TVDistribution - Jun10

No… it’s available at the same price!!

Television DistributionCarpe diem!

Nikhil Vora ● Bhushan Gajaria ● Swati NangaliaJune 2010

Don’t you think we should switch to

digital or DTH?

Why should we? What is wrong with

this?

The picture quality is better & there are more

channels…

But, it would increase our cable

bill…

…but what about the large initial investment

on the set top box It’s only Rs1000-1500 of one time cost…

That’s it???

And you will also be able to record your matches and see movies of your

choice

Better quality, more channels, match recording and so

economical…lets go digital!

Even the next door RiYa has a Set top box

Great!Yes!!… now even I can tell riYa!

Indian TV Distribution industry, world’s second largest with 105m cable & satellite (C&S) homes, is set for a makeover as the long-awaited ‘digitization’ becomes a reality. As of 2009, there are 22m digital homes with 18m of these on the DTH platform. Going forward, we expect digitization to gather pace not only in DTH but also in the ‘hitherto laggard’ cable space. While funded DTH players have invested Rs110bn so far, cable players too are now equipped to seed set-top-boxes (STBs) after the recent fund raise and would look to lock-in customers given the threat from DTH. We expect the total digital homes tally to rise 4x to 86m by 2015E, and address the biggest concern of ‘under-reporting’ in its wake. In the backdrop, we expect a 6.5x increase in the organized pie to Rs340bn even on a modest 14.5% CAGR in industry revenues to Rs480bn by 2015. As we expect C&S operators to retain the economic benefit of improved declarations and turn profitable, the sector makes a compelling case for re-rating. We recommend Outperformer on Dish TV, DEN Networks and Hathway Cable and expect 50% returns over an 18-month period.

Digital base to grow 4x…: India’s digital C&S base is set to expand to 86m by 2015E with 48m DTH (18m as of 2009) and 38m digital cable (4m) homes. While the six funded incumbents keep the momentum ticking in DTH, we believe digitization is no longer a ‘choice’ for cable operators and assumes a sense of urgency in the face of increasing threat from DTH. Importantly, national MSOs are now funded (Rs13bn of recent fund raise) to exert customer pull through subsidized STBs – a competitive edge of DTH players so far. Limited scope of ‘carriage fees-led economics’ from here and industry consolidation are the other drivers of cable digitization.

…and organized pie to swell 6.5x by 2015E: We expect a modest 14.5% CAGR in C&S industry revenues to US$10.8bn over 2009-15 as the C&S homes base expands to 140m and ARPU increases from $3.8 per month to $6.3. However, digitization is bound to reduce the incidence of under-reporting – the bane of the Indian C&S industry, and we expect the declared subscriber base to grow 4x from 23m to 89m by 2015. This, we believe, would drive a 6.5x rise in revenues of organized players.

Economic retention to drive value creation: With the net share of organized MSOs and DTH operators increasing from <10% of the distribution chain to 35% by 2015, the industry is on the threshold of profitability. As MSOs are expected to retain the gains of higher declaration levels and operating leverage kicks in for DTH operators, we see profitability of lead players trending closer to the global average of 30% in the coming period. Drawing an analogy with US peers (top five cable operators are worth $190bn), we see a strong case for re-rating of Indian C&S operators. We value these businesses using EV/ subscriber based on individual subscriber cash flows and recommend Outperformer on Dish TV, DEN Networks and Hathway Cable.

“For Private Circulation only” “Important disclosures appear at the back of this report”

IDFC Securities Ltd. Naman Chambers, C-32, G- Block, Bandra-Kurla Complex, Bandra (East), Mumbai 400 051 Tel: 91-22-6622 2600 Fax: 91-22-6622 2501

INDIA RESEARCH

Reason for report: Industry update

Media

Television Distribution Carpe diem*

30 June 2010

BSE Sensex: 17534

Comparative valuations

FY13E Companies Recommendation Price M Cap EPS PE EV/ EBITDA Target Price (Rs) (Rs m) (Rs) (x) (x) (Rs) DEN Networks Outperformer 198 25,837 15.9 12.4 5.7 292 Dish TV Outperformer 45 47,927 1.8 25.0 5.9 61 Hathway Cable Outperformer 176 25,072 14.7 11.9 4.6 274

Nikhil Vora [email protected] 91-22-6622 2567

Bhushan Gajaria [email protected] 2562

Swati Nangalia [email protected] 2576

*Seize the day

JUNE 2010 3

IDFC Securities

Contents

Investment Argument.................................................................................................... 4 DTH: In Momentum .................................................................................................... 18 Cable: Digitization no more a choice........................................................................ 23

Round 1: A ‘miscarriage’ .......................................................................................... 23 However, on-ground dynamics are changing....................................................... 26 Head-end in the Sky (HITS) ..................................................................................... 29

86m Digital Homes by 2015E...................................................................................... 30 Monetization: Rs480bn by 2015E............................................................................... 31 Economics: Turning profitable .................................................................................. 39

MSOs to retain the gains of declaration ................................................................. 39 DTH: Operating leverage set to play out ............................................................... 40 Distribution Margins: Mapping global trends ...................................................... 42 Economics of MSO and DTH operators ................................................................. 44

Valuations: We see 50% returns................................................................................. 48 Key Risks .................................................................................................................... 53

Evolution of cable & DTH in the US ........................................................................ 54

Companies ..................................................................................................................... 58

Den Networks ................................................................................................................ 59

Dish TV ........................................................................................................................... 75

Hathway Cable .............................................................................................................. 87

Airtel Digital................................................................................................................. 107

Sun Direct ..................................................................................................................... 110

Tata Sky......................................................................................................................... 112

Digicable ....................................................................................................................... 114

You Telecom................................................................................................................. 116

WWIL ............................................................................................................................ 118

Reliance Big TV............................................................................................................ 119

InCable (Hinduja Group) ........................................................................................... 120

JUNE 2010 4

IDFC Securities

INVESTMENT ARGUMENT Indian C&S market paralyzed by rampant under-declaration and poor yields;

while cable industry did not deliver on digitization expectations in the past three years, DTH garnered 18m subscribers (subs) as of 2009

Growth momentum to be sustained on DTH platform with 48m homes expected by 2015; cable industry too now compelled to digitize

A fresh round of public equity, need to secure the existing base and increasing threat of DTH to drive voluntary digitization on cable – 38m subs by 2015E

A 4x increase in declared base and 9% CAGR in ARPU to drive industry growth of 14.5% to Rs480bn and organized pie to grow by 6.5x

Exhibit 1: Indian TV distribution – redefining the landscape

Source: IDFC Securities Research

C&S homes,105m

Non-C&S homes,

30m

Non-C&Shomes,

20m

C&Shomes, 140m

Declaredhomes,

89m

Undeclaredhomes,

51m

Declaredhomes,

23m

Undeclaredhomes,

82m

Total potential

Declared homes

Digital homes 22m 86m

2015E

ARPU US$3.8 US$6.3

Industry composition• 50,000+ LCOs, 7,000+ MSOs and

6,000 DTH operators

• Top 5 MSOs account for <30%

• Consolidation with top 5 MSOsaccounting for ~70%

• DTH could also see consolidation

Capex• USD3bn in last 5 years to add 22m

digital subscribers

• External source of capital

• USD5bn of investments need to reach 4x the scale

• Largely internally funded

Profitability • Industry losses of over USD1.5bn • Industry margins to increase to 30%+

4.9% CAGR

3.9x

4x

8.9% CAGR

Industry size (US$ bn)

1.2

7.73.6

2.8

Organized

Unorganized6.5x

14.5% CAGR

2009

The BIGOpportunity

C&S homes,105m

Non-C&S homes,

30m

Non-C&Shomes,

20m

C&Shomes, 140m

Declaredhomes,

89m

Undeclaredhomes,

51m

Declaredhomes,

23m

Undeclaredhomes,

82m

Total potential

Declared homes


2015E

ARPU US$3.8 US$6.3


6,000 DTH operators





digital subscribers





4.9% CAGR

3.9x

4x

8.9% CAGR


1.2

7.73.6

2.8

Organized

Unorganized6.5x

14.5% CAGR

2009

C&S homes,105m

Non-C&S homes,

30m

Non-C&Shomes,

20m

C&Shomes, 140m

Declaredhomes,

89m

Undeclaredhomes,

51m

Declaredhomes,

89m

Undeclaredhomes,

51m

Declaredhomes,

23m

Undeclaredhomes,

82m

Declaredhomes,

23m

Undeclaredhomes,

82m

Total potential

Declared homes


2015E

ARPU US$3.8 US$6.3


6,000 DTH operators





digital subscribers





4.9% CAGR

3.9x

4x

8.9% CAGR


1.2

7.73.6

2.8

Organized

Unorganized6.5x

14.5% CAGR

1.2

7.73.6

2.8

Organized

Unorganized6.5x

14.5% CAGR

2009

The BIGOpportunity

JUNE 2010 5

IDFC Securities

India – second largest C&S market with 105m customers… With 135m television and 105m C&S homes, India has usurped the US (100m C&S homes) to become the second largest C&S market in the world after China. Interestingly, Indian television distribution space has added 35m television homes over the last three years, ahead of our estimates of 17m additional homes, on the back of 7m-8m new television sets sold annually and penetration of DTH in cable-dark areas (50% of the DTH market). While DTH penetration in India stood at 18m homes as of 2009 (20m by March 2010), India still has 87m cable homes (substantially higher than 62m cable homes in the US).

Exhibit 2: India – world’s second largest C&S market


…however, fraught with inefficiencies While India is the second largest C&S homes market in the world, the industry earns just US$4.8bn in revenues. Notably, Comcast – world’s largest cable operator – generates revenues of $33bn from its 24m subscribers. This can be explained by the fact that ARPU (average revenue per user) in India is <$4 per month vis-à-vis $70-80 in the US and UK, and $15-20 in comparable Asian markets. More importantly, with TV distribution dominated by analogue and addressability a concern on the cable platform, 80% of the collection at the consumer end goes unreported in the hands of the unorganized last mile operators. Additionally, the Indian cable distribution industry is extremely fragmented with 7,000+ independent MSOs and 50,000+ LCOs. Top five players account for <30% of the paying subscriber base, while DTH industry has six players in the race, as against monopoly or duopoly in rest of the world.

232m

135m

Total homes

Television homes

C&S homes

Digital homes

3.5mCable

87mCable

18mDTH

18mDTH

232m

135m

Total homes

Television homes

C&S homes

Digital homes

3.5mCable

87mCable

18mDTH

87mCable

18mDTH

18mDTH

64.0

0.5

71.0

2.0

78.0

5.0

83.0

11.0

87.0

18.0

0

30

60

90

120

2005 2006 2007 2008 2009

Cable DTH(m)160.0

105.0100.0

37.0

24.013.5 10.0

0

40

80

120

160(m) Global C&S market

China India US Germany Japan UK France

Low ARPU (<USD4), extreme fragmentation and

‘under-reporting’ as high as 85% characterize the Indian

cable industry

35m television homes added in the past four

years

JUNE 2010 6

IDFC Securities

Exhibit 3: India – an extremely cluttered cable and DTH market


Exhibit 4: Lowest in terms of ARPU… …LCOs retain the largest chunk out of USD4.8bn


2006-09 – a period high on expectations… Saddled with inefficiencies, the Indian TV distribution industry was considered to be at the cusp of digitization boom in 2006. Mandated CAS in select areas of Mumbai, Delhi and Kolkata, and the government’s target to reach 55 cities and 20m digital homes by 2010 had raised hopes on cable digitization. Simultaneously, DTH penetration was expected to take off with the influx of deep-pocketed corporates like Tata Sky, Bharti Airtel, Reliance ADAG and Sun Direct besides the incumbent Dish TV. In this backdrop, India was expected to garner a base of 90m C&S (including 22m digital) homes by 2009.

3.6

20.0

40.0

50.0

65.0

75.0

0

20

40

60

80

India Malaysia France Australia UK US

(USD / month)

LCO78.0%

MSO and DTH operators

9.4%

Broadcasters12.7%

Broadcasters: 400+ channels

6 DTH operators7,000+ Multisystem operators (MSOs) & Independent satellite operators (ISOs)

18m subscribers87m subscribers

MSOsMSOsMSOs MSOs ISOs

LCO

LCO LCO

LCOLCO

LCOLCO

LCO

LCO

LCOLCO

50,000+ LCOs

Broadcasters: 400+ channels

6 DTH operators7,000+ Multisystem operators (MSOs) & Independent satellite operators (ISOs)

18m subscribers87m subscribers

MSOsMSOsMSOs MSOs ISOs

LCO

LCO LCO

LCOLCO

LCOLCO

LCO

LCO

LCOLCO

50,000+ LCOs

Mandated CAS and entry of funded players in DTH

had raised hopes on digitization…

JUNE 2010 7

IDFC Securities

Exhibit 5: C&S industry in 2006 – high on expectations


By 2009, India has indeed scaled up to 22m digital C&S homes – in line with earlier estimates. However, the composition within the digital platform is quite different from the way it was expected to pan out. While DTH delivered ahead of expectations, cable industry remained in a sorry state of affairs.

Exhibit 6: While DTH delivered ahead of expectations, cable failed


...deliverance in DTH… Globally, DTH markets are mostly a duopoly, whereas India is the only oligopoly with six players in the fray. While this means high competitive intensity, it has also ensured faster-than-expected ramp-up of the DTH market. With government push (mandatory CAS), the seeds of digitization were sown in India in 2003. Sensing the opportunity, two of India’s largest media houses (Essel group and Sun TV), two largest telecom operators (Bharti Airtel and Reliance ADAG), India’s largest conglomerate (the Tatas) and a leading consumer durable company (Videocon) forayed into TV distribution – but on the DTH platform. Besides, Newscorp, which owns USA’s largest DTH player – DirecTV, and UK’s largest DTH operator – BSkyB, partnered with the Tatas (Tata Sky). Astro Malaysia, a leading media company in Malaysia, partnered with Sun Group (Sun Direct). DTH business inherently entails a long gestation period and is capital-intensive in the initial years given the subsidies involved. Also, the less regulated and more organized nature of DTH space vis-à-vis cable made it a preferable platform for these corporates.

90m C&S homes

13m DTH homes

9m digital cable homes

Consolidation in market

7m-8m annual TV set sales

DTH reaching

cable dark areas

Mandated CAS in

notified areas

Funded participants

in DTH market

Plans to digitize 55

cities

90m C&S homes

13m DTH homes

9m digital cable homes

Consolidation in market

7m-8m annual TV set sales

DTH reaching

cable dark areas

Mandated CAS in

notified areas

Funded participants

in DTH market

Plans to digitize 55

cities

3.5m digital cable18m DTH homes

ARPU droppped further to USD3.6

Paying subscribers increased to 22m

Cable industry attracted only USD400m

USD2.5bn invested in DTH

Mandated CAS failed35m additional homes

What didn’t?What delivered?

3.5m digital cable18m DTH homes

ARPU droppped further to USD3.6

Paying subscribers increased to 22m

Cable industry attracted only USD400m

USD2.5bn invested in DTH

Mandated CAS failed35m additional homes

What didn’t?What delivered?TV homes

72

105

C&S homes -2006

Cable DTH Total

17

16

Digital TV homes

C&S homes- 2006

Cable DTH Total

3.51.5

16.5 21.5(m) (m)

TV homes

72

105

C&S homes -2006

Cable DTH Total

17

16

Digital TV homes

C&S homes- 2006

Cable DTH Total

3.51.5

16.5 21.5

Digital TV homes

C&S homes- 2006

Cable DTH Total

3.51.5

16.5 21.5(m) (m)

…with estimates of 22m digital homes by 2009

Globally, DTH is a monopoly or duopoly, but it is a six-

player race in India

JUNE 2010 8

IDFC Securities

Indian DTH has till date witnessed capital infusion of ~$2.5bn. The funds have primarily been utilized for ‘consumer pull’ through heavy subsidies (per subscriber acquisition cost of Rs2,500-3,000) and high ad spends (at Rs7bn of annual ad spend, DTH among the largest after FMCG, Autos and Telecom). Fund availability, we believe, has been the key differentiating factor that has allowed DTH industry to scale up to 18m homes by 2009 (against the estimated 13m). Currently, Dish TV leads the market with 5.7m net subscribers as of March 2010 (5.4m as of December 2009) and Airtel Digital is the fastest growing with 25-27% share of the incremental market.

Exhibit 7: Influx of big names in the DTH space


…but a ‘miscarriage’ for cable The cable industry continues to be dominated by analogue distribution with just 3.5m digital connections of the total 87m cable homes as of 2009. While government apathy as also LCOs and broadcasters’ unwillingness to digitize de-railed mandated CAS (only 25% of the notified areas switched to digital cable), capital constraints with MSOs too hampered voluntary digitization. Importantly, of the ~$400m capital available to MSOs till date, ~$275m flowed to new entrants (DEN, Digicable, You Telecom, etc), for whom customer acquisition was a priority over digitization. While DEN has invested $75m in acquisition of ~67 MSOs, Digicable has invested ~$100m+ to acquire a similar customer base. Thus, there was lack of funds with MSOs to drive digitization through consumer pull the way DTH players did.

