On a Hot Streak

After sinking in ₹700 crore as fresh investments, can ENIL weather falling revenue and rising operating costs?

"It’s hot,” goes the tagline of the country’s biggest radio station, Radio Mirchi 98.3 FM. But the heat that CEO Prashant Panday is facing is far from the sizzling kind. Panday, who completed 16 years at ENIL early this year, is steering the company through a major transition. By bagging 17 new stations and buying out existing four stations from TV Today, ENIL is now the largest FM player with 53 radio stations across 43 cities.

But this growth is coming at a cost. ENIL’s consolidated profit plummeted 70% to Rs.8 crore in the second quarter as operating expenses surged 36% to Rs.120 crore, owing to new channel launches and higher marketing expenses. Compounding its woes was a mere 6% revenue growth from existing radio stations. Slack spending by e-commerce and BFI verticals and the inauspicious Shradh period in the second half of September proved to a dampener. Moreover, as the new channels ran without advertisements for the first month, ENIL lost out on additional revenue. But the pain is unlikely to end anytime soon. The reason: the radio channel’s biggest revenue contributor, the central government, has inflicted a severe blow — albeit indirectly — that is costing the company dear. The Centre’s demonetisation move has resulted in a 10% drop in revenue for the channel in less than a month. Jewellery, real estate, auto and FMCG companies have put their campaigns on hold. Given that nine new stations were launched in the current fiscal and eight more will go on air in FY18, revenue visibility is low.

Not surprising that the burden of the new launches and a drop in revenue has taken the sheen off the stock, which has dropped 20% from its high of Rs.900 to Rs.725. Will the stock, which has almost doubled in two years, overcome the growth bump or is there more pain in store?

Born leader
To begin with, ENIL has all the strappings of a market leader. It has a 30% share of overall radio advertising spend and a presence in the top 13 cities (Metros and Category A cities) that constitute over 75% of the overall radio advertising market in the country. As a market leader, it did what it had to in the phase III auction last September. The company spent close to Rs.700 crore to bid for 17 stations under the phase III auction — Rs.339 crore for 17 new channels across 16 cities and Rs.340 crore for renewing 32 old channels. In many of its strong markets, it has acquired a second frequency. 

Sudip Sural, senior director, CRISIL, believes the phase III regime offers more flexibility to broadcasters compared with the previous two phases. “Longer license period, ownership of multiple frequencies in one city and sharing of network infrastructure for multiple frequencies will support profitability and return for new frequencies,” he says. 

This mammoth investment, funded through internal accruals, has brought ENIL two key advantages. First, it is able to use its cash parked in market-related instruments and bank deposits. That cash can fetch a better return in the core business which delivered a  return on capital in excess of 17% in FY16. Mature stations make close to 30% operating margin and a return on equity in excess of 25%. Second, as a dominant player in the industry, ENIL’s huge investment will enhance its competitiveness or business moat, and help in growing its market share.

To give a perspective of how its rivals fare: the Anil Ambani-controlled Big FM, which is India’s second largest player and in which Zee Media recently acquired a 49% stake, has 17% market share. Radio City, which Jagran Prakashan acquired in December 2014, has 13% market share after merging eight stations of Radio Mantra owned by Jagran Prakashan. In doing so, it has increased its presence to 39 cities. HT Media-owned Fever FM, too, made an aggressive bid in the recent auction by acquiring ten stations and expanded its footprint to 13 cities.

More importantly, given that 800-odd licenses will be doled out in phase III, once the rollout happens, FM radio will have high coverage. Vineet Singh Hukmani, CEO, RadioOne 94.3 FM, says, “We already have 250 channels, and now after the first and second round of phase III, India will add 350 more channels, which is more than double the size of current operational channels. Given that another 500 channels are to be auctioned in the final phase of Phase III, FM radio will penetrate over 85% of the country over the next two to three years.” Currently, radio commands only 4% of the advertising overall pie and if that number were to double to 8%, the revenue pie is expected to be around Rs.3,600-4,000 crore from the current Rs.1,800-2,000 crore. “It is quite realistic considering the increase in reach,” adds Singh.

Dual play
Radio advertising is a highly localised business. Every hour of programme typically has 12-15 minutes of advertising inventory that needs to be sold in order to earn revenue. Radio Mirchi has been a forerunner in this segment by localising 50% of its advertising business and a pan-India reach to attract national advertisers. This is not only helping it command better yields, but is also allowing for better inventory utilisation. ENIL’s scale, which brings in a huge network effect and efficiency, has thus far helped it gain market share and retain pricing power. In an Rs.1,800 crore radio industry, where private players account for almost 70% of the market share, ENIL has leveraged the strong network of its parent Bennett Coleman and Company. With more advertisers on board and catering to about 25% of India’s population, ENIL has turned an attractive proposition for national advertisers, especially e-commerce companies.

With the ad-cap coming into play in television and a general slowdown in the economy, advertisers shifted to the next best medium — radio. As a result, of late, ENIL’s inventory utilisation in the metros has been around 100%, and goes up to 120% during peak hours. Given its peak utilisation in major markets, ENIL, in the recent auction, went in for incremental frequencies, specifically in tier-2 cities of Surat, Ahmedabad and Jaipur under the brand Mirchi Love. It also launched second frequencies under the brand Mirchi 95, which plays Hindi music in Bengaluru and Hyderabad.

