Media and entertainment companies have been riding the market boom to expand and fund their diversified ventures. But the tide has turned against them and they are faced with a scarce capital situation.

Being in the equitties market for over 14 years, Kotak Securities vice president Sadanand Shetty knows best how rough the path is going to be for media companies to tide over the slowdown phase. Managing money on behalf of investors, he is one of the few fund managers to have caught early the trends across verticals within the media and entertainment sector.

In an interview with Sibabrata Das, Shetty talks candidly about the massive erosion of values media companies have seen over the last one year and how grim the real world is for most of them.

Excerpts:

The fund under your management had made succesful investments in media companies. What led you to this bullish sentiment when the prior experience with investors had not been too encouraging except in case of very few media scrips?
We had portfolio investments in some of the leading news broadcasting and cinematic content companies. We also invested in leading print and radio companies. Media and entertainment firms gained since 2004-05, driven by faster economic growth rate, demographic shift and rapid entry of corporates into the sector. The relative value of this sector versus the broad equity market was also low, as was the Ad to GDP ratio.

Most segments of the industry have seen a re-rating and a high level of interest by institutional investors and private equity funds. Companies across various media verticals launched their IPOs during this period and raised large funds to feed their growth plans. Sun TV, ENIL, UTV, Shree Ashtavinayak, HT Media and Jagran Prakshan are the noted ones. This has helped the sector to raise its overall market capitalisation.

Promoter group, management depth and excellent execution and ability to raise large resources led us to invest in these companies. Today almost all them have emerged as leaders of their respective segments. They have offered attractive valuations, relative to the market.

Aren't these companies seeing a massive skid in valuations?
The media and entertainment sector has lost a whopping Rs 640 billion of market value since last year due to the global economic meltdown. There is a massive collateral damage to the wealth of media owners. Valuation corrections for most of these companies are far greater than the broad market.

Most media companies fall under mid cap and small cap categories. These categories have lost much more in stock value than the large cap companies. September '08 has been the worst quarter in recent times for most media companies that are part of the broad-based BSE 500 Indices. The profits of aggregate listed companies are down by 60 per cent for the said quarter, including losses of new Hindi GECs (general entertainment channels). Slowdown in revenue and rising costs have hit earnings.

The market has not even spared large companies like Zee Entertainment Enterprises Ltd and Sun TV Network Ltd; they together have lost market value of close to around Rs 160 billion (as of 10 January 2009 over the year ago period). The broadcasting space has alone lost market value of nearly Rs 280 billion. Economic slowdown in general has impacted the advertising revenues of the sector. Subscription revenues, to some extend, provide the much needed cushion to falling profitability of the broadcasting companies.

Why were media valuations so unrealistic?
Being emerging businesses, the Indian media and entertainment companies commanded higher valuations. Most media companies have demonstrated robust sales, expanding margins and rapid growth in profits in recent times. The stock market rewards high growth with high valuations. A favourable equity market has also helped companies to raise large funds and command these valuations.

Weren't companies stretching themselves too thin in a market hype situation?
Still, I wouldn't call these moves as mistakes. Expansions were planned in a growth environment, which now, though, is hitting the speed breakers. But certainly in some cases large capacities have been created ahead of demand curve and investors are suffering in those ventures.

The industry also witnessed entry of new players with other objectives. For some it was pure market capitalisation as easy money poured into the sector. Investors - foreign and local - have jumped the gun and funded some of the unviable projects. Shortsighted foray into ‘new media’ business verticals that some companies have ventured into will be hard hit.

What are the lessons to be learnt from this?
This is the first true slowdown that the industry is witnessing today. It would be interesting to see how managements of the media companies respond to the situation. In general, business plans built on easy liquidity do not sustain for long. Vision, commitment and excellent execution do. Media, like any other services business, is people driven. Backing the right talent with appropriate incentives will yield large gains.

Have media companies become dependent on foreign capital?
Global media companies except perhaps News Corp. were late to react to opportunities in India. But today almost all the top studios of the world have their presence in India across different media verticals. Favourable economic growth and rapid rise of domestic companies have compelled the global media giants to look at India. For some of these companies, Indian operations have started contributing majorly to their profits in the Asian region.

We are also witnessing rapid rise in FDI (foreign direct investments) and portfolio investments in media companies. You, after all, can’t ignore the second fastest growing economy of the world. India is also in a sweet spot today because of its huge youth population.

What are the challenges the Indian media companies face due to slowdown?
Slowing ad spend, increase in operating costs (specially distribution), and tight liquidity will impact the industry in the medium term. The sector will also have to grapple with excess inventories that have been created in the last few years. Most importantly, economic slowdown will force companies to rethink on their expansion plans and focus on few verticals. Companies will have to maintain their market share without burning too much cash in the process.

The process of consolidation will also accelerate. I expect incumbents with sound financials to take advantage of the current dismal valuations to further their business interests. Venture capital and private equity participation can't also be ruled out. We have already seen certain GECs feel the heat. Consolidation in regional markets is also happening and expansion plans have been put on hold in some cases.

Overall, the economic slowdown will impact the growth plans of most of the companies. Priorities have shifted to consolidating the existing businesses; expansion can wait.

It is testing time for media companies. There will be no better time to demonstrate the strength of their respective market/channel shares as we expect ad spend to consolidate towards the top.

Will news channels have a free fall as they operate in a highly cluttered environment?
News channels in India have grown significantly over the last few years. But for most companies, it has not significantly added to their profitability due to high operating costs (including distribution). Lack of robust subscription revenues have also impacted the bottom lines of many of these companies. Noise value has gone up due to entry of players with other objectives. We have witnessed the entry of so many non-serious players in the market that I think most of them will fold up in the next two years.

Only few news channels with strong brand equity and distribution network would be able to make reasonable profits. Companies with strong balance sheets will survive. Rest all will fade away.

What do you think of the television content companies?
TV content companies have suffered for long due to their fractured business model. Lack of revenue visibility and pricing power have impacted them. There is also lack of long term relationship between content and broadcasting (who own the IPR) companies. The benefit of new distribution platforms has not reached most of these companies.

Unless there is substantial change in the current business model, I do not see real scalability coming to companies. TV content companies also suffer from fragmentation. Having said that, this year has been particularly good for content companies as some of the dominant incumbent players have witnessed loss of market. New players have emerged and done well. I expect few credible players to emerge in the future.

Do you find the cable industry attractive?
Institutional investors have shown interest in the sector in recent times. Investments have flown into the large incumbents and fledging entrepreneurial-led companies. Investors are betting on eventual consolidation and digitalization of last mile to unlock huge value in the sector. Investors seem to be willing to wait for the interim painful process to unlock long term value. We expect increased investments will go into infrastructure creation and customer acquisition.