DQ Entertainment IPO Analysis

Investors with a two-three year horizon can take exposures to the initial public offering of DQ Entertainment (International), given the inherent dynamics of steady growth in the outsourced services of animation processes from overseas entertainment companies, which the company is well-positioned to tap.

At the upper end of the price band (Rs 75-80), DQ Entertainment asks for 26 times its annualised current year per-share earnings, on a pre-offer equity base. This could be diluted by another 20 per cent, post-IPO.

A robust order book (that is three times annualised FY-10 revenues), a broad-based client base across the US and Europe and a strong focus towards creating IP-led growth are key positives for the company. Animation companies such as DQ Entertainment are a play on the outsourced services model, where much of their prospects lie currently, akin to the success story of software companies.

In that sense, the labour-cost arbitrage between India and the western world is still the main driver towards outsourcing animation services to countries such as India. Outsourcing of animation services itself is still in quite a nascent stage. Although the growth of the animation industry worldwide is expected to be around 10 percent, the portion within the pie that could be outsourced to Asian countries such as India could grow at a much faster pace.

DQ Entertainment was incorporated only in April 2007. In 2008-09, the company saw its revenues grow by about 60 per cent over FY-08 to Rs 150.9 crore, while net profits more than doubled to Rs 16.1 crore. The half-year profits of the fiscal stood at Rs 10 crore, largely due to a tight leash that was maintained on employee costs and SG&A expenses.

Well-positioned

The animation process essentially comprises of four steps: IP development, pre-production, production, and post-production.

Of these, the first two processes are accomplished by the clients, mainly movie production houses and broadcasting channels, themselves in the US or Europe. That is, the conceptualisation of animation stories, characters, the script and layouts, among other procedures, are done abroad. It is the labour-intensive production and post-production processes that are outsourced. These include actual 2D and 3D animation, added special effects and making the final product ready for distribution in various digital forms such as theatrical reels, DVDs and broadcast tapes.

It is in these areas that companies such as DQ specialise. The company derives over 90 per cent of its revenues from delivering these animation services for clients, which also includes developing animation video games.

The company has an order book of Rs 456.7 crore, executable over the next couple of years. This gives reasonable revenue visibility for DQ Entertainment.

Another key factor that may augur well for the company is the large base of around 90 clients. These include marquee names such as Disney Group, Nickelodeon, BBC and NBC Universal among others. The company derives 41.5 per cent of its revenues from US based clients and 51.2 per cent from the European ones. The rest of the revenues accrue from India.

A Nasscom report pegs the growth of the global animation industry to be at a compounded annual rate of 10 per cent to become a $100 billion industry by 2012. The domestic animation opportunity is yet to take off in a big way, but as with IT players, there is a huge untapped opportunity for offshore players such as DQ Entertainment.

Apart from this, the company also derives a small portion of its revenues from developing co-produced animation series for which there is sufficient offtake.

For example, The Jungle Book, a 52 episode animation series, has been sold to several broadcasters in the US and in the Europe and Middle East Africa (EMEA region), spanning multiple languages.

The co-production model allows for distribution rights revenues to accrue for the company.

Risks

The rupee appreciation vis-a-vis the dollar or euro is a key risk to realisations. An increase in the minimum alternative tax rate is another risk, especially as the STPI scheme has not been extended. This may strain margins till the company shifts operations to a SEZ over the next 12-18 months.

The issue

DQ Entertainment is offering over 16 million shares through this issue and hopes to raise Rs 128 crore. It plans to utilise the proceeds towards investment in co-production agreements (Rs 55 crore) and development of office infrastructure at an SEZ in Aindhra Pradesh (Rs 39 crore). The issue is open from March 8-10. SBI Capital Markets is the book-running lead manager to the issue.

via BL