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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.


Bangalore Maha Rally


Over 5000 students, professionals, doctors participated in the rally.

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Friday, May 26, 2006

Strong earnings growth may provide downside protection


A major correction was always round the corner on the domestic bourses after a solid run up in share prices that was witnessed over the past few months. Excessive leveraging by traders and retail investors provided the trigger for correction when FIIs pressed heavy sales as global emerging markets witnessed a sell-off. As the weakness in the market triggered off a series of margin calls, brokers and banks were forced to liquidate positions of retail investors that could not meet margin payments.

Analysts feel that the fundamentals of the Indian corporate sector remain strong and strong corporate earnings growth would limit downside on the domestic bourses. The macro growth outlook for India remains strong, supported by structural factors like robust domestic consumption to a healthy take-off in the capital expenditure cycle. Favorable demographics with large young population will drive consumer demand.

In fact, Indian companies are better place than their Asian counterpart to weather global upheavals given that they don't rely excessively on external demand as a source of growth.

However, some more correction in near term may not be ruled out given that the rally has been quite steep over the past few months

Investmart:Tata Steel


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Banks: After an eventful FY06...


Better economic growth, relatively lower interest rates, capacity expansion by corporates, retail credit penetration and technological upgradation are factors that have facilitated the banking sector's 'dream run' so far. In the initial years of this decade, with the spiraling bond prices, banks could afford 'lazy banking'. Later on (2004 onwards), the highest credit growth in two decades, net interest margins and asset quality comparable to global standards and extended reach, more than made up for the treasury losses.

  • Exponential growth: A consistent year on year growth in incremental credit disbursals of more than 30% persuaded banks to lighten their treasury portfolios and concentrate on the higher yielding advance book.

  • Not just retail...The growth was not just in the retail segment (especially mortgage loans) but also in the corporate book (primarily SMEs). The corporates who initially borrowed only for working capital purposes, gradually sourced capital for capex also, as overseas borrowing became expensive.

  • Margins at the zenith: Higher demand for credit coupled with low cost of deposits enabled banks to extract a very attractive spread (interest income less interest expended). The average NIMs of above 3% in FY06 are almost comparable to that of the banking sector in the developed countries.

  • Marked improvement in quality: The asset quality of Indian banks has shown a remarkable improvement over the last 5 years, wherein average gross NPA levels have shrunk from the highs of 11% in FY02 to 3% in FY06. Also, banks that enjoyed high treasury gains, utilized the same to write off the stressed assets from their books. Of late, the secondary market for stressed assets has further facilitated banks to offload the bad assets.

Nevertheless, we reckon, that the route forward is not as rosy for the players in this sector.

Here on...
Going forward, we perceive certain encumbrances that may handicap the ability of the players in this sector to enhance their profitability.

  • High base effect: With the larger banks in the sector now having attained a sizeable asset book, the growth hereon with be at a lower clip due to the high base effect. While we are not trying to negate the possibility of future credit growth being robust, the YoY growth in percentage terms (as against absolute terms) is expected to be lower. Also, the fact that interest rates charged across asset classes have seen an upward revision over the last couple of months, may discourage potential borrowers.

  • Margin pressures inevitable: With interest rates headed northwards (impact of rising global interest rates weighing heavily), banks have been compelled to raise funds at higher interest rates to meet the incremental credit demand. However, the time lag for passing on the rate hike to the customers is typically 6 to 9 months. This has started squeezing the net interest margins for players across the sector and we see the margin pressure continuing, going forward.

Investors should look for...

  • Attractive valuations: The valuation parameter typically used for banks is price to adjusted book value. Unlike other sectors, a bank's asset is cash and the ability to grow the topline (interest income) is therefore, largely dependent on the capital base (net worth in a broader sense). Therefore, rather than price to earnings ratio, the price to adjusted book value (book value less net NPA per share) is more relevant while valuing a banking stock.

    Besides this, investors could also look at some of the unconventional parameters such as net interest income per share and net NPA per share. While the former is to banking what sales per share is to manufacturing, net NPA per share could be considered as erosion from the book value per share. Similarly, the price to pre-provisioning profit (PPP) per share multiple would be similar to the price to EBIDTA valuation used for manufacturing companies.

    FY06 P*/ ABV (x) P*/ PPP (x) NII/ share (Rs) Net NPA/share (Rs)
    HDFC Bank 4.8 12.0 81.3 4.9
    ICICI Bank 2.3 10.4 47.8 11.7
    UTI Bank 3.1 8.3 38.7 5.6
    SBI 2.1 4.1 297.1 89.5
    OBC ** 1.1 5.9 64.1 5.7
    Corp Bank 1.3 3.9 85.5 10.0

    * Considering prices as on 25th May 2006
    ** For OBC the pre-provisioning profits are net of the extraordinary write-offs.
  • Dividend yield: Investors must also look out for a regular dividend history and an attractive dividend yield that can provide them with a regular income stream at times when capital appreciation is not commensurate with expectations.

Not undermining the banking sector's ability to capitalise on the superior growth prospects of the Indian economy, what we would like to point out to investors, is the fact that the historic growth levels seen so far are not sustainable. Also, the future growth prospects will be subjective and dependent on a bank's scalability, operating efficiency and competitive edge, more so once the sector opens to foreign players in 2009. Investors, must therefore, take their decisions based on critical evaluation of the parameters as mentioned above.

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Thanks Manish Chauhan

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Thanks Ramesh - Keep them coming.

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