Exhibit 8: Reasons for failure of cable digitization


100

600

400

400

600

400

Investments in DTH ($ m)

0.11.5Leading consumer DurablesVideocon VideoconVideocon D2h

4.35.0Largest media house in South India

Sun TV, Dinakaran, Sumangali Cable

Sun Networks

Sun Direct

1.626.0Second largest telecom playerR-Communications, R-Infra, Reliance Entertainment

Reliance ADAG

Big TV

2.225.0India’s largest telecom playerBharti AirtelBhartiAirtel

Airtel Digital

4.575.0India’s largest conglomerate (Tata) and world’s largest media house (Newscorp)

Tata Steel, Tata Motors, TCS, Tata Tea, Indian Hotels

Tata and Newscorp

Tata Sky

5.45.0Amongst the largest media houses

Zee Entertainment, Zee News, WWIL, Essel Propac, Fun Cinemas

EsselDish TV

Subscribers(m)

Market value ($ bn)

Group CompaniesGroupDTH venture

100

600

400

400

600

400


0.11.5Leading consumer DurablesVideocon VideoconVideocon D2h

4.35.0Largest media house in South India

Sun TV, Dinakaran, Sumangali Cable

Sun Networks

Sun Direct

1.626.0Second largest telecom playerR-Communications, R-Infra, Reliance Entertainment

Reliance ADAG

Big TV

2.225.0India’s largest telecom playerBharti AirtelBhartiAirtel

Airtel Digital

4.575.0India’s largest conglomerate (Tata) and world’s largest media house (Newscorp)


Tata and Newscorp

Tata Sky

5.45.0Amongst the largest media houses

Zee Entertainment, Zee News, WWIL, Essel Propac, Fun Cinemas

EsselDish TV

Subscribers(m)

Market value ($ bn)


Failure of mandated CAS Only 25% of the CAS areas digitized

Inadequate funding - just USD400m invested Not funded for voluntary digitization

Entry of new players like DEN, Digicable USD250m into customer acquisition

LCO and independent operators' role Acquisition price 2-2.5 years ARPU

Failure of mandated CAS Only 25% of the CAS areas digitized

Inadequate funding - just USD400m invested Not funded for voluntary digitization

Entry of new players like DEN, Digicable USD250m into customer acquisition

LCO and independent operators' role Acquisition price 2-2.5 years ARPU

With $2.5bn invested so far, India has scaled up to

18m DTH homes as of 2009…

…while Indian cable industry has added just 2m

digital homes in the past three years

Failure of mandated CAS, inadequate funding and focus on acquisitions –

key reasons for failure of digital cable

JUNE 2010 9

IDFC Securities

The way forward – digital base to jump 4x by 2015E… If the hopes of digitization in the previous round rode on government initiative and corporate funding, digitization from here would be driven by increasing consumer acceptance. With higher capital availability and peaking out of consumer subsidies, we expect sustained momentum in DTH proliferation. More importantly, business dynamics are changing in the cable industry, which we believe will be conducive for cable digitization. Players with relatively funded balance sheets and increasing threat of DTH would be the key drivers of voluntary digitization on the cable platform. We see India at the cusp of a digital boom and expect it to emerge as world’s third largest digital market – next only to China and US. We estimate the total digital subscriber base to rise from 22m in 2009 to 86m by 2015 (of the total 140m C&S homes).

Exhibit 9: Rapid scale up of digital subscriber base

84 84 80 75 70 66 60 54

3 4 6 10 16 22 30 38

11 18 26 33 38 42 45 48

0

40

80

120

160

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Analogue Cable Digital Cable DTH(m)


…as DTH sustains momentum; 48m DTH homes by 2015E DTH industry, a 20m homes market as of March 2010, is finding increasing consumer acceptance. Also, we do not anticipate further price wars as the industry is already populated with six players and we rule out advent of new players. More importantly, two key players – Reliance ADAG (Big TV) and Airtel Digital – are facing substantial cash flow issues in the core telecom business given the increased competition and huge outlay on 3G Bandwidth. This makes us believe that subscriber acquisition cost (SAC) will be arrested at the currently prevailing 12-14 months of ARPU (globally at 8-10 months). Further, internal cash flows are improving in the business as operating leverage delivers a marked improvement in operating numbers. (Dish TV is already profitable at the operating levels; Tata Sky, Sun Direct and Airtel Digital expected to turn profitable at operating level within the next two years.)

As capital usage towards subsidies stabilizes and the industry continues to spend Rs7bn-8bn annually on advertising, we see sustained addition of 2m subscribers per quarter. We expect the Indian DTH industry to ramp up to 48m homes by 2015 (30m homes to be added over 2010-15E). At 48m DTH homes by 2015E, India would be a bigger market than the US – an estimated 41m homes market by then.

Sustained momentum in DTH and changing on-

ground dynamics in cable…

…to scale up digital C&S homes by 4x to 86m by

2015E

Continued customer subsidies and aggressive

advertising – India to surpass US DTH market

JUNE 2010 10

IDFC Securities

Exhibit 10: India to have 48m DTH homes by 2015E… …and emerge as world’s largest DTH market (2015E)


…and digitization the ‘only’ option for cable While cable distribution is an inefficient and fragmented market, there are some structural changes under way that would drive a digitization boom on the cable platform. And unlike in the past when hopes were pinned on regulatory changes and government mandate, digitization will be driven by market forces this time round. Onslaught of DTH has increased the churn for cable distributors, and MSOs – rather than ‘add’ – are now working to ‘secure’ and then ‘monetize’.

Exhibit 11: Key drivers for cable digitization


Hathway, DEN Networks and WWIL have raised a cumulative Rs13.4bn in the past one year while Digicable and You Telecom are set to raise an incremental $150m. With players having attained critical mass, the focus would now turn to securing (locking-in) the existing subscriber base and improve upon declaration levels. From our interaction with some MSOs and LCOs, we gather that key operators have struck a truce-of-sorts. Incrementally, MSOs are deploying capital more judiciously and allocating higher spends towards seeding of STBs (Hathway, DEN, WWIL and You Telecom have allocated Rs4.6bn for digitization and network upgrades). MSOs are offering STBs at Rs1,000 each, implying a subsidy of Rs700-800. The process of digitization is picking pace on ground as LCOs are more receptive to digitization rather than lose out subscribers to DTH, an alternate digital platform. To ensure rapid roll-out, MSOs are not looking to disrupt LCO economics in the initial phase.

We expect digital cable to gather pace from hereon and reach 38m homes by 2015, with 28m subscribers to be added over 2012-15. Besides rapid digitization, we also anticipate a major consolidation wave in the market, as smaller LCOs and MSOs do not have the wherewithal to drive digitization.

11

18

26

33

38

4245

48

0

10

20

30

40

50

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

(m)48

41

22

15

6.5

0

10

20

30

40

50

India US China UK Latin America

(m)

Rs bn Details Hathway 4.8 IPO DEN 3.6 IPO WWIL 5 Rights issue You Telecom 3.6 Filed DRHP Total 17

Factors driving digitization Rs13bn of fund raise ● Funded for subsidizing STBs ● Rs4.6bn allocated for digitization Critical mass achieved ● Incremental carriage revenue growth

limited Increasing threat of DTH ● Need to secure subscriber base ● LCO willing to re-align

With the recent fund raise, critical mass and growing

threat of DTH – digitization becomes a priority

Rs4.6bn of the recent/ planned fund raise

allocated for digitization

JUNE 2010 11

IDFC Securities

Exhibit 12: Digitization on cable platform gathering pace

84

3

83.5

3.5

80

6

75

10

70

16

66

22

60

30

54

38

0

25

50

75

100

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Analogue Cable Digital Cable(m)


Declaration-led monetization to begin; 89m paying subs by 2015E As digitization picks up pace, monetization is bound to follow sooner than later. We believe the first round of monetization would be driven by higher declaration, and not higher ARPU. While all DTH homes would be paying subscribers, improvement in declaration levels in cable industry would lag digital subscriber addition. Initially, MSOs would be keen to seed STBs to prevent subscribers from moving to DTH. At the same time, they would not prefer to disrupt the economics of LCOs, and therefore addition of digital subscriber base may not translate into a correspondingly higher paying subscriber base. We expect paying cable subscriber base to increase from 10m in 2009 to 16.7m in 2012, whereas digital cable subscriber base would expand from 3.5m to 16m over the same period. Only when an MSO digitizes a relevant mass of subscribers under a particular LCO, its share of ARPU can be expected to inch up.

From our interaction with LCOs, we understand that MSOs are currently not pushing for higher declaration. We expect declarations to improve significantly 2012 onwards and estimate the total declared cable homes base to touch 43m by 2015. Overall declared homes would increase from 23m in 2009 to 89m by 2015E.

Exhibit 13: Declared subscriber base to grow by 4x

80

117

82

1112

81

12

20

77

13

28

73

17

34

65

25

40

59

34

43

51

43

46

-

35

70

105

140

(m)

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Non-paying/undeclared homes Declared cable homes Non-subsidized DTH homes


Indian cable industry to add 35m digital homes by

2015E

As digitization brings in ‘addressability’…

…declared subscriber base to grow from 23m in

2009 to 89m in 2015E

JUNE 2010 12

IDFC Securities

…ARPU gains to be gradual but guaranteed At <$4 a month, India is among the cheapest in terms of TV entertainment. Not only that, per month television ARPU is abysmally low against the cost of a single movie ($3) within India. As against this, global monthly cable ARPU is 5-8x the cost of a movie ticket. The wide margin between Indian and international ARPU suggests that TV ARPU in India has to move up substantially. While subsidy-led growth, lack of content differentiation and slow pick-up in VAS would keep ARPU growth at low ebb in the near term, we expect cable and DTH ARPU to increase to $6.3 by 2015.

Exhibit 14: India cable ARPU lower than international peers… …and also compared to multiplex and telecom


A Rs480bn industry by 2015E – organized pie growing 6.5x With basic ARPU improving from $3.6 to $5 and C&S home base expanding from 130m in 2009 to 140m by 2015, we expect 11.5% CAGR in basic subscription revenues to Rs373bn. However, share of organized players in TV distribution would grow multifold as declarations go up by 4x. We expect the share of organized MSOs and DTH operators in subscription revenues to rise from Rs38bn in 2009 to Rs240bn by 2015, with Rs125bn of this for DTH industry. Besides, we see TV distribution revenue model being enhanced with newer streams like STB rentals, upfront digitization revenues, broadband revenues (10x growth in subscriber base to 7m by 2015E), advertising revenues and VAS revenues on gaming, Movie on Demand, recorder services, etc. On the other hand, carriage revenues, currently accounting for >40% of cable operators’ revenues, will stagnate. Overall, we expect 14.5% CAGR in C&S revenues to Rs480bn over 2009-15 with 20% of revenues coming from newer streams.

Exhibit 15: Growing share of organized players


0

4

20

45

65

75

45

20

40

60

80

India Malaysia Australia UK US France

(USD / Month) ATP Movies (USD) ARPU (USD) Multiple (x) India 4.0 4.0 1.0 USA 6.5 75 11.5 UK 11.4 65 5.7 France 6.1 45 7.5

Telecom ARPU (USD) ARPU (USD) Multiple (x) India 5.0 4.0 0.8 USA 49.0 75 1.5 UK 45.0 65 1.4 France 46.0 45 1.0

202 216245

268

307

346

408

480

0

125

250

375

500

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

(Rs bn)

OrganizedRs48.4bn

UnorganizedRs154bn

OrganizedRs341bn

UnorganizedRs139 bn

Expect overall ARPU to rise from $3.8 now to $6.3

by 2015

While we expect 14.5%CAGR in industry revenues

by FY15, organized pie to grow by 6.5x

14.5% CAGR

JUNE 2010 13

IDFC Securities

While MSOs would retain the gains of better collections... After two decades of operations for the cable industry and five years for DTH businesses, only a handful of them are making any money. As we expect MSOs to retain a substantial portion of the gains arising from higher declaration, content cost would increase at a much lower pace. While content cost for cable operators is Rs150-160 per paying subscriber, the same on the DTH platform is <Rs100. This gives comfort that improved collections do not imply a proportionate increase in content cost. Thus, even a marginal improvement in declarations would drive a sharper profit improvement. Profitability would further improve on the back of primary point acquisitions (LCOs retain 80% of the distribution revenues).

Exhibit 16: Increasing share of MSOs in the distribution pie and declining content cost to sales


DEN is the first MSO in India to be profitable (PAT of Rs303m in FY10; estimated PAT of Rs2.1bn by FY13E). Hathway too is expected to turn profitable in FY11.

Exhibit 17: While DEN has already turned profitable… …Hathway to turn profitable in FY11


25.9 25.5 28.231.7

39.8

56.6

85.0

115.3

0

30

60

90

120

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

MSOs share of net subscription(bn)

84.4 82.9 81.1 79.0 77.6 75.971.2

65.8

0

30

60

90

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Content cost % of subscription collection(%)

PAT

-151

303 461

908

2,077

-500

150

800

1450

2100

FY09 FY10 FY11E FY12E FY13E

(Rs m)PAT

291

871(580)(623)

2,103

-1,000

-300

400

1,100

1,800

2,500


(Rs m)

MSOs to retain the gains of improved declaration level

JUNE 2010 14

IDFC Securities

…DTH industry witnessing operating leverage gains DTH industry is incrementally moving towards achieving operating leverage benefits with 40% of the cost structure in the initial phase being fixed in nature and 10% linked to new subscriber acquisition. With an expanding base and stabilizing customer acquisition cost, we see improving operational performance ahead for DTH operators. While Dish TV clocked Rs845m of operating profits in FY10, Sun Direct, Tata Sky and Airtel Digital would turn profitable over the next two years as they achieve 5.5m subscribers and operating leverage sets in. Further, given the rapid scale-up of DTH businesses, broadcasters are willing to enter into fixed content-cost deals with players (a case in point is Dish TV’s latest deals with some broadcasters). Dish TV is expected to turn profitable at the PAT level in Q4FY12 and operating margins would improve from 8% currently to 32% by FY13E.

Exhibit 18: Cost components of a DTH model

Expense Nature of expense Content cost Variable License cost Variable Transponder cost Step variable Other goods and services Fixed Employee cost Step variable Administrative Fixed Advertisement cost Fixed Selling & Distribution Variable to new subscriber addition Source: IDFC Securities Research

Exhibit 19: Dish TV – operating leverage coming to the fore

0

22

44

66

88 2.9

4.0

4.6 5.36.0 6.7

7.1 7.6

Q1FY09 Q3FY09 Q1FY10 Q3FY10 Q1FY11E Q3FY11E Q1FY12E Q3FY12E

Content Cost Selling & Distribution Cost Subcribers


Just $5bn of incremental investments required to turn the tide The C&S business has failed to generate free cash so far while it is inherently a capital-guzzler. DTH industry too has been in the investment phase for the last three years. However, we see profitability round the corner. DTH industry, with consumer premise equipment cost of <Rs3,000, would need only $2bn to add 30m incremental homes over the next five years, even at the prevailing per customer acquisition subsidy of Rs2,500-3,000. Similarly, cable industry too would require $1.4bn to touch the estimated base of 38m homes by 2015, assuming STB cost of Rs1,700-1,800 each. Additionally, we expect $1.5bn to go into consolidation as C&S players (Hathway, DEN, etc) continue to acquire LCOs and MSOs (acquisition of 20m customers).

Operating leverage gains coming to the fore in DTH

industry as ~40% of the costs are fixed in nature

Dish TV – significant operating leverage gains in

the offing

Of the $5bn, $3.4bn to be invested in seeding STBs, and remaining for market

consolidation

JUNE 2010 15

IDFC Securities

Exhibit 20: USD5bn of capital investment needed over 2010-15

Cable - consolidation

31%DTH - STBs

40%

Cable - STB29%


More importantly, the industry has so far been dependent on external funds and while we expect this to continue for another couple of years, players like Dish TV, DEN and Hathway would not need any incremental capital and the capex would entirely be internally funded. At the same time, as we expect players (Tata Sky, Sun Direct and Airtel Digital) to turn profitable over the next 18 months, the dependence on external capital would reduce even further.

Profits in sight; we turn bullish on the distribution space With multifold growth in the revenue base of organized players in the distribution chain and profitability round the corner, we believe it is time to invest in the TV distribution space. While structural changes in the cable space would drive profitability of MSOs closer to the global average of 30%+, we believe competitive intensity in the DTH business would also abate.

