attributed to digital rights) as expense at the time of sale of content. For perpetual rights, in the first year of first cycle of re-selling (first five years after acquisition), 65% of cost of acquisition is booked while rest 35% is booked in first year of second cycle of re-selling (Year 5 to 10 after acquisition). This business has high receivable days i.e. 160-180 days.
New Media business: Company distributes the content in digital form through various ecosystems such mobile, Internet and Over-the-Top broadcasters. The digital content rights are typically acquired along with the content distribution rights for broadcasters. Though, company may acquire separate digital rights or creates its own content and distribute through new media platforms, it is not a common practice. There are three separate modes through which the content gets distributed in new media business. Here the content is chopped/churned creatively to form targeted short and long form contents (i.e songs/comedy scenes/movie in 15 mins) thus increasing the monetization potential of the content. Dynamics of two main ecosystem for new media businesses are
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Mobile: 50% of new media business comes from Mobile VAS and other forms of content consumed by the subscribers of telecom companies. This is a mostly subscription based revenue where the user pays for the content. Company and telecom operator share revenue in proportion of 30-40:60-70 if the content is hosted on telecom operator’s platform. If the content is hosted on Shemaroo’s platform, the revenue share is 60-70% in favour of company. More and more content is migrating from Telecom opertator’s platform to Shemaroo’s platform.
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Internet:50% of new media business comes from this stream. 66% of this stream (i.e. 33% of new media business) comes from Youtube. It is an ad supported model where Youtube shares 55% revenue it receives on advertising on Shemaroo’s content. Company runs number of channels with different type of programming (Comedy scene, songs, full movies, regional language content, kids content, devotional music etc) and gets viewers for its content.Company has achieved phenomenal growth in viewer ship on this platform with total monthly views reaching 120 million in Q4 FY16.It has 4-5 channels in top 100 most viewed Youtube channels in India. Other than you tube, the revenue comes from over the top players like Hooq, Spool, Airtel Digital, Tata Sky etc. Both these models largely works on revenue share models (though have different variants within that)
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New media business has been growing at 60-70% and is likely to grow upward of 50% due to multiple tailwinds such as increasing penetration of smart phones, internet and migration from low speed to high speed (2G to 3G/4G).
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Margins in this business is higher than consolidated margin of the company (28-29%), and there is enough room to increase due to operating leverage available in the business.
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Receivable days in the business range from 60-90 days.
Home Distribution: This business in declining mode as the consumption is moving from physical media to digital media. Typically a low margin business because of high fixed cost involved. Overall contribution to the business has been reducing (23% in FY 10 to less than 10% in FY 16) and this trend is likely to continue in future too.
Investment Rationale:
Business
New media business is likely to grow at 40-50% for next 3-5 years (it has grown at 70%+ CAGR in last few years albeit on much smaller base) due to number of tailwinds such as increasing internet and smart phone penetration and high speed internet becoming affordable due to launch of 4G services by Jio at rock bottom rates. The high growth in New media will come from combination of volume and realization growth.The volume growth will come the above mentioned tailwinds as more viewers consume content. The rationale for increased realization is that higher number of consumers of content combined with increase in average engagement level (time spent on viewing content) will lead to higher monetization of views (i.e fill rates) and increased realization of CPM rates (currently in India CPM rates are USD 2 to10 per CPM for top Youtube partners, the same is USD 10-40 for other countries. Though India may not reach the level of developed countries any time soon, directionally it will move towards that number…thus CPM rates will increase as digital penetration will increase).
Traditional media business on the other hand is likely to grow at 13-15% in base case scenario considering the strong catalog of the company, continuing preference of Indian viewers towards movie as content class and consistently increasing movie channels leading to higher demand for movie rights . However, in traditional business too, the tailwinds of better financial resource availability with broadcasters due to increased ARPUs and lower carriage fees combined with inherent demand supply mis-match for quality content (demand far exceeding supply) is plausible. This has not been built in the base case scenario and any gains from that shall be taken as upside. . Home Entertainment business will continue to decline and hence for next couple of years will take away 1-2% of growth in traditional media business.
The differential in growth rate in both the business stream will lead to change in business mix. Revenue contribution of New media business will rise from 16% in FY 16 to 40-50% in next 4-5 years. Since, margin in new media business is much higher than traditional media business and there is still decent operating leverage available in New media business to take its margin higher- we can see decent margin expansion for next 3-5 years. Similarly, asset utilization efficiency too will eventually increase as New media business has lower receivable days and earns higher yield on inventory.