Panday describes its strategy. “We are now offering our clients two big options. One is the core Mirchi product, which targets youngsters or young adults with a fast-contemporary-modern option. The other is a premium love network targeting youngsters or young adults but with a more melody product,” he says. Sural believes the move makes sense. “In large advertisement markets, top radio companies are already operating at peak utilisation and an addition of one or two incremental frequencies would still keep their advertisement inventory utilisation healthy at 60-65% in the first year.”

Near-term worries
In the latest auction, ENIL entered seven new cities, while the remaining new frequencies are in existing cities. However, one obvious question here is: will these stations make money and whether there is space for new entrants and channels in tier-2 cities. “Western markets like New York, Los Angeles and London have close to 30-40 stations. Moreover, Indian cities have far more diversity in terms of language and culture. Most of these companies are starting with the top 10-13 cities in India having population in excess of about 10-12 million,” says Anand Chakravarthy, managing partner at Maxus, who earlier worked with Reliance Broadcast. Growth, today, is expected to come from smaller towns. After the phase III auction, a regional expansion to hubs such as Chandigarh, Jaipur, Nagpur, Surat, Kanpur, Kochi, Ahmedabad and many others have eventually begun.

Where advertising and expansion are long-term worries for radio companies, the near-term worry for large networks and stations is that it will open up huge inventory which, in turn, will put pressure on realisations and operating margins because of a sudden spurt in spending. Companies incur two kinds of costs related to acquisition of new stations. It has to bear a one-time entry fee, which is amortised over a period of 15 years along with an annual license fee. According to the applicable broadcasting policy, license fees are pegged to the revenue at the rate of 4% of gross revenue or a minimum fixed fee (2.5% of one time entry fees) for the concerned city, whichever is higher. The impact of eight newly launched channels in the first two quarters of the current fiscal is already visible. ENIL’s programming royalty and licensing fees jumped up almost 20% from Rs.12 crore to Rs.14 crore along with a 111% spike in marketing expenses to Rs.33 crore. This hammered margins by 1480 basis points to 17%, leading to net profit dropping 70% to Rs.8 crore in Q2FY17. 

During Q2FY17, the company launched five new radio channels — Mirchi in Chandigarh, a new market, and Mirchi Love featuring only romantic songs in Ahmedabad, Surat, Jaipur and Lucknow. With this launch, the company has completed nine launches out of the 17 stations that it had won in phase III of the auction. Though the new radio stations have huge operating leverage, considering that once a certain amount of fixed cost gets absorbed, additional revenue generated from a particular station will directly add to the operating margins and earnings; that’s not the case now. For instance, in the first half of the current fiscal, new stations incurred revenue of Rs.7 crore but total expenditure was Rs.25 crore. Though ENIL has said it will continue to price new channels higher and keep the advertisement cap at 10 minutes, it remains to be seen if it can 

stick to the strategy. ENIL’s strategy of acquiring dual stations across major cities could help it garner a higher revenue market share at a minimal incremental cost, provided the new channels are accepted by the listeners. But Panday is not too worried. “We want to go slow with revenues, since in the media business, it is important to get pricing right in the beginning, or else the whole 15-year licence period could end up being compromised,” he says.

Panday, though, is clear that benefits of the expansion will only be visible from 2018 onwards. It is estimated that from a negative free cash flow of Rs.626 crore in FY16, ENIL will generate close to Rs.200 crore of free cash flow in FY19. “These stations form the foundation of the company, and we keep investing in order to build the brand. We believe our margins will remain reduced for another four to six quarters, but absolute operating profit will hopefully remain at FY16 level in FY17 as well,” says Panday.

ENIL, on average, makes close to Rs.14 crore revenue and an EBIDTA of about Rs.4.2 crore per station. It is making 30% operating margin, which is a good reason to believe that once the new stations mature, they can expect higher margins. But all that is in the future. The market seems to be more worried about near-term earning concerns. The situation that ENIL faces is similar to what happened between FY07 and FY09.

From about 10 stations in FY07, the operator’s tally surged to 32 stations. During this period, ENIL went from a profit of Rs.25 crore in FY07 to a Rs.78 crore loss by FY09. It returned to the black three years later, posting a profit of Rs.56 crore in FY11. During this period, the stock fell from Rs.600 to Rs.200. But, the current situation is far better as the company has a huge cushion in its existing profitable channels. To put it in perspective, in H1FY17, the existing 35 channels made a profit of Rs.71 crore, which is enough to cover the operating loss of Rs.18.6 crore incurred by the eight channels launched recently. 

However, worries over earnings growth, particularly post its Q2FY17 results on November 9, and correction in the broader market has pressurised the stock. Some are keeping the faith, though. In November, institutional investor Amansa Capital brought 258,000 shares at Rs.730 and overall institutional holding is now 20%. By 2020, if the advertising pie touches Rs.4,000 crore and if ENIL were to hold on to its existing market share of 30%, the channel will be hitting Rs.1,600 crore in revenue. And assuming its current operating margin of 30%, ENIL will have an operating profit of Rs.480 crore. Today, the stock trades at 22x FY16 EV/EBIDTA. Even at a conservative 15x EV/EBIDTA, the company will command a market cap of Rs.7,200 crore — more than double the current market cap of Rs.3,000 crore. If that indeed turns out to be the case, then this is one frequency that investors should definitely tune into.