Exhibit 21: Outperformer on Dish TV, Hathway Cable and DEN Networks


• Operating leverage – 32% by FY13E

2,103 (705)17,057 7,361 4.1m paying1.6m paying• Largest national MSO in IndiaHathway Cable

4.7m digital 1m digital• Rs13bn+ fund raise since 2000

1.4m broadband0.3m broadband• Aggressive on LCO acquisition

• Credible management

2,077 303 19,651 9,191 3.8m paying1.1m paying• 2nd largest MSO in 2nd yearDEN Networks

3.5m digital0.4m digital• $75m invested in acquiring 67 MSOs

0.7m broadband• Raised USD80m through IPO

• Star DEN offers scale

• First MSO to turn profitable

• Aggressive management

• Funded balance sheet - raises Rs16bn

11.3m gross6.9m gross• 22% of the incremental market

1,916 (2,612)22,492 10,853 8m net5.7m net• Largest DTH player - 30% market shareDish TV

FY13EFY10FY13EFY10

PAT (Rs m)Revenues (Rs m)Subscribers - FY13Subscribers - FY10Investment rationalePlayer















FY13EFY10FY13EFY10


As DTH operators and MSOs turn profitable, we

expect capex to be largely internally funded

With industry showing signs of profitability for the

first time, we have a positive stance on the

sector

JUNE 2010 16

IDFC Securities

Cable and DTH distribution is among high value-creating media businesses globally, particularly in the US where three of top 10 media companies are in distribution. Top five distribution companies (Comcast, DirecTV, Dish Network, Time Warner Cable and Cable Vision) account for market capitalization of $120bn and EV of $190bn on a base of 77m subscribers. In this context, Indian TV distribution (89m declared homes by 2015E) offers immense value creation potential – particularly as business economics are progressively trending towards the global average.

Exhibit 22: C&S companies – among the largest value creators

Subscribers Revenues EBITDA PAT Mkt cap EV EV / subscribers (m) (USD bn) (USD bn) (USD bn) (USD bn) (USD bn) (US $) Comcast Corp 23.8 35.8 13.7 3.6 51.5 80.2 3,368 DirecTV 23.2 21.6 5.3 0.9 32.7 38.5 1,659 Dish Network 14.2 11.7 2.7 1.4 13.7 14.4 1,015 Time Warner Cable 13.0 17.9 6.5 1.1 17.6 39.2 3,022 Cablevision Systems Corp 3.1 7.8 2.7 0.3 7.6 18.5 6,042 Total 77.2 94.6 30.9 7.3 123.1 190.8 2,470 Source: IDFC Securities Research

We value businesses on EV/ subscriber basis; 50% returns Given that the Indian DTH and cable industry is in the investment phase, which implies high growth but muted profits, we do not see merit in valuing the stocks on earnings multiple or EV/ EBITDA methodology. Global peers too are not the best comparables as these industries are in the maturity stage of their life cycles. We also do not find the discounted cash flow valuation method appropriate given the back-ended nature of returns and aggressive subscriber addition in the initial years.

We have hence adopted a different parameter to value distribution businesses. To capture the potential to scale up, we have used the EV/ subscriber methodology. However, at the same time, we believe it is not fair to use the global comparable of $1,000+ EV/ subscriber as ARPU and profitability are not comparable with the Indian market. Hence, to capture the inherent ARPU, profitability and long-term subscriber economics in India, we have used cash flow of individual DTH, primary point digitized, secondary point subscribers and broadband subscribers from the time of acquisition. Using this methodology, we have arrived at a fair EV/ subscriber of 29 months of ARPU for secondary point acquisition, 32 months ARPU for primary point acquisition, 33 months ARPU for DTH and 36 months ARPU for broadband subscriber.

Exhibit 23: Valuation assumptions

Rs DTH Secondary Point Primary Point Broadband SAC/ Basic capex 1,315 2,000 4,500 2,500 Consumer premise equipment 2,750 1,500 1,500 1,100 Less - Receipts 1,690 750 750 500 Net acquisition cost (2,375) (2,750) (5,250) (3,100) Total APRU - year 1 115 320 220 300 5 year ARPU CAGR 16 3 3.3 1 Revenue / subscriber - year 3 2,353 4,046 2,849 3,600 EBITDA % - year 3 20 29 48 41 Terminal growth rate (%) 5 5 5 5 WACC (%) 11.9 11.9 11.9 11.9 Discounted EV/ subscriber 5,997 9,794 7,543 10,928 Non-subsidized ARPU 184 337 237 300 Number of months of ARPU 33 29 32 36 Source: IDFC Securities Research

Distribution businesses create value – EV of top

five operators in the US is $190bn

We use a different valuation matrix – EV/

subscriber based on cash flow of individual

subscriber

We value DTH business at 33 months of ARPU, 29 months for secondary

points, and 32 months for primary points

JUNE 2010 17

IDFC Securities

We have used this methodology on players’ FY13 subscriber base. This methodology helps us to arrive at a fair value of Rs61 for Dish TV, Rs292 for DEN Networks and Rs274 for Hathway.

Exhibit 24: Comparative valuations


292 274 61 Target price (Rs)

27 25Less; Minority stake (%)

400 366 61 Per share value (Rs)

131 142.91,065Number of shares (m)

52,20752,27764,357Equity value (Rs m)

(2,500)2,5003,250Less: Debt (Rs m)

49,707 54,77767,607Total EV (Rs m)

4,400 7,64910,00727,65116,26518,68919,82367,607Enterprise value (Rs m)

10,9289,53010,16611,4749,5309,4408,451EV / subscriber (Rs)

36.4 31.8 29.0 36.4 31.8 29.0 32.5 Month of ARPU

300300350315300325260ARPU (Rs/month)

0.71.052.721.4 2.0 2.1 8Number of subscribers (m)

Star DENBroadbandPrimarySecondaryBroadbandPrimarySecondary

DEN NetworkHathwayDish TV





52,20752,27764,357Equity value (Rs m)

(2,500)2,5003,250Less: Debt (Rs m)

49,707 54,77767,607Total EV (Rs m)


10,9289,53010,16611,4749,5309,4408,451EV / subscriber (Rs)

36.4 31.8 29.0 36.4 31.8 29.0 32.5 Month of ARPU

300300350315300325260ARPU (Rs/month)




18-month price target of Rs61 for Dish TV, Rs274 for Hathway and Rs292 for DEN

JUNE 2010 18

IDFC Securities

DTH: IN MOMENTUM An organized industry with no last-mile hassles, DTH industry has attracted

big corporate houses like the Tatas, Bharti, Essel, Sun Network, Reliance ADAG and Videocon, as also global partners like Sky and Astro

With $2.5bn invested so far, DTH has grown ahead of expectations to 20m subscribers by FY10 (earlier estimates of 16m by Dec’10)

With $500m+ spent annually on subscriber acquisition and advertising, 28m more DTH subscribers are expected to be added; the 48m base by 2015 would be bigger than the US DTH industry

With abating competition, no rationale for ‘irrational’ price wars; on the contrary, players moving up the curve to DVR and HDTV technology

DTH industry has lured deep pocketed players… TV distribution businesses are inherently long gestation and entail heavy investments in the initial years. Being a more organized market and positioned as a premium offering to analogue cable, DTH industry saw influx of deep-pocketed corporate houses like Tatas, Bharti, Reliance ADAG and Videocon, as also two of the largest media companies – Essel Group and Sun Networks. Besides large Indian corporates, DTH industry has also attracted players like Newscorp (owner of the largest DTH operators like DirecTV, BSkyB, Sky Perfect, etc) and Astro Malaysia (Malaysia’s sole DTH operator) aligning with Tata and Sun Networks respectively.

With heavyweights as also their strategic partners and financial investors like Temasek and Apollo Management entering the space, the Indian DTH industry has so far seen investments to the tune of $2.5bn.

Exhibit 25: Strong participants in the DTH space


100

600

400

400

600

400


1.5Leading consumer DurablesVideocon VideoconVideocon D2h

5.0Largest media house in South IndiaSun TV, Dinakaran, Sumangali CableSun Networks

Sun Direct

26.0Second largest telecom playerR-Communications, R-Infra, Reliance Entertainment

Reliance ADAG

Big TV

25.0India’s largest telecom playerBharti AirtelBharti AirtelAirtel Digital

75.0India’s largest conglomerate (Tata) and world’s largest media house (Newscorp)


Tata and Newscorp

Tata Sky

5.0Amongst the largest media housesZee Entertainment, Zee News, WWIL, Essel Propac, Fun Cinemas

EsselDish TV

Market value ($ bn)


100

600

400

400

600

400


1.5Leading consumer DurablesVideocon VideoconVideocon D2h

5.0Largest media house in South IndiaSun TV, Dinakaran, Sumangali CableSun Networks

Sun Direct

26.0Second largest telecom playerR-Communications, R-Infra, Reliance Entertainment

Reliance ADAG

Big TV

25.0India’s largest telecom playerBharti AirtelBharti AirtelAirtel Digital

75.0India’s largest conglomerate (Tata) and world’s largest media house (Newscorp)


Tata and Newscorp

Tata Sky

5.0Amongst the largest media housesZee Entertainment, Zee News, WWIL, Essel Propac, Fun Cinemas

EsselDish TV

Market value ($ bn)


DTH industry attracted big corporates, large private

equity players as also strategic investors

JUNE 2010 19

IDFC Securities

Ability to create consumer pull and distribution push… Presence of funded players enhances the sector’s ability to create customer pull through heavy advertising and distribution. With an annual spend of Rs7bn-8bn annually on advertising, DTH is among the largest advertisers on television (32% of total television advertising by the service sector in 2009) and print (3% of total advertising spend). Similarly, DTH operators have created strong pan-India distribution networks. Presence of India’s two largest telecom operators, Bharti Airtel and Reliance Communications – with distribution networks next only to FMCG, has helped create deep distribution in DTH business. Tata Sky also reaches out to >5,000 towns while Dish TV has a dealer network of 40,000+.

Exhibit 26: DTH amongst the lead advertisers


…and drive voluntary digitization through aggressive subsidies In the absence of mandatory digitization and with a well-entrenched alternative in the form of analogue cable (at low ARPU), customer pull through heavy ‘subscriber subsidies’ was the only way to drive digitization. With funded players investing $1.5bn+ on customer acquisition in the last three years, DTH industry has been able to generate consumer pull and drive voluntary digitization. Funded balance sheets of players have helped them offer an upfront subsidy of Rs1,500+ on hardware and incur a per subscriber acquisition cost of ~Rs3,000 (including subsidized ARPU).

Exhibit 26: Continuous subsidized offerings…


Rs7bn+ of advertising spends and deep

distribution network helped DTH’s cause

Rs2500-3,000 of subsidization to drive voluntary digitization

JUNE 2010 20

IDFC Securities

Exhibit 27: …reflected in increased cost of customer acquisition

0

750

1,500

2,250

3,000 (Rs m)

Q1FY07 Q1FY08 Q1FY09 Q1FY10 Source: IDFC Securities Research

Broadcasters too are willing to align with DTH Broadcasters have been more receptive to the DTH technology so far, as it is perceivably the only platform driving better declaration levels. While initial pricing was set by the TDSAT (must-provide content at half the rate charged on the analogue cable), broadcasters end up getting paid higher as the declaration is 6-8x that of analogue cable. Of the total 30m declared C&S homes in India today, 18m are on the DTH platform. Relevance of DTH platform for broadcasters’ revenue stream is visible in the pay revenues of Zee TV and Sun TV. While Sun TV’s collection on the DTH platform is higher than that on analogue cable (Rs630m and Rs450 respectively in Q4FY10), Zee Entertainment earns as much from DTH as from its cable operations.

Exhibit 28: DTH contributing as much as what cable does to broadcasters’ kitty

0

400

800

1200

1600 (Rs m)

Q1FY09 Q2FY09 Q3FY09 Q4FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10

DTH Cable


SAC up 5x in four years

DTH contributes as much to broadcasters’ revenues

as analogue cable does

While DTH is equal contributor to Zee’s pay

revenues, Sun TV gets more from DTH

JUNE 2010 21

IDFC Securities

DTH surpasses expectations – 20m homes by FY10… With entry of funded players (and thereby the ability to subsidize subscribers), absence of unorganized LCOs in the chain and acceptance from broadcasters have helped the DTH industry grow rapidly in the past three years. With entry of every new player, the pace of subscriber acquisition has accelerated with DTH industry adding 7m subscribers in 2009 to touch 18m homes (20m homes by March 2010; ARPU collection of Rs23bn). While Dish TV, the industry pioneer, continues to be a market leader with 5.4m subscribers by December 2009 (5.7m now), Airtel Digital is the fastest growing player accounting for 25% of the incremental subscribers. DTH subscriber addition has clearly surpassed our earlier estimate of 16m homes by 2010.

Exhibit 29: DTH industry grew multifold… …with Dish TV leading the space


…on course to grow to 48m subscribers by 2015E With strong consumer-pull ability, we see DTH sustaining the high growth momentum in the coming years. Capital availability is improving further with Dish TV (the only inadequately funded player so far) raising funds to the tune of Rs16bn and now generating profits at the operating level.

While analogue cable remains an easy hunting ground for DTH, the industry continues to target the 25m television homes in cable-dark areas as well. Further, we expect India’s TV owning homes to increase from 135m currently to 160m by 2015. Also, we believe digitization is bound to gather pace with the gradual shift towards higher-end TV sets (LCD TV, HD TV, etc), and DTH stands to gain. We expect DTH industry to add 30m subscribers over 2010-15 with 8m customers to be added in 2010E. By 2015, India is expected to be the largest DTH market in the world – overtaking the US in terms of subscriber base (US DTH industry has 33m subscribers and adds 1.5m subscribers per year).

-

7,000

14,000

21,000

28,000

2,006 2,007 2,008 2,009-

5

10

15

20Revenues (Rs m - LHS) Subscribers (m - RHS) Number of subs (m)

Dish TV30%

Tata Sky25%

Airtel Digital12%

Big TV9%

Sun Direct24%

Videocon0.1%

Dish TV, with 5.7m net subscribers, leads the 20m

DTH space in India

Industry’s funding capabilities are

improving…

JUNE 2010 22

IDFC Securities

Exhibit 30: 48m DTH subscribers by 2015

0

10

20

30

40

50(m)

11

18

26

33

38

4245

48

2008 2009 2010 2011 2012 2013 2014 2015 Source: IDFC Securities Research

HDTV – the next wave While India has been a decade and half late in adoption of DTH technology, it is just couple of years late in High Definition TV. With upwardly moving consumer base and increasing sales of HD LCD TV in India, DTH operators are increasing their focus on offering HDTV services. All the players have launched HDTV services at a heavily subsidized upfront cost. Tata Sky has launched HDTV services at Rs2599 only. Besides the television set and STB enabling HD viewing, it is important for channels to move to HD technology. Few channels are moving in this direction, including Sun TV and ESPN. While upfront subsidies remain high, HDTV offering can garner better ARPU, as operators are charging as high as Rs35 per month. We believe that India would see a rapid scale up of HDTV.

…which would drive industry size up to 48m

subscribers by 2015

HDTV to drive improvement in ARPU

JUNE 2010 23

IDFC Securities

CABLE: DIGITIZATION NO MORE A CHOICE The 87m-homes Indian cable industry is the most fragmented and under-

reported globally as paying subscribers are just 10m

Cable digitization a dud (~3.5m connections) so far due to lack of funding, LCO resistance and government apathy

However, cable digitization imminent as industry now funded (Rs13bn of recent fund raise), and with LCOs feeling the heat of DTH and MSOs turning their focus on digitization to ‘secure’ the base

Indian digital cable base set to expand 10x+ to 38m subscribers by 2015E; declared subscriber base expected to increase to 43m

Consolidation would continue as larger MSOs keep acquiring primary as well as secondary points

Round 1: A ‘miscarriage’

Even as DTH technology ramped up to 18m homes by 2009 within a short span of five years, cable industry failed on the digitization front. The government, LCOs and broadcasters showed indifference, whereas MSOs were not funded. Of the $400m invested in the cable industry, $275m flowed mainly to new entrants – focused on first amassing the critical subscriber base by secondary and primary point acquisitions (at any cost). Also, MSOs, with no recourse to additional funds for seeding of STBs, had solace in the form of carriage revenues. This stream, linked to reach, supported the acquisition economics. While the industry did see consolidation to an extent, digital cable could penetrate only 3.5m subscribers as of 2009.

Mandated CAS failed CAS was mandated in 2006 in select areas of Mumbai, Delhi and Kolkata, and set high expectations on cable digitization in the country. Though the areas selected were in relatively premium pockets, and also at notified pricing to ensure consumer acceptability, the move met with stiff opposition from LCOs and broadcasters. While success of CAS would have meant moving to 100% reporting for LCOs (which would have stemmed unreported revenues), broadcasters were miffed at the pricing cap of Rs5. This, coupled with MSOs’ inadequately funded books, prevented CAS from being a success with only 25% of the 2m homes in notified areas shifting to digital cable. Ironically, more than cable, it was DTH that gained from mandated CAS.

Inadequate funding…and limited to new ventures While mandated CAS failed, voluntary digitization called for heavy customer subsidization. Unlike DTH, cable industry was inadequately funded for the same – not even the incumbent national MSOs. Also, unorganized nature (cash transactions, and suspect legitimacy of many participants) of the cable business kept large corporate houses away. Against $2.5bn invested in DTH till early-2009, the cable industry could attract only $400m from private equity players like ChrysCap, CVC, Ashmore, New Silk Route, etc. Notably, only $125m of this was invested in the incumbent player – Hathway, whereas a much bigger chunk was channelized into new ventures including DEN Networks, Digicable, You Telecom, etc.

