We are re-initiating coverage on Adlabs Films with a `buy' on the stock. With strong financial backing from its promoter, the Anil Dhirubhai Ambani group (ADAG), Adlabs has the makings of a media conglomerate. It is making the transition from being a company focused on film processing and a budding interest in film exhibition to one that is involved in everything from production and distribution of films to multiplexes.
Scope for growth
Forays into providing television content, animation and home videos provide the company scope for broadening the revenue profile. ADAG's aggressive entry into the media space, which includes plans in the Direct-to-Home (DTH) and cable network spaces, is likely to provide an impetus to Adlabs' own growth plans. The de-merger of the radio business will free up Adlabs' balance sheet from the heavy investments in this space, besides unlocking value for the shareholders, who will get to hold a direct stake in the radio business.
Over the next two years, revenue and earnings growth is likely to be driven by rapid expansion of multiplexes. The stock now trades at about 30 times its annualised FY-07 earnings, on a fully expanded equity base (post conversion of foreign debt). This is at a discount to peers, such as PVR and Inox Leisure.
The commercial risks of the new segments such as production and theatre exhibition are, however, higher than that in film processing(where Adlabs has a stronghold), asthe revenue stream is more dependent on the box office success of films. Earnings could, as a result, display a lumpy pattern. This makes it an investment option for those with an appetite for risk. However, as film processing is likely to continue to be a source of steady cash flow, the company remains a less risky alternative to pure-film or pure-exhibition plays in the sector. Exposures can be considered from a two-year perspective.
Good show in Q2
Adlabs turned in a spectacular performance in the second quarter and also in the first half. Revenues more than doubled, and profits expanded three-fold in the September quarter.
There was a massive expansion in operating margins from 46 per cent to about 60 per cent. It has been a blockbuster year for the Indian film industry. A series of box office hits buoyed revenues of its exhibition business, which witnessed a rapid addition of properties over the past year. Revenues from the segment expanded three-fold. Adlabs is investing heavily in building multiplexes in metros and the smaller cities and towns. It expects to have more than 100 screens by 2008, thus retaining its size advantage, even as its competitors are putting through heavy expansion plans.
With the onset of the multiplex era, the success of a film is decided in the first couple of weeks of screening. This has increased the demand for more prints.
Hence the continued buoyancy in its processing business, which, till FY-06, contributed more than 60 per cent of the revenues.
Changing revenue mix
With the scaling up of the multiplex business, however,Adlabs' revenue mix has undergone a change. Revenues from the exhibition segment accounted for a third of revenues in the first half of the fiscal, while the share of processing fell to about 30 per cent. Production, content and distribution accounted for the remaining third, where Adlabs is a recent entrant.
Adlabs has set up offices in the UK and the US for overseas distribution . Overseas markets now contribute at least 10 per cent to a film's revenues, and offer better margins to distributors. Adlabs also has plans to expand its distribution presence in the domestic market.
Umrao Jaan and Jaan-e-man mark its entry into the domestic distribution market. The initial response to these films at the box office has been lacklustre. But the heavily marketed Umrao Jaan appears to have had a warmer reception overseas . The distribution segment is likely to act as a captive source of content once the exhibition business assumes scale.
Adlabs is also stepping up funding of films through co-production deals with reputed filmmakers such as Mr Ram Gopal Varma and Mr Prakash Jha. Its investments in production are not expected to exceed 15 per cent of its networth and will be spread over four to five films at least. Upcoming productions include Sarkar 2 and the Amitabh Bachchan-starrer Nishabd. It recently entered into a deal with Mr Ashok Amritraj's Hyde Park Entertainment — this marks its foray into Hollywood productions. While these are high-growth businesses, they expose the company to box office performances to a greater degree.
With multiplexes likely to lead revenue growth over the next couple of years, these risks are higher. Moreover, given the scale of expansion across multiplex-operators, there can be overcrowding in some pockets, and this can affect occupancy rates and therefore, profitability. Adlabs might be able to reduce some of these risks through the sale of satellite TV rights and the proposed entry into the home video segment.
Other ventures
The company is also trying to diversify into television content. It recently acquired a majority stake in Mr Siddharth Basu's Synergy Communications, the creators of the famous Kaun Banega Crorepati, and the popular reality-dance, Jhalak Dhikla Jha.
Given the significant resources at its disposal, Adlabs is likely to make forays into other segments as well.
It is likely to snap up some of the small fish in the business, which could fast-track growth across segments.