Based on above base case scenario, we can expect 20%+ CAGR in top-line and significantly higher bottom line growth (upward of 30% CAGR) with much better return ratios (upward of 20% RoE) due to twin filip from higher margins, increased asset utilization efficiency and tapering off of investment phase toward end of 2018.
Management
Management has demonstrated its ability to time and again transform the business to remain in sync with changes in consumer preferences and emergence of new technologies (Book libray to video library to CD/DVD distribution- broadcast right syndication- new media). More importantly, they have managed to pull these transformations off while taking a well calibrated approach where they run small experiments/pilot projects and the scale it up based on response to their pilot projects and changes in external environment. Management is also extremely focused on risk. They continue to trade path of generating adequate returns without taking undue risk as is evident from their unwillingness to participate in pre-release/first cycle of content aggregation and distribution and disinterest in infusing significant capital in film production business. Management has demonstrated its ability to take rational decisions even if it means acting counter cyclical or not bowing down to industry imperative. In 2008-09, they refused to participate in buying new content and suffer loss for a year against buying content at irrational prices due to entry many big corporates in content aggregation business. They were willing to bear short term pains for doing what was rational decision that will pay off in long term.
Thus, there is high probability that management will do a god job at capital allocation. On corporate governance, they have been reasonably candid in projecting the picture of business through their communication. Feedback from reference check on promoters is very good.
Scenarios for Valuation and Expected Returns:
Base case scenario- Bottom line growth of 30%+ as articulated in the investment thesis- probability of this scenario playing out is 60-70%. Fair P/E multiple in this case will be 20 times forward earnings
Scenario 1: There is 20% probability that New media business grows at much lower pace of 25-30%. In this scenario, the earning growth can be in range of 20% and hence the P/E multiple is unlikely to expand.
Worst Case scenario:There is 10% probability of losing money from here in case if company acquires content at very high price and then is not able to monetize it.
Variant View on the business:
The variant view on the business is that the cash flow from operations is negative and hence company is not making any positive cash flows making the business model unsustainable. Though this is true at the moment, the reasons for the same are threefold.
- For Sheamroo, Inventory is equivalent to CAPEX and hence OCF calculation in traditional manner is not a good fit.
- Shemaroo is currently in investment mode and hence they are front-loading investment thus reducing the asset turns and return ratios. This is likely to change post 2018 as they slow down on building inventory. Management has already indicated that post 2018, they will slow down on building inventory.
- Cash flow generation cycle in new media business is much shorter and hence as the contribution of new media business increases, free cash flow generation will improve further.
Thus, by FY 18/FY 19, there is high likelihood that company will start generating free cash flow and reduce the gearing. In fact, management has on record said that they intend to turn free cash flow positive latest by FY 18.
Interesting view point
Company has increased perpetual rights library from 500 to 900+ over last 5 years. Perpetual rights library gets expensed out over 10 years. However, the value of perpetual rights keeps on increasing. Typical increase in the value of perpetual library is at 12-15% CAGR (as indicated by management in commentary). Thus, after 10 years of acquisition, the accounting value of perpetual rights become zero, while the economic value of perpetual rights will increase by 3-4 times. This will help increase the margins and return ratios. A large portion of perpetual rights are acquired post 2006, hence significant part of positive impact from this is likely to come in next 3-5 years. The economic value of perpetual rights will also provide downside protection to the value of the business as it will keep on increasing.
Key Risks
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Company’s inability to acquire meaningful content consistently can impact its standing with broadcasters and hence mean weakening of its competitive position.:
Likelihood: Low ; Impact: Moderate -
Euphoria around the content monetization can drive many players to market (like 2008-09) and can jack up prices of the content to irrational level. This may lead to capital mis-allocation and/or sharp reduction in business volume in short term.
Likelihood: Moderate; Impact: Moderate to High depending upon scenario
- Company continues to make very high upfront investment in acquiring content while the new media business doesn’t grow leading to piling debt and no free cash flow.
Likelihood: Low; Impact: High
Discl: 7% Allocation with Average Buying Price of 240
I am not a research analyst/investment adviser and the portfolio here is not a buy/sell recommendation in any manner. Please do your own due diligence before taking an investment decision.