Cable industry in a sorry state of affairs as

mandated CAS fails

Cable industry funded to the tune of just $400m, vs

$2.5bn invested by DTH

JUNE 2010 24

IDFC Securities

Exhibit 31: Cable funding through the private equity route

Company USD m Investor Hathway 125 ChrysCapital, Morgan Stanley Digicable 140 Ashmore DEN 75 IL&FS, EMSAF Ortel 25 NSR, Actis, SREI YouScod18 60 CVC Source: IDFC Securities Research

Funds went in for subscriber acquisition Funding came largely to new entrants, which was used to acquire subscribers rather than for digitization. To quickly gather critical mass, DEN, Digicable and You Telecom opted to acquire reach through secondary (smaller MSOs/ independent operators) and primary point (LCOs) acquisitions. For instance, DEN has invested $75m in 67 acquisitions for a controlling stake in the last three years to have a reach of 10m homes, while Digicable has invested $100m+ in achieving a similar scale. Overall, we estimate the cable industry to have invested $250m+ only in acquisitions.

Exhibit 32: Operators acquire critical reach…

0

3

6

9

12 (m)

DEN

Networks

Hathway DigiCable WWIL InCable YouTelecom


Exhibit 33: …through aggressive acquisitions


As large part of funding went to the new entrants…

…funds used for aggressive MSO and LCO

acquisition so as to achieve critical mass

JUNE 2010 25

IDFC Securities

Carriage stream supported aggressive acquisition costs With MSOs incurring losses on the subscription stream, it is the carriage stream that justified acquisition economics. With a series of new launches in 2008, the Indian television industry saw exponential growth in carriage revenues. For instance, DEN earns Rs2.2bn through carriage fees, more than the subscription stream of revenues, and Hathway Rs3bn of carriage revenues. Ability to further consolidate the market and garner a higher share of carriage revenues has halved the payback period for these MSOs to 3.5-4 years.

Exhibit 34: Carriage revenues justifying business economics

Time of acquisition Post acquisition Customer acquisition cost - per sub 600 600 Number of subscribers 10,000 10,000 Total acquisition cost (Rs m) 6.0 6.0 Declaration levels 12.0% 12.0% Paying subscribers 1,200 1,200 Average ARPU per month 160 160 Total subscription revenue collection (Rs m) 2.3 2.3 Carriage revenues - Rs m 1.6 2.3 Total Revenues 3.9 4.6 Content Cost and placement cost - per sub 170 165 Total content and placement cost 2.45 2.38 Other operating costs 0.58 0.58 Total costs 3.0 3.0 Operating profit / (loss) 0.88 1. 60 Payback period 6.8 3.7 Source: IDFC Securities Research

Exhibit 35: Carriage stream forms a relevant chunk of MSOs’ revenues

Hathway

Subscriptionrevenues

36%

Other revenues

22%

Carriage revenues

42%

DEN

Carriage revenues

51%

Other revenues

6%


43%

Digicable


41%

Other revenues

11%

Carriage revenues

48%


Increasing carriage stream of revenues justified the

economics of acquisition

JUNE 2010 26

IDFC Securities

However, on-ground dynamics are changing

The Indian cable industry is finally finding its feet. While the need to secure the existing base is driving a shift to digitization, the recently raised Rs14bn by various MSOs gives them the wherewithal to drive voluntary digitization. Even LCOs are now more receptive to aligning with MSOs as DTH has already eaten into 20% of the market and every subscriber loss causes a hole in the pocket. With players like DEN and Hathway having aggressive plans and Rs4.6bn earmarked for digitization, we see Indian digital cable space scaling up to 38m by 2015.

Fresh round of public money infusion Capital has been a key constraint for the cable industry. Various MSOs could raise only $400m through the private equity route but had to utilize it largely for subscriber acquisition, and not digitization. While acquiring a customer base was an imperative, critical mass has been achieved and we believe these players are now equipped to deploy incremental funds into driving digitization. Importantly, a fresh round of capital infusion is underway with Hathway and DEN Networks raising Rs4.8bn and Rs3.6bn respectively through IPO, and WWIL raising Rs5bn through a rights issue. You Telecom too has filed the DRHP to raise Rs3.6bn. Also, we believe Digicable would have to raise capital as the $140m invested by Ashmore has been largely utilized. Notably, this round of capital raise is through public issuance which, we believe, will bring in more accountability (and pressure) to monetize.

Of the total planned outlay of Rs16.4bn by the key players, Rs4.6bn has been allocated for digitization (implying the ability to fund 5.8m STB subsidy), Rs2.8bn set aside for subscriber acquisition and Rs2.6bn towards broadband.

Exhibit 36: Objects of IPO and rights issues by various players

(Rs m) Hathway DEN Networks WWIL YouTelecom Total MSO / LCO Acquisition 2,436 347 2,783 Digitization and infrastructure 1,564 2,100 978 4,642 Broadband 830 250 1,573 2,653 Repayment of debt / advances 967 400 3,180 48 4,595 General corporate purpose 625 972 171 1,768 Total 5,797 3,375 4,499 2,770 16,441 Source: IDFC Securities Research, Companies

Incumbents have achieved critical mass In last three years, cable industry saw entry of three national players – Digicable, DEN Networks and You Telecom (You Scod18), whose focus was to first build a relevant subscriber base through acquisitions. Hathway, the funded incumbent, too participated in the acquisitions to get access to the last mile. While acquisition costs shot up in the process, economics were supported by the carriage stream of revenues. Currently, five national operators (Hathway, DEN, Digicable, WWIL and InCable) have a reach of 5m+ subscribers each, with a paying subscriber base of 0.5m+.

Carriage revenues can no more justify additional reach Carriage stream of revenues has trebled in the last four years to Rs15bn and now that ~80% of TAM homes are covered, we do not expect material growth in carriage revenues from here. Hathway and DEN, that have been the most aggressive on acquisitions, already account for Rs5bn of carriage revenues and going forward, incremental acquisitions will yield a proportionate increase in carriage fees for these players. While DEN in the past gained from its ability to increase per subscriber

MSOs raise / plan fund raise of Rs16.4bn

Rs4.6bn of allocation for digitization suggests shift

in focus away from acquisition…

…as new entrants have achieved critical mass…

…and we see limited scope of incremental

carriage revenues

JUNE 2010 27

IDFC Securities

carriage revenues by 60-70% on the back of consolidation, we do not expect such differentials in incremental acquisitions. While we do not rule out acquisitions, they would not be driven by carriage revenues – and hence we see a sharp correction in acquisition costs ahead.

Digitization required to secure the existing base Digitization, we believe, is no more an option but a compulsion for MSOs. Having paid a hefty price for MSO and LCO acquisitions for securing a customer base, cable players will now have to work on retaining the same. While the secondary point acquisition strategy poses risk of losing the LCO to another MSO, primary point acquisition is more detrimental to economic health by losing an end-customer to DTH. The only way to secure a subscriber, or an LCO, is to start seeding STBs and make LCO/ customer acquisition unviable for the acquiring company. For instance, if an MSO manages to digitize 25% of the subscribers under a particular LCO, upfront acquisition cost of that LCO will increase by 10% and payback period will get extended by five months.

On the other hand, if an MSO loses an LCO or the subscriber that it has acquired, the economics of the acquisition would get disrupted as a drop in revenues will directly hit the bottom-line.

Exhibit 37: Digitization makes LCO acquisition expensive

Not digitized 25% digitized Customer acquisition cost - per sub 4,500 4,500 Set Top Box replacement cost 400 Total acquisition cost - per sub 4,500 4,900 Number of subscribers 100 100 Total acquisition cost (Rs m) 450,000 490,000 Declaration levels 100% 100% Paying subscribers 100 100 Average ARPU per month 190 190 Total subscription revenue collection (Rs m) 228,000 228,000 Carriage revenues (Rs m) 57,000 57,000 Total revenues 285,000 285,000 Content cost 48,000 48,000 Other operating costs 79,800 86,640 Total costs 127,800 134,640 Operating profit / (Loss) 157,200 150,360 Payback period (months) 34 39 Source: IDFC Securities Research

DTH threat more prominent – LCOs willing to realign With DTH already accounting for 20% of C&S homes, LCOs (analogue platform) have started feeling the heat. Even assuming that 50% of the DTH subscribers have come in from cable-dark areas, cable industry has lost ~10m (or 12%) of its subscribers to the DTH industry. Given the heavy under-declaration at LCO level, loss of subscriber base would not get compensated for by lower content cost as the content cost paid by an LCO to the MSO is for a lower number of subscribers. Thus, revenue loss would mean loss of profit. As the development unfolds, some LCOs have already either sold off or aligned with an MSO to drive digitization. Hathway has, in the last two years, acquired 0.5m and DEN 0.2m primary points.

With increasing threat of losing LCOs to another

MSO and from DTH, digitization needed to

secure the base

Acquisition of LCO becomes uneconomical with

increased digital subscriber base

LCOs willing to align with MSOs…

JUNE 2010 28

IDFC Securities

Exhibit 38: Impact of subscriber loss on profitability

12% subscriber loss Paying subscribers 100 88 Average ARPU per month 190 190 Total subscription revenue collection (Rs m) 228,000 200,640 Carriage Revenues - Rs m 57,000 50,160 Total Revenues 285,000 250,800 Total content and placement cost 48,000 48,000 Other operating costs 79,800 79,800 Total Costs 127,800 127,800 Operating Profit / (Loss) 157,200 123,000 Change in profits (21.8) Source: IDFC Securities Research

Digitization execution has begun Digitization has become a reality in India and the process is picking up pace with MSOs seeding STBs at consumer homes without pushing LCOs to improve declaration levels. For instance, if an LCO has seeded 100 boxes, higher than the declared customer base of 75, it will continue to pay for 75 subscribers to the MSO. This, we believe, will go a long way in ensuring LCO acceptance of digitization. Also, on-ground execution of seeding STBs has become easier given consumers’ increasing awareness of digital technology (thanks to the heavy investments committed by the DTH industry) and favourable pricing with just Rs1,000 of upfront charges (Rs700 of subsidies) and no change in ARPU (even for multiple TV homes). While Hathway leads the pack with 1m digital homes, DEN as also Digicable have attained a reach of 0.4m digital homes.

India to have 38m digital cables by 2015E While we are not betting big on a mandated digitization drive, voluntary digitization is bound to increase as cable operators are now funded, focus is shifting from acquisition to digitization and LCOs are feeling the heat of DTH. Cable industry is adding digital homes at a monthly rate of ~0.1m currently and the pace is expected to accelerate to 0.25m per month by the end of the year to increase further to 0.3m per month in 2011. We expect cable industry to add 34m digital homes in the next five years, to touch 38m by 2015. Hathway and DEN are at the forefront of the drive and are expected to account for 50% of the digital market by that year.

Exhibit 39: Rapid scale-up of digital cable base

0

10

20

30

40

3 46

10

16

22

30

38(m)

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E Source: IDFC Securities Research

…as subscriber loss to DTH a direct hit to bottom-

line

MSOs have started seeding STBs – Hathway

and DEN likely to add 1.25m-1.5m digital

subscribers in FY11

India to have 38m digital cable homes by 2015E

JUNE 2010 29

IDFC Securities

Continued acquisitions to consolidate the existing base While the near-term focus of cable companies is expected to shift to digitizing the existing subscriber base, we believe acquisition would continue to be the long-term growth strategy. As digitization picks up pace, smaller LCOs and independent operators lacking the wherewithal to digitize and subsidize would be the potential acquisition targets for larger MSOs. Also, consolidation of the carriage stream of revenues would put pressure on business model of independent operators. However, if the latest round of acquisition strategy was characterized by secondary point acquisition to acquire reach, the next round would comprise primary point acquisition within the existing market to consolidate the base. Hathway, which has been the most aggressive on primary point acquisition so far, has earmarked Rs2.5bn for subscriber acquisition in the coming years. DEN is expected to spend Rs3bn over the next three years on MSO and LCO acquisitions.

Head-end in the Sky (HITS)

HITS is a digital cable distribution technology. In HITS, an operator downlinks signals from various broadcasters at a single location (called hub/ teleport) and then uplinks it to a single satellite (called HITS) after encryption. This is downlinked at the LCO’s head-end and then the channels get distributed to consumers through a wired network. A HITS operator need not be an MSO and can just provide passive infrastructure like transponder space on satellite, earth stations and offer simulcrypting and multicrypting facilities to MSOs. HITS operator can use C Band or Ku Band. In India, HITS licenses have been issued to the Essel group (through Dish TV) and Jain Studios (owner of Jain News Channel).

Difference between HITS and Digital head-ends While an MSO would need multiple digital head-ends in various cities to downlink and then uplink content, a single satellite can reach out to multiple markets using the HITS technology. Hathway, for instance, has 70+ analogue head-ends and ~20 digital head-ends. HITS does not require multiple uplinking facilities in various cities; however, investments are required at the LCO end to turn digital.

Difference between HITS and DTH While DTH reaches out to the end consumer, HITS services can be offered only through an LCO. Also, DTH services can use only Ku Band, whereas HITS has the option to use Ku or C Band. C Band is a superior technology. Also, unlike DTH, HITS offers a two-way path.

Capital requirement While the initial license fee for HITS has been pegged at Rs100m, capital is also required for transponder facilities (each transponder costs $1m per year), digitizing the LCO infrastructure and seeding of STBs at the consumer end. We estimate an overall investment requirement of Rs1bn-1.2bn to implement HITS technology.

Advantages of HITS HITS can help step up the pace of digitization as an MSO then need not set up digital infrastructure in multiple cities. Also, HITS technology can help reach out the sparsely populated cable dry area, which would otherwise be an unviable business proposition. However, many of the MSOs believe that fibre network in India is adequate for offering services in multiple cities without having head-end facility in each of the cities.

Hathway has lined up Rs2.5n and DEN Rs3bn on

acquisitions

JUNE 2010 30

IDFC Securities

Challenges

Regulation has been the biggest hurdle for HITS roll-out. While HITS licenses were issued in 2003, it was only in 2009 that the government came out with guidelines pertaining to the technology.

The government has not yet come out with guidelines pertaining to content tariff and distribution of collection among MSOs and LCOs.

On HITS, there is no option of analogue transmission and the MSO does not have an option but to invest in STBs at the consumer end. This, we believe, could see immense resistance.

WWIL exits HITS platform WWIL, an Essel group company, was the only player to have launched services on the HITS platform. However, it has recently announced its exit from this in the wake of lack of regulatory guidelines, non-allowance to use DTH transponder and satellite to transmit HITS signal. WWIL has supposedly incurred losses to the tune of Rs1bn.

86m Digital Homes by 2015E

With DTH industry all set to sustain the growth momentum and a turnaround in sight in the cable industry, digitization of TV distribution in India is a reality. From a meager 3m digital homes three years ago, India is already a 24m homes market as of March 2010 and is well on its way to garner a base of 86m subscribers by 2015 – higher than the digital C&S home base in US today. While DTH industry would touch the 48m mark by 2015, higher than the DTH penetration in the US, digital cable would grow by >10x, to 38m homes (42m in USA currently). This would make India the second largest C&S homes market by then, next only to the US (~100m digital subscribers by 2015E; 85m currently).

Exhibit 40: India to have 86m digital subs by 2015… …as against estimated 105m in the US


84 84 80 75 70 66 60 54

3 4 6 10 16 22 30 38

11 18 26 33 38 42 45 48

0

40

80

120

160

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

Analogue Cable Digital Cable DTH(m)

0

25

50

75

100

2009 2015

India US(m)

With 86m digital homes by 2015E, India would inch

closer to US’s estimated 105m homes by then

JUNE 2010 31

IDFC Securities

MONETIZATION: RS480BN BY 2015E As digitization picks up pace, monetization to follow

While monetization would initially be led by higher declarations (89m subscribers by 2015E; 23m currently), ARPU-led growth to happen gradually

Also, business models of both cable and DTH players would evolve with newer streams of revenues like STB rentals, advertising, broadband and VAS

We expect 12% CAGR for the TV distribution industry over 2009-15 to Rs480bn; revenues from declared subscribers to grow 6.5x to Rs341bn

Monetization to be declaration-led – 89m paying subs by 2015E We believe industry revenues from here would be driven by improving declaration levels rather than higher realizations. Cable distribution currently has ~10m paid subscribers. We believe the initial round of STB installation will not directly translate into a corresponding increase in paying subscribers as it will be more towards securing subscribers as also ensuring LCO acceptability. Therefore, while we expect the cable industry to digitize 12.5m incremental subscribers over 2009-12, overall paying cable subscriber base will increase by only 6.5m. However, once critical mass is achieved, MSOs will push for higher declaration by LCOs – which we expect to happen 2013 onwards. By 2015, we expect a 43m strong overall paying cable subscriber base and 38m digital cable homes. On the DTH platform, subscriber base will increase to an estimated 48m by 2015 with 46m paying homes. This would take the tally of overall paying subscribers to 89m by 2015.

