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Sunday, May 28, 2006

Prime Focus: Invest at cut-off

Investors with a long-term horizon and an appetite for risk can consider the initial public offer of Prime Focus, a leading player in post-production and visual effects.

New genre of films that require a higher degree of technical expertise, the launch of TV channels and programmes, the increase in advertising spending across sectors, and the outsourcing of post-production work by international film houses are the sub-plots of a script that spells opportunities for players in this segment.

Prime Focus, in expanding its presence both at the national and international levels, appears well-placed to garner a greater share of this business.

Valuation and risks

The Rs 450-500 price band values the offer at 38-42 times its annualised per-share FY-06 earnings, on an expanded equity base. Our recommendation is based on a long-term outlook and is not linked to gains upon listing. We believe that, given the bright prospects, Prime Focus is likely to trace a high growth trajectory over the next three-four years.

While the company is expanding its reach, revenues from newer markets are likely to trickle in gradually, as it will take time to build its reputation, especially at the international level. In the medium term, higher depreciation expenses, which now account for 10-12 per cent of sales, could also temper earnings growth.

Prime Focus derives about 50 per cent of its revenues from films. It may, however, be among the safer plays in the entertainment space, relative to production houses or multiplexes, as its fortunes are not linked to the success or failure of films.

Bigger role for films

Prime Focus offers a range of post-production services, including visual effects, high-resolution film scanning and recording, offline and online editing and Telecine (the process of transferring motion pictures into the electronic form, enabling it to be viewed on television, video or on computers).

The company boasts of a state-of-the-art technological infrastructure, which makes it one of the preferred players for post-production, be it for films, TV commercials or television programmes. It also rents equipment which, given the current boom in the industry, is likely to remain a highly lucrative business.

Changes in Indian cinema are likely to benefit the company; the contribution of films to its revenues has been steadily increasing.

The multiplex age has, more often than not, rewarded movies are a visual treat. Indian film-makers are also on experimenting mode, with the traditional love stories giving way to murder mysteries, action films, horrors and grand dramas

The role played by post-production in the making of a successful Indian film has never been stronger. Prime Focus has been associated with films such as Gayab, Black, Sarkar, The Rising, Darna Zaroori Hai and Fanaa.

It now hopes to gain a share of the South Indian film industry as well. Prime Focus has set up a studio in Chennai; operations are to commence shortly. The proceeds of the offer will partly be used to set up another visual effects and animation facility in Mumbai and a studio in Hyderabad.

A big name in Mumbai's entertainment industry, it is sure to make its presence felt in the South as well.

Shooting for outsourcing

Prime Focus has its eye on international markets as well. Overseas production houses and special effects studios are beginning to outsource work to cut costs.

India has been attracting attention on this front, especially in the field of animation; post-production outsourcing, however, is still at its infancy.

The cost-savings from such outsourcing is put at a high 60-70 per cent. Prime Focus hopes to capture a share of the outsourcing opportunity by setting up studios in hubs such as London, Los Angeles and Dubai.

It recently acquired for about Rs 35 crore a 55 per cent stake in VTR Plc, a London-based studio with revenues of £20 million. This will provide the company access to some British clientele in the immediate future.

Prime Focus will also be able to cut costs substantially by outsourcing most of the post-production work.

This can help turnaround VTR, which is now making losses. Prime Focus is also at an advanced stage of acquiring a studio in Los Angeles.

Studios in these hubs are likely to commence operation in the first half of FY-08. It may be a while, however, before these ventures begin to pay off in a big way.

Investors would have to hold on to the stock for a longer period, before it unlocks value.

Financials: Prime Focus has a revenue base of Rs 35 crore. Revenues and profits have grown at a compound annual growth rate of 30 per cent and 50 per cent respectively. The operating margins are at about 55 per cent; they tend to fluctuate due to last-minute discounts, rebates and bad debt write offs.

Offer details: About 22 lakh shares are on offer. Prime Focus would raise between Rs 88 crore and Rs 110 crore from the offer. The promoter's stake, post-offer, will be about 55 per cent.

Adlabs and Reliance Capital hold 4.67 per cent and 14.5 per cent respectively. The offer closes on May 31. The lead managers are Centrum Capital and ICICI Securities.

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