Exhibit 41: Digitization ahead of declaration initially… …before declaration levels improve to 89m by 2015E


ARPU bound to grow in the longer term… While cable ARPU in USA and UK stands at >$75 per month, it is $40-50 in Australia and $15-20 in comparable Asian markets like Malaysia and Singapore. At $3.6 of basic video ARPU and $5 of total ARPU (including other streams of revenues), television entertainment is thus one of the cheapest in India when compared to cable charges globally or other forms of entertainment in the country itself (like movie in a multiplex). For a content-heavy market like India with 400+ television channels, ARPU of $4 is extremely low. Entertainment cost in India is moving up – as seen in multiplex ticket prices (~5% of the tickets sold at $4-5 per movie ticket). Globally, cable ARPU is 8-10x higher than multiplex ticket prices as against 1x in India. Also, when compared to telecom ARPU, global cable ARPU is 1-1.5x the telecom pricing,

0

25

50

75

100

2008 2009 2010 2011 2012 2013 2014 2015

Paying homes Digital homes

18.022.7

31.1

41.1

50.9

64.5

76.4

89.0

0

25

50

75

100

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

(m)

Expect 4x increase in declared subscriber base

by 2015 to 89m

Low ARPU in India offers immense upside

potential…

JUNE 2010 32

IDFC Securities

whereas it stands at 0.8x in India. These are some indicators that suggest that cable ARPU in India is bound to move northward in the long run.

Exhibit 42: Indian cable ARPU lower to international peers… …and also compared to multiplex and telecom


…but only gradually in the near term While we remain upbeat on the long-term ARPU potential in cable and DTH industry, we believe ARPU in the near term would remain low as DTH industry continues to grow on the back of subsidies and cable business would be more focused on digitization rather than monetization. Also, we expect the pick-up in value added service in India to be only gradual and limited to movie-on-demand. Incrementally, triple play too remains some time away for the cable industry.

We expect a limited 5.5% CAGR in basic subscription ARPU over 2010-12 to Rs176 per month and then scale up to Rs222 per month by 2015 (8% CAGR over 2012-15).

Exhibit 43: Overall ARPU growth ahead of basic ARPU growth

-

75

150

225

300

2008 2009 2010 2011 2012 2013 2014 2015

Total ARPU Video ARPU


0

4

20

45

65

75

45

20

40

60

80

India Malaysia Australia UK US France

(USD / Month) ATP movies (USD) ARPU (USD) Multiple (x) India 4.0 4.0 1.0 USA 6.5 75 11.5 UK 11.4 65 5.7 France 6.1 45 7.5

Telecom ARPU (USD) ARPU (USD) Multiple (x) India 5.0 4.0 0.8 USA 49.0 75 1.5 UK 45.0 65 1.4 France 46.0 45 1.0

…though initial growth would be gradual as the

focus would be to seed STBs

While basic ARPU to grow to $5, overall ARPU to grow

to $6.3 by 2015E

JUNE 2010 33

IDFC Securities

ARPU subsidization to continue in DTH

Given the six-player race in the DTH industry, we believe the focus is more on ramping up volumes. As the industry is expected to add 8m subscribers per year, we believe DTH players will continue to offer aggressive pricing (initial package of Rs55-125) and overall ARPU would remain low. For instance, 0.8m of the total 6.9m gross subscribers of Dish TV are at an ARPU of Rs35 per month. Similarly, average ARPU for Sun Direct is at Rs75-100 per month. Also, 50% of the DTH market is from cable-dark areas, where ARPU is lower.

Exhibit 44: DTH – ARPU is subsidized

0

50

100

150

200

250

Sun TV Dish TV Big TV Bharti Airtel Tata Sky

(ARPU / month)


Non-differentiated content – no content exclusivity

Given the ‘must carry’ clause and content for all, there is no content differentiation in India. Globally, movies, sports events and adult programmes are differentiating content for operators – and this enables them to earn higher ARPU. For instance, BSkyB gained on the back of English Premiere League and in the US, DirecTV and Echostar garner higher ARPU by offering Asian content, cricket matches and movies. In the absence of any differentiated content in India, ARPU would remain subdued in the near term. However, as addressability issues get sorted out, distribution of niche differentiated content would become a relevant contributor to the ARPU.

Value added services – a slow pick-up

While Indian DTH operators have already started offering VAS like movie-on-demand, matrimonial, education, gaming, etc, we believe growth will happen only gradually. Reasons for the slow uptick in VAS are (i) less than 2% of STBs sold offer two-way interactivity as against 65%+ in UK; (ii) a shorter movie telecast window; and (iii) non-exclusivity of sports content.

DTH industry continues with heavy subscription

subsidies

Lack of differentiated content the biggest hurdle

to sharp improvement in ARPU

Only 0.1m of the total Tata Sky subscriber base of ~5m

are high-end STBs

JUNE 2010 34

IDFC Securities

Exhibit 45: VAS growth to be gradual….. …though increasing focus from DTH operators


However, this could emerge as an avenue with significant revenue potential as sale of two-way interactive STBs increases, movie release window on pay per view platform shortens and operators populate services like pay per view of international non-cricket sports (WWF, F1, etc). Tata Sky has also been aggressively marketing its premium offering (like video recording services) under Sky+. We expect VAS revenues, which are negligible today, to scale up to Rs27.5bn by 2015.

Exhibit 46: Overall VAS revenues to grow to Rs27.5bn by 2015E

099 8 122 27 234 90 693 504

2,052 1,650

5,6704,050

10,1258,550

18,900

9

5000

10000

15000

20000

2008 2009 2010 2011 2012 2013 2014 2015

Cable DTH


Broadband gathering momentum, telephony some time away Broadband and telephony form an integral part of an operator’s offering in the global market with cable operators in the US offering broadband services to ~42m subscribers and telephony to 22m homes. Comcast is the largest residential telecom and broadband player in the US. Time Warner currently has 9.3m internet subscribers and 4.2m telephony subscribers, and these two streams contribute ~40% of the total subscription revenues of Time Warner Cable.

Why would VAS growth be gradual?

Sports content is not

differentiated

Less than 2% penetration of high end STBs

Predominantly basic STBs

Movie telecast window as

short as DTH

No content exclusivity

Why would VAS growth be gradual?

Sports content is not

differentiated

Less than 2% penetration of high end STBs

Predominantly basic STBs

Movie telecast window as

short as DTH

No content exclusivity

Expect VAS growth from 2013 onwards

JUNE 2010 35

IDFC Securities

Exhibit 47: Internet and telephony subscribers of cable operators in the US

23.6

15.9

7.6

12.9

9.3

4.23.1 2.6 2.1

0

5

10

15

20

25 (m)

Video Internet Telephony

Comcast Time Warner Cable Cable Vision


Exhibit 48: Internet and telephony form relevant source of revenues


Broadband penetration in India is extremely low at 3% as against 70% in the US and 30% in China. India currently has 0.6m broadband subscribers being serviced by cable operators – and this means that less than 10% of the total broadband users are on the cable platform. As against this, 50%+ of the broadband connections in the US are bundled with or provided by C&S operators. Comcast alone reaches out to ~16m households with its high-speed internet services. With basic infrastructure in place, cable operators, we believe, would now up the ante. We expect India to have 7m broadband homes serviced through cable networks by 2015. However, telecom services by cable operators is still some time away.

Comcast

Video63.7%

Internet25.5%

Telephony10.7%

Time Warner Cable

Video62.7%

Internet26.3%

Telephony11.0%

Broadband and telephony a major contributor to

cable operators’ revenues in the US

Expect 7m of the estimated 40m broadband

connections by 2015 to be serviced by cable operators

JUNE 2010 36

IDFC Securities

Exhibit 49: Broadband penetration in Asia Pacific… …Indian broadband too picking up pace


DTH can offer a synthetic triple play

While technology does not permit DTH players to offer triple play services, global DTH operators have found a way to compete with cable operators by bundling the three services – video, telephony and data – through tie-ups. DirecTV has tied up with Verizon and AT&T to offer telephony and internet services, which are bundled at a discount. Therefore, though DTH sector will technically not be in a position to offer triple play, it can offer synthetic triple play (cable industry too currently not offering the three services through a single cable). We expect DTH to step up bundling activities, more so as three of the largest telecom and broadband players (Bharti, Reliance Communication and Tata Indicom) are in the DTH business. While this may not form a relevant revenue base for DTH operators, it would help players stay competitive post triple play on the cable platform.

Exhibit 50: Dish TV marketing triple play services… …triple play forms a relevant source of DirecTV’s revenues


Carriage fees – to continue but consolidate At Rs16bn, carriage revenues have grown manifold in the past five years prior to 2009. While broadcasters cut carriage spends in 2009, the share of national MSOs only increased – thereby suggesting consolidation of carriage revenues. For operators like Hathway and DEN, carriage revenues are currently higher than subscription revenues. Though we expect carriage revenue growth to incrementally taper as TAM homes are largely covered now, we see further consolidation of carriage revenues.

(%) 2008 Singapore 88 HongKong 82 Korea 82 Taiwan 64 Japan 62 Australia 61 China 19 India 2

Indian Broadband industry

0.0

3.5

7.0

10.5

14.0

2.23.0

5.5

7.2

8.7

10.3

12.0

(m)

2006 2007 2008 2009 2010 2011 2012

Video67.9%

Broadband17.1%

Voice15.0%

JUNE 2010 37

IDFC Securities

Also, contrary to the market belief that carriage revenues would discontinue post digitization, we expect them to sustain though the mode of transaction could change. The digital platform could create an artificial logjam by creating multiple offering bouquets and broadcasters will have to pay for being part of the basic package. Also, India is yet to see one more round of aggressive channel launches before the broadcast market consolidates. In addition, FTA channels will remain an advertising-driven business model – and would thereby pay to get an effective reach (as operators will not carry the signals in the absence of pay revenues).

Carriage fees prevalent in the US too, but in a different form

Even in a mature market like the US with >82m digital homes, carriage fees have not dried up. However, the color of the revenue is different. Operators continue to charge a placement fee on new channel launches. The placement fee, or carriage fee, charged at the time of launch is either adjusted from content cost (affiliate fees) or operators take equity stakes in new launches. From our interaction with DirecTV and Comcast, we gather that another form of placement fee is advertising slots. Operators are offered two minutes every hour as advertising slot for them to market. While DTH players have advertising slots only on national networks, cable companies have advertising slots on national as well as local networks. Even as the revenue stream accounts for a paltry $2 of the total $75 ARPU for DTH operators, it forms nearly $4 of the total ARPU of $100 of cable ARPU.

Television distribution – a Rs480bn opportunity by 2015E C&S businesses are largely dependent on basic subscription and carriage revenues. With emergence of new revenue streams, we see substantial improvement in business models of distribution companies. As the overall declared subscriber base moves up to 89m and basic ARPU increases to Rs222 per month by 2015E, we expect subscription revenues to rise to Rs373bn (11.8% CAGR over the period). However, declared subscription revenues are likely to witness 41% CAGR to Rs234bn. We expect broadband and telephony revenues to increase to Rs32.6bn and VAS revenues to Rs27.5bn. We expect overall revenues to grow to Rs480bn by 2015.

Exhibit 51: 14.5% CAGR in industry size (2009-15) Source of distribution revenues


202216

245268

307

346

408

480

0

125

250

375

500

2008 2009 2010E 2011E 2012E 2013E 2014E 2015E

(Rs bn) 2015

VAS, Rs27bn

Carriage fees, Rs19bn

STB Rentals, Rs22bn

Advertising, Rs10bn

Broadband Rs29bn

Subscription, Rs373bn

Carriage revenues to continue, but consolidate in the hands of few large

players

Overall industry expected to register 14.5% CAGR to

Rs480bn; subscription revenues to grow to

Rs373bn

14.5% CAGR

JUNE 2010 38

IDFC Securities

Organized pie to grow 6.5x to Rs341bn by 2015E While the overall industry CAGR of 14.5% over 2009-15E looks a normal growth trajectory, the organized pie is set to grow much faster than this. This would happen on two counts – a 4x increase in the declared non-subsidized subscriber base to 89m by 2015 and increasing direct access to end consumer (DTH and primary point consumer). The share of organized players within the distribution channel is expected to rise from Rs41bn now to Rs240bn by 2015 and including the other streams of revenues, the share would increase by 6.5x to Rs341bn.

Exhibit 52: A much steeper growth in the organized pie

48 5878

102

141

191

260

341

0

70

140

210

280

350

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

(Rs bn)


4x increase in declaration and newer stream of

revenues to drive 6.5x growth in revenues of

organized pie

JUNE 2010 39

IDFC Securities

ECONOMICS: TURNING PROFITABLE As monetization gathers momentum and overall paying subscriber base grows

4x, C&S industry looking to break even

As profits would be mainly declaration-led, C&S operators (cable in particular) would retain the gains

Share of operators in the chain would increase from 8% to 35% by 2015E

Revenue streams expected to grow multifold while content cost increase would lag over the period; we see operating leverage setting in

MSOs to retain the gains of declaration

As industry growth would be declaration-led in the near term, we believe incremental collections would largely be retained by the MSOs. While this would ensure substantial operating leverage on content cost, overall profitability in the business would also be driven by other profitable revenue streams like broadband, VAS, STB rentals, etc. Reported profits of MSOs would get further fillip from accounting of upfront digitization fees. While DEN is the first MSO to have turned profitable in FY10, Hathway is expected to follow suit in FY11.

Increasing share of ARPU collection… Given the high under-declaration levels (85-90%) at LCO level, MSOs receive only 10-15% of the total ARPU collection done at the customer end. However, we see this changing rapidly on two counts – MSOs have started acquiring the end consumers and they would now push for higher reporting as digitization accelerates. As declaration levels move up from 15% to 20%, MSOs’ revenues would tend to increase by 33% and share of the reported ARPU collection to 18.4% from 13.8% currently.

Exhibit 53: MSOs share of ARPU collection with improving declaration

Secondary point Secondary point Secondary point Secondary point Primary Point Declaration levels 15% 20% 25% 30% 100% Number of subscribers 10,000 10,000 10,000 10,000 10,000 End consumer ARPU 190 190 190 190 190 LCO's revenues 22.8 22.8 22.8 22.8 22.8 ARPU paid to MSOs 175 175 175 175 190 MSOs revenues 3.15 4.20 5.25 6.30 22.80 Gross share of ARPU collection 13.82 18.42 23.03 27.63 100.00 Source: IDFC Securities Research

…while content cost growth to lag MSOs’ content cost is currently more than what they earn in subscription revenues. This is a stark anomaly vis-à-vis the DTH platform, where content cost is ~40% of the basic revenues. As against the per subscriber content cost of Rs80 per month for Dish TV, Hathway and DEN pay Rs150 per month as content cost. However, we expect content cost for cable operators to incrementally trend closer to the DTH cost structure, as MSOs retain a major chunk of improved collections. The bargain would increasingly be in favour of MSOs as the distribution channel consolidates. All these factors suggest that content cost would inflate at a lower pace initially – 12-15% increase as against subscription revenue growth of 35%+. However, broadcasters would subsequently push for higher pay revenues as profitability of cable companies improves disproportionately. We expect MSOs’ net share of the ARPU collection to

MSOs to eventually push for higher declaration,

thereby improving their share in collection pie…

…and MSOs expected to retain the gains of

declaration – content cost increase to lag

JUNE 2010 40

IDFC Securities

increase from nearly nil currently to 12% if declaration levels were to increase to 30%. In case of primary subscriber acquisition, MSOs should retain 88% of the collection.

Exhibit 54: Increasing net share of MSO

Secondary point Secondary point Secondary point Secondary point Primary Point Declaration levels 15% 20% 25% 30% 100% LCOs’ revenues 22.8 22.8 22.8 22.8 22.8 MSOs’ revenues 3.15 4.20 5.25 6.30 22.80 Gross share of ARPU collection 13.82 18.42 23.03 27.63 100.00 Subscribers paid for to broadcasters 15% 15% 17% 18% 15% Content cost per sub 160 160 160 160 160 Content Cost 2.9 2.9 3.3 3.5 2.9 Residual income for MSOs 0.27 1.32 1.99 2.84 19.92 % of total ARPU collection 1.18 5.79 8.71 12.47 87.37 Source: IDFC Securities Research

Newer revenue streams highly profitable While improving declaration would boost profitability on account of higher subscription revenues, other streams like broadband, advertising and STB rentals would further enhance profitability. Broadband business is highly profitable with bandwidth cost at just 16-18% of the revenues and overall profit margins of 45-50% in the business. On the other hand, MSOs are pushing for monetization through rental collection. Notably, these revenues would flow through to the bottom-line in entirety. For instance, Comcast’s gross margin on video business is 63%, whereas that in HSD and telephony business is 93% and 81% respectively.

DTH: Operating leverage set to play out

Operating leverage has already set in for Dish TV with 5.7m net subscribers, while other players are expected to achieve breakeven on attaining 5.5m subscribers each. Given that nearly 40% of the cost structure is fixed in nature and selling & distribution cost is linked to only new subscriber acquisition, operating leverage gains can be quite significant despite the high subscriber acquisition cost. We expect Dish TV’s operating margins to increase from 8% in FY10 to 32% in FY13.

SAC will remain at Rs2,500-3,000 Over the last four years, subscriber acquisition costs have moved up from Rs400 per subscriber in 2006 to Rs2,400 in 2010 for Dish TV (peak of Rs2,800 per subscriber). Including subsidized ARPU, SAC works out to ~Rs3,000. While we rule out any price wars, and thereby an increase in SAC, we do not also expect any decline in the cost given that the industry is in a high-growth phase. In India, SAC is at 12-15 months of blended ARPU for every player compared to 10 months of ARPU in mature markets like USA and UK. Dish Network, USA, currently has SAC of $700 – 10 months of ARPU, which used to be 12 months in 2005. While the absolute SAC amount has not dropped, the number of months has come down on the back of higher ARPU.

0

25

50

75

100

63.6

93.381.5

58.466.4

97.1

Comcast Time Warner cable

Video Internet Telephony

Expect sharp operating leverage gains for DTH…

JUNE 2010 41

IDFC Securities

Exhibit 55: Subscriber acquisition cost in DTH

Basic Offer - Rs1590 Offer Current Receipts 1690 Costs STB, dish and other hardware 2750 Dealer margin 225 VAT 115 Activation charge 200 Advertising cost per sub 800 Total cost 4090 Net subsidy (2,400) Subsidized content cost 480 Total subscriber acquisition cost (2,880) Source: IDFC Securities Research

Exhibit 56: SAC at 10-12 months of ARPU - DISH Network, US

2005 2006 2007 2008 2009 ARPU (USD / month) 58.3 62.8 65.8 69.3 70.0 SAC (USD) 693.0 686.0 656.0 720.0 697.0 Number of months of ARPU 11.9 10.9 10.0 10.4 10.0 Source: IDFC Securities Research

Fixed cost model – high operating leverage benefit DTH is a fixed cost model and at a subscriber base of 3m, over 50% of the costs are fixed in nature or step-variable. Fixed cost structure includes employee cost, transponder, advertising cost (to retain subscribers) and other administrative costs. Among other costs, license fees and content costs are directly linked to revenues. Of the selling & distribution cost, while commission on recharge is variable (5% of ARPU) to overall revenues, a large portion of S&D expenses are related to dealer commission on new subscriber addition. Dish TV has already started realizing operating leverage gains with the fixed cost component dropping from 58% of revenues in Q1FY09 to 35% in Q4FY10 on a net subscriber base of 5.7m. We see further scope for operating leverage benefits and expect the fixed component to decline to 27% by Q4FY12 at 7.7m net subscribers. Operating leverage comes in even after assuming a steady SAC. DTH industry would also stand to gain on implementation of the proposed change in license cost from 10% to 6% of revenues.

Exhibit 57: DTH cost components

Expense Nature of expense Content cost Variable License cost Variable Transponder cost Step variable Other goods and services Fixed Employee cost Step variable Administrative Fixed Advertisement cost Fixed Selling & Distribution Variable to new subscriber addition Source: IDFC Securities Research

…with stabilization in subscriber acquisition

costs…

…and a fixed content cost (40% of total) model

JUNE 2010 42

IDFC Securities

Exhibit 58: Dish TV – operating leverage to the fore

0

22

44

66

88 2.9

4.0

4.6 5.36.0 6.7

7.1 7.6

Q1FY09 Q3FY09 Q1FY10 Q3FY10 Q1FY11E Q3FY11E Q1FY12E Q3FY12E

Content Cost Selling & Distribution Cost Subcribers


Fixed content-cost deals to augment profitability Besides operating leverage accruing from the fixed content cost model, broadcasters have shown willingness to enter into fixed content-cost deals with players like Dish TV. This deal would make content cost step-variable, and thereby add to the operating leverage of Dish TV. Content cost for Dish TV has come down from 48% of revenues in Q1FY09 to 35% now and is expected to drop further to 30% in the absence of differentiated content. In the long run, we expect content cost to stabilize at ~40% of basic revenues, as witnessed globally.

Distribution Margins: Mapping global trends

TV distribution business entails annuity with profitability at >25% for DTH operators and 30%+ for cable operators. However, Indian players – given the rampant revenue leakage and unorganized structure – have been in the red since inception. Going forward, we see clear signs of profitability driven by improving declaration levels, and access to last mile in cable business and operating leverage in DTH.

Notably, DEN has turned profitable at the net level, while Hathway and Dish TV have broken even at the operating level. We expect operating margins for DEN and Hathway to trend closer to the global average of 35%. Dish TV too has already surpassed the 5.5m net subscriber base, which is a critical milestone for turning EBITDA-positive. Dish TV clocked in Rs845m of EBITDA in FY10 and as operating leverage sets in, the margins would increase to 32% by FY13E. Tata Sky, Sun Direct and Airtel Digital are also expected to turn EBITDA-positive in the next 18 months as they approach the 5.5m subscriber base. We expect EBIT margin of Indian cable operators to be at 20% and for DTH operators at 10-11% - in line with global trends.

Broadcasters willing to enter into fixed content

cost deal – added leverage gains

From huge losses, industry margins expected to trend closer to global averages

JUNE 2010 43

IDFC Securities

Exhibit 59: EBIT margins – India in FY13E v/s global today

20.219.0 18.4

15.2 15.0

12.410.7

23.1

20.3

10.1

0

5

10

15

20

25

(%)

Comcast TimeWarnerCable

CablevisionSystems

BSkyB DishNetwork

DIRECTV SKYPerfect

Hathway DenNetworks

Dish TV

EBIT margins


CY09 FY13E

JUNE 2010 44

IDFC Securities

Economics of MSO and DTH operators

Secondary point acquisition With players looking to consolidate their existing subscriber base, secondary point subscriber acquisition costs have corrected in the past one year. With tapering growth in carriage revenues and DTH eating into the existing subscriber base, we expect acquisition costs to drop from Rs4,500 (2-2.5 years of ARPU) per paying subscriber now to Rs3,500 in the next couple of years. While the payback works out to around four years at the current prices and declaration levels, the key lies in ability to drive declaration levels. For instance, a 8% improvement in collections to 20% would lead to a considerable drop in payback period from 3.7 years to 2 years.

Exhibit 60: Economics of a secondary point acquisition

On acquisition Improved declaration Customer acquisition cost - per sub 600 600 Number of subscribers 10,000 10,000 Total acquisition cost (Rs m) 6.0 6.0 Declaration levels 12.0% 20.0% Average ARPU per month 160 160 Total subscription revenue collection (Rs m) 2.3 3.8 Carriage revenues - Rs m 2.3 2.3 Total revenues 4.6 6.1 Content cost and placement cost - per sub 165 Total content and placement cost 2.38 2.38 Other operating costs 0.58 0.58 Total costs 3.0 3.0 Operating profit / (Loss) 1.6 3.2 Payback period 3.7 1.9 Source: IDFC Securities Research

Primary point acquisition – upfront profitable While the economics of secondary point acquisition are largely linked to the ability to improve declaration, primary point acquisition offers better upfront payback. With acquisition cost higher at Rs4,500-Rs5,000 per subscriber (up to Rs7,000 per subscriber in some cases), the MSO gets access to the entire under-reported mass, which brings down the payback to ~2.9 years. However, barring ARPU improvement, there is no scope for further improvement in economics. Also, the risk on loss of subscriber to DTH is substantially higher.

Exhibit 61: Economics of a primary point acquisition

Primary Point Acquisition Customer acquisition cost - per sub 4,500 Number of paying subscribers 10,000 Total acquisition cost (Rs m) 45.0 Average ARPU per month 190 Total subscription revenue collection (Rs m) 22.8 Carriage Revenues – (Rs m) 5.7 Total Revenues 28.5 Content Cost and placement cost - per sub 200 Total content and placement cost 4.8 Other operating costs 8.0 Total costs 12.8 Operating profit / (loss) 15.7 Payback period 2.9 Source: IDFC Securities Research

JUNE 2010 45

IDFC Securities

Digitization – pay off in case of rentals With a view to secure the existing subscriber base, MSOs are turning aggressive on seeding of STBs. As against the average cost of Rs1,600-1,800 for an STB, MSOs are currently charging Rs750-1,000 upfront – which translates into net per subscriber acquisition cost of ~Rs800. While MSOs are not pushing hard for higher ARPU, they are trying to garner rental revenues of Rs25-30 per month. Even if MSOs manage to collect rental revenues from 50% of the customers, the payback period would be 4.4 years.

Exhibit 62: Economics of digitization

Economics of Digitization Rental - 50% pay Rental - 100% pay ARPU - 50% pay ARPU - 100% pay Set Top Box Cost 1,500 1,500 1,500 1,500 Upfront recovered from customer 750 750 750 750 Net subsidy 750 750 750 750 Rental @Rs30 / month ARPU @Rs160/month Annual Revenues 180 360 960 1920 Pay back period 4.2 2.1 0.8 0.4 Source: IDFC Securities Research

Broadband economics – highly attractive for scaled-up operations Broadband business is not just a very profitable proposition, but has a short payback period as well. However, the economics of the business will start to look good only post critical mass is achieved as per subscriber capex cost depends on the number of subscribers. Notably, the cost of laying the network up to a building is substantially higher.

Exhibit 63: Economics of broadband business

250 customers 500 customers Cost of equipment 1,100 1,100 City network 1,500 1,000 Drop it capex 500 500 Total capex 3,100 2,600 Upfront charged 500 500 Net subsidy 2,600 2,100 Total subsidy 650,000 1,050,000 ARPU 300 300 Broadband revenues 900,000 1,800,000 Bandwidth cost (%) 20% 20% Bandwidth Cost 180,000 360,000 Other cost (%) 35% 25% Other cost 315,000 450,000 EBITDA 405,000 990,000 Payback 1.60 1.06 Source: IDFC Securities Research

JUNE 2010 46

IDFC Securities

DTH payback at five years

At the current subscriber acquisition cost of Rs2,500 and three months of subsidized ARPU, we believe payback period for an individual DTH subscriber is five years. However, given the growth model, overall business breakeven would happen once a player achieves scale (5m subscribers).

Exhibit 64: Economics of a DTH subscriber

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Receipts 1690 Costs STB, dish and other hardware 2750 Dealer margin 225 VAT 115 Activation charge 200 Advertising cost per sub 800 Total cost 4090 Net subsidy (2,400) Basic video revenues 1,350 1,980 2,059 2,142 2,227 2,316 2,409 3 months of subsidized ARPU - Normalized ARPU 150 165 172 178 186 193 201 % ARPU growth 10.0 4.0 4.0 4.0 4.0 4.0 VAS revenues - 50 150 200 280 360 480 % yoy growth Total revenues 1,350 2,030 2,209 2,342 2,507 2,676 2,889 Content cost 900 900 936 973 1,012 1,053 1,095 Cost per subscriber 75 75 78 81 84 88 91 % of revenues 67 44 42 42 40 39 38 License cost 135 203 221 234 251 268 289 % of revenues 10 10 10 10 10 10 10 Advertising cost 200 196 192 188 184 181 % of revenues 10 9 8 8 7 6 Recharge commission cost 68 99 103 107 111 116 120 % of revenues 5.0 5.0 5.0 5.0 5.0 5.0 5.0 Corporate cost allocation 68 102 110 117 125 134 144 % of revenues 5 5 5 5 5 5 5 Total cost 1,170 1,504 1,566 1,624 1,688 1,755 1,830 % of revenues 87 74 71 69 67 66 63 Net EBITDA 180 527 643 718 819 922 1,059 EBITDA margins 13.3 25.9 29.1 30.7 32.7 34.4 36.7 Net cash flow (2,220) 527 643 718 819 922 1,059 Cumulative cash flow (2,220) (1,694) (1,051) (333) 486 1,408 2,467 Payback period 5 years Source: IDFC Securities Research

JUNE 2010 47

IDFC Securities

Accounting policies critical to reported profitability We believe reported profitability of players would depend on the accounting policy pertaining to reporting of upfront collection on STB, rental allocation and depreciation. Players could likely resort to an aggressive accounting policy in the initial years. While cable operators at present report upfront installation charges as revenues in year-one, Dish TV accounts for Rs300 as upfront activation and Rs950 as rental income apportioned over a period of three years.

Exhibit 65: Accounting policies

Dish TV Hathway DEN Networks Upfront charges 1,590 750 750 Revenue reporting Upfront activation / Year 1 300 750 990 Rental booking 950 Rental booking over 3 years 3 years 1 year Asset price 2,750 1,500 1,500 Depreciation of STB 5 years - 20% 8 years 8 years Source: IDFC Securities Research

JUNE 2010 48

IDFC Securities

VALUATIONS: WE SEE 50% RETURNS Organized pie of Indian TV distribution industry set to grow to Rs341bn;

profitability moving closer to global peers

Globally, distribution has created immense value; Comcast, DirecTV, Dish (US) and Time Warner Cable among USA’s top 10 most valuable media companies

We have valued Indian distribution companies on EV/ subscriber ARPU month – derived from the normal economics of an individual subscriber

We have a positive stance on the sector; Outperformer on Dish TV, Hathway and DEN with 18-month price target of Rs61, Rs274 and Rs292 respectively

Distribution businesses among the largest value creators globally Comcast, the largest cable company in the US, is also among the largest media companies globally in terms of market capitalization. Five largest cable and DTH operators in the US – Comcast, DirecTV, Dish Network, Time Warner Cable and Cablevision Systems – cumulatively account for 77m subscribers, and have a market capitalization of ~$123bn and an enterprise value of $190bn. Value attributable to these businesses is aptly justified given the annuity model and high profitability in the business (EBITDA of $31bn and PAT of $7.3bn). In UK, BSkyB – the largest DTH player with 9.5m subscribers – is being valued at $15bn.

Exhibit 66: C&S operators amongst leading value creator

US’s top 10 media companies Mkt cap (USD m) EV (USD m) Google 158,603 132,089 Walt Disney 68,530 80,185 Comcast Corp 51,903 79,543 Largest cable operator Time Warner 37,611 49,095 Also owns Time Warner Cable

- mkt cap of USD20bn News Corp 39,360 45,481 Conglomerate owning a

majority stake in DirecTV DirecTV 35,670 41,380 Largest DTH operator in the US Viacom 21,502 28,057 CBS Corporation 10,451 16,549 Dish Network 9,745 13,787 2nd largest DTH operator Omnicom 11,848 13,644 Source: IDFC Securities Research

We value Indian distribution on EV/ subscriber basis Given that Indian DTH and cable industry is in the investment phase, which implies high growth but muted profits, we do not see merit in valuing the stocks based on the earnings multiple or EV/ EBITDA methodology. Global peers too are not the best comparables as these industries are in the maturity stage of their life cycles. We also do not find the discounted cash flow valuation method appropriate given the back-ended nature of returns and aggressive subscriber addition in the initial years. We see rationale in valuing these stocks on EV/ subscriber basis (at number of months of ARPU), arrived at by using cash flow of individual subscribers. We have separately valued the economics for a new DTH, primary, secondary and broadband subscriber. From our workings, we gather that EV/ subscriber comes to 33 months of steady ARPU for DTH, 32 months for primary subscriber points, 29 months for secondary subscriber points and 36 months for broadband subscribers.

Three C&S operators among US’s top 10 media

companies

We take a different approach – EV/ subscriber value based on cash flows

of individual subscriber

JUNE 2010 49

IDFC Securities

Exhibit 67: Cash flow valuation of primary point – 32 months of ARPU

Year 1 2 3 4 5 6 7 8 9 10 Subscriber acquisition cost 4,500 Set Top Box 1,500 Less - Receipts 700 Net acquisition cost (5,250) - - - - - - - - - Basic Video ARPU - per month 190 195.7 202 210 218 227 243 260 278 297 Video revenues - per year 2,280 2,348 2,419 2,516 2,616 2,721 2,911 3,115 3,333 3,567 Carriage Revenues 365 387 411 428 419 435 437 436 450 464 VAS and Advertising revenue - 12 68 138 265 409 546 687 967 1,257 Total Revenues 2,645 2,748 2,849 2,983 3,104 3,271 3,502 3,748 4,064 4,405 ARPU 220 229 237 249 259 273 292 312 339 367 Content Cost 570 587 617 654 693 735 786 872 967 1,070 Other overheads 821 845 871 931 981 1,048 1,135 1,246 1,383 1,534 EBITDA 1,254 1,315 1,362 1,398 1,430 1,489 1,580 1,630 1,714 1,801 % of total revenues 59 47.4 47.9 47.8 46.9 46.1 45.5 45.1 43.5 42.2 40.9 Total fixed Assets 2,100 Depreciation & amortization 375 375 375 375 375 75 75 75 50 50 Profit Before interest and tax 879 940 987 1,023 1,055 1,414 1,505 1,555 1,664 1,751 PAT 615 658 691 716 738 990 1,054 1,088 1,165 1,226 WACC 11.9 Discounted cash flow (3,808) 825 761 697 635 543 515 474 442 415 Terminal growth rate (%) 5 Terminal value discounted to today 6,042 Total Net present value 7,543 Average ARPU 237 Number of months of ARPU 32


Exhibit 68: Cash flow valuation of secondary point – 29 months of ARPU

Year 1 2 3 4 5 6 7 8 9 10 Subscriber acquisition cost 2000 Set top Box 1,500 Less - Receipts 750 Net acquisition cost (2,750) - - - - - - - - - Basic Video ARPU - per month 160 160 160 166 173 180 193 206 220 236 Video revenues - per year 1,920 1,920 1,920 1,997 2,077 2,160 2,311 2,473 2,646 2,831 Carriage Revenues 1,920 1,920 2,112 2,196 2,284 2,289 2,311 2,300 2,249 2,180 VAS and advertising revenue 0 10 14 80 152 236 366 498 662 883 Total Revenues 3,840 3,850 4,046 4,224 4,415 4,538 4,742 4,928 5,115 5,306 ARPU 320 321 337 352 368 378 395 411 426 442 Content Cost 2,304 2,266 2,208 2,097 2,077 2,160 2,195 2,225 2,381 2,548 Other overheads 729.6 729.6 672.0 698.9 726.8 755.9 808.8 791.3 793.7 849.3 EBITDA 806 854 1,166 1,429 1,611 1,623 1,738 1,911 1,940 1,909 % of total revenues 21.0 22.2 28.8 33.8 36.5 35.8 36.7 38.8 37.9 36.0 Total fixed Assets 2,000 Depreciation and amortization 362.5 362.5 362.5 362.5 362.5 62.5 62.5 62.5 30 30 Profit Before interest and tax 444 492 804 1,066 1,249 1,560 1,676 1,848 1,910 1,879 PAT 311 344 563 746 874 1,092 1,173 1,294 1,337 1,315 WACC 11.9 Discounted cash flow (1,856) 565 661 708 706 589 563 553 498 438 Terminal growth rate (%) 5 Terminal value discounted to today 6,370 Total Net present value 9,794 Average ARPU 337 Number of months of ARPU 29.0


JUNE 2010 50

IDFC Securities

Exhibit 69: Cash flow valuation of broadband subscriber – 36 months of ARPU

Year 1 2 3 4 5 6 7 8 9 10 General Capex 2,500 Set top Box 1,100 Less - Receipts 500 Net acquisition cost (3,100) - - - - - - - - - Broadband ARPU - per month 300 300 300 309 318 328 338 348 358 369 Broadband revenues 3,600 3,600 3,600 3,708 3,819 3,934 4,052 4,173 4,299 4,428 Bandwidth cost 720 720 720 742 764 787 810 835 860 886 Other overheads 1,620 1,512 1,404 1,372 1,337 1,377 1,418 1,461 1,505 1,550 EBITDA 1,260 1,368 1,476 1,594 1,719 1,770 1,823 1,878 1,934 1,992 % of basic revenues 35.0 38.0 41.0 43.0 45.0 45.0 45.0 45.0 45.0 45.0 Total fixed Assets 3,600 Depreciation and amortization 533 533 533 533 533 313 313 313 Profit Before interest and tax 728 836 944 1,062 1,186 1,458 1,511 1,566 1,934 1,992 PAT 509 585 660 743 830 1,020 1,058 1,096 1,354 1,395 WACC 11.9 Discounted cash flow (1,840) 893 852 814 778 680 625 574 493 454 Terminal growth rate (%) 5 Terminal value discounted to today 6,605 Total Net present value 10,928 Average ARPU 300 Number of months of ARPU 36 Source: IDFC Securities Research

Exhibit 70: Cash flow valuation of DTH subscriber – 33 months of ARPU

Year 1 2 3 4 5 6 7 8 9 10 Receipts 1,690 Costs STB, Dish and other hardware 2,750 Commission, VAT, Advertising 1.315 Total Cost 4,065 Net subsidy (2,375) Basic video revenues 1,350 1,890 1,985 2,123 2,272 2,431 2,626 2,836 3,062 3,307 Normalized ARPU 150 158 165 177 189 203 219 236 255 276 VAS revenues - 50 150 250 400 600 700 700 800 1,000 Other stream of revenues 27 38 79 106 136 170 210 284 337 397 Total Revenues 1,377 1,978 2,214 2,480 2,808 3,201 3,536 3,819 4,199 4,704 Total ARPU 115 165 184 207 234 267 295 318 350 392 Content Cost 960 912 885 929 1,052 1,199 1,324 1,431 1,573 1,762 License Cost 138 198 221 248 281 320 354 382 420 470 Advertising and sub management cost 200 196 192 188 183 177 172 163 155 Recharge commission cost 68 95 99 106 114 122 131 142 153 165 Corporate Cost allocation 551 494 443 397 393 384 389 382 420 470 Total Cost 1,716 1,899 1,844 1,872 2,028 2,208 2,375 2,508 2,729 3,024 % of revenues 125 96 83 75 72 69 67 66 65 64 Net EBITDA (339) 79 370 608 780 994 1,160 1,311 1,470 1,681 EBITDA margins (24.6) 4.0 16.7 24.5 27.8 31.0 32.8 34.3 35.0 35.7 Asset cost per subscriber 2750 Depreciation / amortization 550 550 550 550 550 50 50 50 50 50 Profit before interest and Tax (889) (471) (180) 58 230 944 1,110 1,261 1,420 1,631 Profit after tax (889) (471) (180) 52 196 755 744 845 951 1,093 WACC 11.9 Discounted cash flow (2,426) 63 264 384 426 411 362 365 365 372 Terminal growth rate (%) 5 Terminal value discounted to today 5,411 Total Net present value 5,997 Average ARPU 184 Number of months of ARPU 33 Source: IDFC Securities Research

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IDFC Securities

Mature markets valued at 26 months ARPU, EMs at 45+ months Even in maturity stage, US and UK distribution businesses trade at an average PE of 23x and EV/ EBITDA of 7x. During the high-growth phase, and particularly at the time of turnaround, these businesses traded at 2-year forward EV/ EBITDA of 14-16x. On an average, players trade at 26 months of EV/ subscribers. As against mature markets, operators (Astro All Asia and Austra United) in growing markets, like Malaysia and Australia, trade at premium valuations of 46-49 months of ARPU.

Exhibit 71: C&S operators trading at 25-36 months of ARPU

M cap ($ m) EV ($ m) Subscribers EV/ Subs EV/ subs EV/ EBITDA - EBITDA CAGR (m) (USD) ARPU month CY11E 2yr (%) Comcast Corp 51,903 79,543 23.8 3,342 30.4 5.4 3.9 DirecTV 35,670 41,380 23.2 1,784 23.2 5.9 15.1 Dish Network 9,745 13,787 14.2 971 13.9 4.6 5.6 Time Warner Cable 19,536 40,618 13.0 3,134 31.3 5.7 4.9 Cable Vision Systems 7,699 18,634 3.1 6,078 28.8 6.8 0.1 BSkyB 18,289 21,321 9.8 2,176 36.0 10.5 6.9 Source: IDFC Securities Research

Indian distribution space offers 50%+ returns With profitability in sight, we turn positive on the sector and put an Outperformer rating on Dish TV (leader in the DTH space; turning profitable), Hathway (the largest MSO) and DEN Networks (the most aggressive MSO and first to turn profitable). Positive on the DTH as well as cable platforms, we recommend a basket approach to the Indian TV distribution space, which would likely offer 50% returns. Applying the EV/ subscriber methodology, we arrive at a fair value of Rs61 for Dish TV, Rs274 for Hathway and Rs292for DEN Networks.

Exhibit 72: Indian DTH and cable operators
















FY13EFY10FY13EFY10
















FY13EFY10FY13EFY10


Even at lower growth, mature markets trading at

25+ months of ARPU

Target price – Dish TV Rs61, Hathway Rs274 and

DEN Rs292

JUNE 2010 52

IDFC Securities

Dish TV – upgrade to Outperformer and valued at Rs61

Using 33 months of ARPU as a parameter to arrive at EV/ subscriber, we have arrived at Rs67.7bn of enterprise value for Dish TV in FY13. We arrive at an 18-month price target of Rs61.

Hathway – incumbent leader; fair value of Rs274

Given that Hathway has secondary paying points, primary points and also broadband subscribers, we value each subscriber class differently. Valuing the 2.1m secondary subscriber points at 29 months ARPU, 2.0m primary subscriber points at 32 months and 1.4m broadband subscribers at 36 months ARPU, we have arrived at an 18-month fair price of Rs274 for Hathway.

DEN – the first to turn profitable; fair price of Rs292

Using the valuation parameters similar to that used for Hathway, we have arrived at an 18-month fair value of Rs292 for DEN – 50% upside from the current price.

Exhibit 73: Current valuations suggest 50% returns from here






52,20752,27764,357Equity value (Rs m)

(2,500)2,5003,250Less: Debt (Rs m)

49,707 54,77767,607Total EV (Rs m)


10,9289,53010,16611,4749,5309,4408,451EV / subscriber (Rs)

36.4 31.8 29.0 36.4 31.8 29.0 32.5 Month of ARPU

300300350315300325260ARPU (Rs/month)








52,20752,27764,357Equity value (Rs m)

(2,500)2,5003,250Less: Debt (Rs m)

49,707 54,77767,607Total EV (Rs m)


10,9289,53010,16611,4749,5309,4408,451EV / subscriber (Rs)

36.4 31.8 29.0 36.4 31.8 29.0 32.5 Month of ARPU

300300350315300325260ARPU (Rs/month)




JUNE 2010 53

IDFC Securities

Key Risks

Cable industry Given the high dependence on unorganized LCOs, we believe execution is the biggest risk faced by the cable industry. Besides this, key risks pertain to faster roll-out of DTH, entry of new funded players and technological changeover (particularly broadband).

Execution

Given that cable industry is in the initial phase of digitization, there could be substantial resistance from LCOs. We believe on-ground execution would be the biggest challenge to ensure LCOs’ acceptance as also gradually improve declaration levels without disrupting the trade.

Faster roll-out of DTH

We expect DTH industry to add 8m subscribers in 2010; the technology is incrementally eating into the subscriber base of cable industry. Any delay in digital cable roll-out would mean increasing threat from DTH. Also, as DTH eats into the cable industry’s subscriber base, the economics of primary acquisitions done so far would be under stress.

Entry of new funded players

Entry of new funded players in the cable space could spell trouble for the cable industry as it could again start the race for aggressive subscriber acquisition. However, we do not expect the risk to play out as the sector has always been open to 49% FDI and we do not expect any telecom player to foray in this business.

Technology changeover

Technology upgrade is a constant threat that the cable industry is exposed to. The current STB installation done by cable operators is the basic and to offer VAS and two-way interactivity, existing STBs will need to be replaced. For instance, broadband prospects can be impacted by rapid growth of WiFi and WiMax. Unlike in USA, where wireless technologies came in after many years of broadband emergence, WiFi is already there in India and WiMax licenses would be issued soon.

DTH industry Irrational price wars

While profitability is just round the corner for the DTH industry, irrational price wars could upset the cart. However, we do not see this happening in the near future as the likes of Bharti and Reliance ADAG are already facing immense pressure on telecom business profitability and will not be in position to play irrational price wars. Tata Sky, positioned at the top end, will rather not dilute its premium positioning.

Technology changeover and demand for high end STBs

Given the rapid volume growth driven by subsidies, DTH operators are seeding basic STB models that do not support two-way interactivity and DVR facilities. As demand for value added services increases, these STBs would need to be replaced – resulting in another round of subsidization or churn.

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IDFC Securities

Evolution of cable & DTH in the US

With a view to understand evolution of the Indian C&S market, we tried to compare it with global trends. While China is the largest C&S market with 160m homes, the content is highly regulated. Other Asian markets like Malaysia are too insignificant in terms of subscriber base and, more importantly, are dominated by a single platform – DTH, with UK market too mainly on this platform. So far, USA has been the only market characterized by non-regulated content supply, co-existence of cable and DTH and relevant C&S scale. Besides, USA’s C&S market has other similarities with the Indian market including a fragmented nature of the cable market in the initial years, growth of DTH on the back of cable-dark areas and heavy subsidies. Hence, we draw upon USA’s C&S evolution to understand the Indian C&S market’s evolution. USA currently has a base of 100m C&S homes with 34m DTH and 62m cable homes. Of the total, 84-85m homes are digitized.

Evolution of cable industry in the US The 62m homes US cable industry has been stagnant at 1995 levels. Since the advent of DTH, incremental subscribers have opted only for DTH. Yet, revenues of the cable industry have grown from $27bn in 1995 to $89bn currently (9.7% CAGR). The evolution of cable industry in the last 15 years can be segregated into consolidation, digitization, ARPU improvement and subsequently enhanced revenue models.

Exhibit 74: While number of cable homes remains flat… …US cable industry revenues have grown at rapid pace


Consolidation phase: As DTH grew multifold in the late-1990s, smaller cable systems turned economically unviable due to mass-shifting of consumers to the DTH platform. This led to large-scale consolidation in the market. Comcast, the largest cable operator today, went on an acquisition spree between 1996 and 2003. Of the total 21m cable subscribers that Comcast had by 2003, we believe more than half were acquired through the inorganic route (customers from EW Scripps, Maclean Hunter’s US business, AT&T broadcasting, etc). With 4.28m subscribers in 1996, Comcast was just 7% of the cable industry then and accounts for ~40% of the market now. Consolidation in the market continues with CableVision buying Bresnan – the 13th largest MSO with 0.3m subscribers. Overall, the number of cable systems in the US came down from 11,408 in 1998 to 7,677 in 2009. Today, top five cable operators account for ~73% of the market.

(m)

61.6

64.2

65.966.9

6665.4 64.9

62.1

56

59

62

65

68

1,995 1,997 1,999 2,001 2,003 2,005 2,007 2,009

(US$ bn)

0

29,80237,391

45,44754,394

65,678

78,824

89,901

25,000

50,000

75,000

100,000

1997 1999 2001 2003 2005 2007 2009

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IDFC Securities

Exhibit 75: Comcast – acquisition-led growth… …driving industry consolidation


Digitization – early-2000: With DTH driving consumers towards digital technology, emergence of digital cable was a given (also a compulsion). From a negligible digital home base in 1999, US currently has 42m such homes and Comcast has 18.4m digital cable homes. In the last five years, Comcast has not been aggressive on expanding the base but is more focused on digitization and monetization (ditto for Time Warner Cable and Cable Vision).

Monetization – yield and enhanced revenue models: Consolidation of the industry was followed by digitization and subsequently monetization. While ARPU for basic video has registered 5.5% CAGR since 2000, overall ARPU improved by 8.8% CAGR to $118 per month on the back of emergence of other streams of revenues like VAS, advertising, high-speed internet and telephony. Of the $89.9bn cable industry, $36bn is accounted for by non-basic video streams. Comcast’s revenues have witnessed 13% CAGR since 2004, despite addition of only 2m subscribers. This is largely driven by scale-up of the digital subscriber base to 18.4m (15.9m internet and 7.6m telephone subscribers). While basic video revenues registered 9.7% CAGR, internet revenues saw 21% and telephony revenues 39% CAGR over the period.

Exhibit 76: Increasing share of non-video revenues in the US Enhanced revenue model of Comcast


USD165bn of capex in last 15 years Cable industry in the US has been highly capital intensive with $165bn of investments made so far and current annual capex of $14bn (<20% of industry revenues). We believe that capital expenditure in the US has been extremely high on account of the following reasons – high cost of laying fibre optic network, higher STBs (more importantly with enhanced technology) and continued consolidation.

Subscribers

0

4.45.7

8.5

17.8

20.3

24.1 23.6

7

14

21

28

1997 1999 2001 2003 2005 2007 2009

Comcast Corporation34.9%

Time Warner Cable, Inc.19.1%

Others26.6%

Charter Communications, Inc.

7.2%

Cablevision Systems Corporation

4.5%

Cox Communications, Inc. I

7.7%

0

25,000

50,000

75,000

100,000

1997 1999 2001 2003 2005 2007 2009

Residential Video All Other Revenue

0

10000

20000

30000

40000

2004 2005 2006 2007 2008 2009

Video High Speed Phone Advertising Other Franchise fees

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IDFC Securities

Challenges faced by US cable industry today While US cable industry emerged unscathed from competition in the form of DTH, it is incrementally facing competition from entry of telecom operators like AT&T and Verizon into the cable business. As triple play offering helped cable companies emerge as a relevant competition to telecom operators (Comcast is the largest residential telephony and internet service provider too), telecom operators made a foray into the cable space and now have 5m subscribers between them. This, we believe, could result in intense competition and risk to cable ARPU. While cable business makes a logical extension for telecom companies, telcos in India have forayed into DTH given it organized nature. However, this threat cannot be ruled out in the long run given that fibre networks are owned by telcos.

Evolution of DTH – heavy subsidies and cable-dark areas USA is currently world’s largest DTH market with 33m subscribers with DirecTV and Dish Network dominating the space. Commencing operations in 1990s, the platform has scaled up from 13m homes in 2000 to 33m now. Like in India, DTH industry in the US never enjoyed content exclusivity and hence grew on the back of heavy subsidies. Also, growth in the initial years came in from cable-dark areas. Besides, DTH industry growth was also propelled by the emergence of national broadcasters, while cable was focused on local content.

Heavy subsidization: While extremely high customer premise equipment cost ($600 then) had resulted in sluggish penetration of DTH in the early-1990s, the industry grew manifold once these costs fell led by heavy consumer subsidies in the wake of increasing competition (launch of Dish Network and Prime Star in 1996). (This is akin to India, where 10m subscribers were added in the last 15 months – as many as added in the first four years.) Besides access to a few movie and sports properties, heavy subsidy and better picture quality have been the key factors driving the shift from analogue cable to DTH. As of today, DTH operators spend $700 (10 months of ARPU) towards SAC.

Little content exclusivity: As in India, the US also operates on ‘must-carry’ rule – which implies no content exclusivity even as cable industry in the US is more focused on local content than on a national network. This gives some leeway to DTH players to offer ‘differentiated’ international sports events and movies on pay per view format. Incidentally, there was then only one movie channel in the US (HBO) against more than 10 channels in India.

Cable-dark areas: In 1990s, 30% of the US market was in cable-dark areas. Thus, DTH industry initially grew by reaching out to cable-dark areas (a trend also noticed in the Indian DTH market). Notably, since the advent of DTH, C&S homes in US have grown entirely on the DTH platform with the number of cable homes remaining at 1995 levels.

Allowing local content: A key differentiating factor between the two industries is that there is narrowcasting first in US and then broadcasting, whereas it has been the other way round in India. Almost 50% of the viewership has been for local channels. Until two years ago, DTH players were not able to offer local content. However, in the last two years, local content has been allowed on DTH network. DTH industry has added 5m subscribers in the last two years.

Exhibit 77: DTH driving the growth in the US DirecTV and Dish dominating the space


0

20

40

60

80

61.664.2 65.9 66.9 66.0 65.4 64.9

62.1

6.410.5

15.020.2

24.829.7

33.738.9

1,995 1,997 1,999 2,001 2,003 2,005 2,007 2,009

Cable DTH

DirectTV47.8%

Dish Network36.2%

Other DTH15.9%

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IDFC Securities

India context We believe India too will tread a similar trend given the similarities between the two markets. Like in the US, the first round of digitization in India has been driven by DTH with 18m homes by 2009, though cable would surpass DTH in the long run. Also we expect Indian cable market to consolidate rapidly, as smaller LCOs and independent operators find it difficult to fund digitization and customer subsidies. What is common and what is not between India now and US C&S market then? Similarities Like India in 2005, cable industry in the US was well-entrenched before the advent of DTH in 1990s. USA had

nearly 52m cable subscribers at the time of DTH launch, as against 60m+ cable homes in India

USA’s cable distribution market was highly fragmented in 1990s with the largest player having 10% share.

First round of digitization boom in the US was driven by DTH; USA had 14m digital DTH homes by early-2000, and digitization of cable platform followed

The initial growth in USA’s DTH industry came in from cable-dark areas and on the back of heavy subsidies

Both the countries have over-supply of content. India has +400 channels currently operational

Dissimilarities In the US, cable companies controlled the last mile, while few MSOs own the last mile in India

While India has been a broadcasting market and regional focus is happening gradually, USA was predominantly a narrowcasting market (local channels account for >50% of advertising revenues) – and then came in broadcasting. This helped cable companies maintain supremacy for a longer period given their access to local content

Cable infrastructure, in terms of fibre network, in the US has been owned by cable operators, whereas telecom operators have done this in India.

DTH market in the US is a duopoly with dominance of DirecTV and Dish Network, whereas Indian DTH market has six players in the race and the leader accounts for a 30% share of the market.

Cable ARPU in USA was at $30 per month in 1990s as against $4 in India.

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Companies

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DEN Networks (DEN) has, within two years of operations, emerged as India’s second largest MSO with an estimated reach of 10m and 1.1m paying subscribers. With aggressive secondary point acquisitions (67 till date), DEN is well-entrenched in 77 cities across nine states. While DEN will continue to pursue inorganic growth, it plans to plough Rs1.6bn in digitization over the next three years. A funded balance sheet (Rs3.6bn of IPO proceeds) and the need to ‘secure’ the existing base would enable DEN to add 3.1m digital homes and increase its paying base to 3.8m by FY13E. Improved declaration levels and a stronger revenue model are expected to drive 43% CAGR in DEN’s cable revenues to Rs13.2bn over FY10-13. Syndication business under Star-DEN (Rs6bn in FY13E for 50% share) will also add to the scale. DEN’s proven execution capabilities provide comfort on its ability to emerge as a formidable consolidator in the cable industry. We initiate coverage on DEN with Outperformer and an 18-month price target of Rs292.

Commendable feat: With limited capital, urgency to scale up and economics supported by better carriage, DEN has been in an aggressive secondary point acquisition mode in the past two years to attain a reach of 10m homes and 1.1m paying subscribers. DEN has invested Rs3bn in acquiring majority stake in 67 MSOs and ISOs across Karnataka, Delhi, NCR, UP, Gujarat, etc. While the cable business has scaled up to Rs4.5bn as of FY10, Star-DEN (50:50 JV with Star for syndication) offers scalability with revenues of Rs4.7bn (for 50% stake).

Change in tack towards digitization: Having acquired critical mass, DEN’s focus has shifted to STB seeding for securing the subscriber base as also improving declaration levels. With Rs1.6bn of funds earmarked for digitization and increased acceptance from LCOs, we see DEN adding 3.1m STBs to its existing reach of 0.4m. While ARPU-led growth would happen only gradually, monetization would happen in the form of higher declaration, digitization revenues, and streams like broadband.

High growth visibility; Outperformer: We see 29% revenue CAGR for DEN over FY10-13 with 60% CAGR in subscriber revenues, 5% CAGR in carriage revenues and 12% CAGR in Star-DEN JV. As MSOs retain most of the gains from the initial round of monetization, we expect DEN’s operating profit to grow 6.5x with PAT of Rs2.1bn in FY13. The management’s aggressive approach to growth offers added comfort on execution.

Key valuation metrics Year to 31 Mar FY09 FY10 FY11E FY12E FY13ENet sales (Rs m) 7,122 9,191 11,288 14,316 19,651 Adj. net profit (Rs m) (151) 303 461 908 2,077 Shares in issue (m) 18 130 130 130 130 Adj. EPS (Rs) (8.3) 2.3 3.5 7.0 15.9 % change (36.9) (127.8) 52.3 96.9 128.9 PE (x) n/a 85.4 56.1 28.5 12.4 Price/ Book (x) 1.6 3.4 3.2 2.7 2.1 EV/ EBITDA (x) 90.1 28.2 17.2 10.3 5.7 RoE (%) (7.1) 6.1 5.9 10.3 19.2 RoCE (%) (4.3) 8.8 9.7 17.1 29.6

80

90

100

110

23-Nov-09

23-Dec-09

23-Jan-10

23-Feb-10

23-Mar-10

23-Apr-10

23-May-10

23-Jun-10

DEN Networks Sensex

Price performance

Bloomberg: DEN IN 6m avg daily vol. (m): 0.061-yr High/ Low (Rs): 220/150 Free Float (%): 46.3

Reason for report: Initiating coverage

Rs198

Mkt Cap: Rs25.8bn; US$556.1m

OUTPERFORMER

DEN Networks Execution speaks for itself!




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EXECUTIVE SUMMARY Established in 2008, DEN has already emerged as the number two MSO in

India with cable revenues of Rs4.5bn and 1.1m paying subscribers

Secondary point acquisition strategy has worked; next step is to secure the primary points through seeding of STBs

The course of business could change materially going forward as we expect DEN to focus on digitization and also remain aggressive on inorganic growth (including large MSOs)

With Rs3.6bn raised recently, DEN expected to add 3.1m digital subscribers by FY13 to the 0.4m base; overall paying subscribers to grow to 3.8m

We value the business on EV/ subscriber basis and arrive at a fair value of Rs292 per share

Strong on execution: Second largest in two years

Promoted by Sameer Manchanda and backed by the TV18 Group, DEN forayed into cable distribution in late-2007. An aggressive management and $65m invested by IL&FS and EMSAF have helped DEN cover significant ground within this short span of time via the acquisition route. DEN has emerged as one of the fastest growing MSOs with reach of ~10m homes and 1.1m paying homes. Following the Comcast (world’s largest cable operator) model of growth and the only option available then, DEN has acquired 67+ Independent Cable Operators/ MSOs and LCOs and has extended its presence across 77 cities of India. A 50:50 JV with Star India for content syndication has further added to the scale. DEN has clocked revenues of Rs9.2bn, EBITDA of Rs898m and PAT of Rs303m in FY10.

An impressive paying subscriber base of 1.1m… Within two years of operations, DEN has scaled up its business reach to 10m homes, of which 1.1m are paying subscribers. While 85% of these are secondary points, DEN also owns 175,000 primary points. In terms of paying subscribers (1.1m), it has as many paying subscribers as Digicable and in terms of revenues (Rs4.5bn of cable revenues in FY10), DEN is the second only to Hathway (1.6m paying subscriber base and Rs7.1bn of revenues). In the digital services space too, which DEN entered in February 2008, it has already garnered a base of 0.4m subscribers.

Exhibit 1: DEN – second largest in terms of paying subscribers as well as revenues


1.6

1.1 1.1

0.7

0.5

0.0

0.4

0.8

1.2

1.6

Hathway DEN Networks Digicable WWIL InCable

No. of paying subscribers(m)

7.1

4.5

3.12.73.0

0.0

2.0

4.0

6.0

8.0

(Rs bn)

Hathway DEN Networks Digicable WWILInCable

Revenues

Rapid scale up in twoyears on the back of 67

acquisitions and syndication JV

Second largest national MSO with 1.1m paying

subs and Rs4.5bn of cable revenues

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IDFC Securities

…driven by aggressive acquisition of MSOs and LCOs With limited capital availability and urgency to scale up, DEN decided to be aggressive on secondary point acquisition across India. In the first nine months of operations, DEN had acquired a majority stake in 22 MSOs with 45 MSOs acquired subsequently. While DEN has extended its presence across 77 cities in Uttar Pradesh (22 acquisitions), Karnataka, Maharashtra, Gujarat (10), Rajasthan, Haryana, Madhya Pradesh, Kerala and NCR, it has adopted the ‘cluster strategy’ to optimize on the carriage and content deals. MSO acquisition has given DEN access to 112 analogue Head Ends and 16 Digital Head Ends besides access to the laid-out cable network. Apart from secondary acquisitions, DEN also has access to 175,000 primary points. DEN has invested a cumulative Rs3bn through cash & equity swap in acquiring majority stakes in these companies with the deals involving asset and business transfer and entailing a value of Rs5,000-6,000 per paying subscriber.

Exhibit 2: DEN has a reach across 77 cities

Source: Company

Rajasthan

Madhya Pradesh

Uttar Pradesh

Haryana

Delhi & NCR

Maharashtra

Gujarat

Karnataka

Kerala

NasikNavi MumbaiPune

DelhiGurgaonFaridabadGhaziabadNoida

LucknowKanpurAllahabadMeerutMoradabadBudaunAligarhShukla GanjGorakhpurJaunpurUnnaoBarelliFarukabadJhansiVaranasiMughal SaraiFirozabadHathras

CochinPalakkadAlleppyTrichurAluvaKunnukara

RajkotBarodaJamnagarSurat

GwaliorJabalpur

JaipurTonkKotaUdaipurJodhpur

BangaloreTumkurGadagDharwadGulbargaKopalBellaryHubliUdupiMandyaHassanMysoreRaichurShimogaKadur

Bangalore Rural – AmruthahalliBagalkotBidarRannebennurHariharDavanagereHospetBhatkalChanapattnaChanarayapatnaK.R.PetBirurChintamaniKumtaRamanagara

SirsaYamunanagarSonepatPalwal

Rajasthan

Madhya Pradesh

Uttar Pradesh

Haryana

Delhi & NCR

Maharashtra

Gujarat

Karnataka

Kerala

NasikNavi MumbaiPune

DelhiGurgaonFaridabadGhaziabadNoida

LucknowKanpurAllahabadMeerutMoradabadBudaunAligarhShukla GanjGorakhpurJaunpurUnnaoBarelliFarukabadJhansiVaranasiMughal SaraiFirozabadHathras

CochinPalakkadAlleppyTrichurAluvaKunnukara

RajkotBarodaJamnagarSurat

GwaliorJabalpur

JaipurTonkKotaUdaipurJodhpur

BangaloreTumkurGadagDharwadGulbargaKopalBellaryHubliUdupiMandyaHassanMysoreRaichurShimogaKadur

Bangalore Rural – AmruthahalliBagalkotBidarRannebennurHariharDavanagereHospetBhatkalChanapattnaChanarayapatnaK.R.PetBirurChintamaniKumtaRamanagara

SirsaYamunanagarSonepatPalwal

0.7

0.0

0.8

0.1

0.9

0.2

0.0

0.3

0.6

0.9

1.2

(m)

FY08 FY09 FY10E

Secondary subscribers Primary subscribers

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IDFC Securities

Carriage fees justified secondary point acquisition With new entrants in the cable space as also incumbent Hathway going on an acquisition spree, the cost of acquisition shot up to Rs4,500-5,500 per paying secondary point and Rs7,000 per paying primary point (i.e. 2-2.5 years of ARPU or 8x EV/ EBITDA). While the costs were not justified on pure economics of subscription revenues at the time of acquisitions, the strategy nevertheless imparted the ability to garner higher carriage fees, drive better content deals and potential to improve declaration levels in the future. As DEN has scaled up in clusters (e.g. reaches out to 70% of the UP market), it is better placed to earn a higher carriage fee. DEN earned Rs2.2bn in carriage revenues in FY10 for 1.1m paid subscribers – Rs2,000 per paying subscriber per year as against Rs1,850 for Hathway.

DEN’s carriage revenues are 60-70% higher than the cumulative carriage fees collected by independent operators prior to being acquired. Also, consolidation of cable distribution by DEN has given it more bargaining muscle on content deals in the capacity of a national MSO. These two aspects immediately change the economics of the business and thereby justify DEN’s secondary point acquisition strategy – especially as the effective payback period of acquisitions has come down to three years as against seven years earlier. Though primary point acquisition strategy offers better business economics at the onset (100% declaration on day-1), merit of the MSO acquisition route lies in the potential to improve the declaration levels.

Exhibit 3: Better carriage and lower content cost post acquisition

Time of acquisition Post acquisition Customer acquisition cost - per sub 600 600 Number of subscribers 10,000 10,000 Total acquisition cost (Rs m) 6.0 6.0 Declaration levels 12.0% 12.0% Paying subscribers 1,200 1,200 Average ARPU per month 160 160 Total subscription revenue collection (Rs m) 2.3 2.3 Carriage revenues - Rs m 1.6 2.3 Total Revenues 3.9 4.6 Content Cost and placement cost - per sub 170 165 Total content and placement cost 2.45 2.38 Other operating costs 0.58 0.58 Total costs 3.0 3.0 Operating profit / (loss) 0.88 1. 60 Payback period 6.8 3.7 Source: IDFC Securities Research

Star-DEN JV – adding to scale and stability In January 2008, DEN entered into the syndication business through a 50:50 JV with Star Network. The JV is an aggregator and distributor of 25 channels (Star Network, select TV18 Group channels and Times group among others) across India, Nepal and Bhutan on analogue cable, digital cable as also the DTH platform. In comparison, Zee Turner has 33 channels and Sony One Alliance has 20 channels. With revenues of Rs9.3bn, Star-DEN is the largest syndication bouquet (Zee at Rs7bn and Sony Rs6.8bn). The cumulative weekly GRPs of the channels distributed through Star-DEN network are at ~675. Star-Den JV currently clocked revenues of Rs9.3bn (for 100% entity) and EBITDA of Rs475m in FY10. Being a part of one of the largest MSOs, Star-

MSO acquisition costs shot up to 2-2.5 years of

ARPU…

…justified by ability to scale up carriage collection

by 60-70%

With Rs9.5bn of collection, Star-Den is the largest

syndication bouquet in terms of revenues…

Increasing carriage stream of revenues justified the

economics of acquisition

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IDFC Securities

DEN JV is better placed to ensure higher collections from the cable industry. For DEN, the deal also offers stability and higher returns at low capital involvement.

Exhibit 4: GRPs of various syndication bouquets

795

667600

0

200

400

600

800

Sony One Allaince Star DEN Alliance Zee Turner Source: Industry estimates

As per the deal between Star and DEN, Star has an option to increase its stake by 1%, which is exercisable in a 30-day period once in a year from January 2010. However, in that scenario, DEN has a put option on the remaining 49% stake. In case of a default by DEN, Star can buy the stake from DEN at a price 20% lower than the market value. However, in case of default by Star, DEN’s stake will have to be bought over by Star at market value.

Profitable within two years Given the pace at which DEN has grown on ground, it has already become a Rs9.2bn business (100% of cable business and 50% of Star-DEN JV) in FY10. Of the total revenues, subscription-based cable revenues are at Rs2bn. DEN generated Rs2.3bn in carriage revenues and Rs4.7bn from Star-DEN (50% equivalent) operations in FY10.

Exhibit 5: Rapid revenue scale up Revenue mix


826

7,122

9,191

0

2,500

5,000

7,500

10,000

FY08 FY09 FY10E

Revenues

(Rs m)

Carriage Fees24%

Star DEN51%

Other3% Subscription

revenues22%

…whereas it is the second largest in terms of

cumulative weekly GRPs

Business scaled up to Rs9.2bn - Rs4.5bn from cable and Rs4.7bn from

Star-DEN

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Not only has DEN been the fastest growing MSO in terms of revenues, it is also the fastest to turn profitable in India. DEN reported EBITDA of Rs898m and PAT of Rs303m (Rs159m of PAT from Star-DEN) in FY10.

Exhibit 6: DEN – India’s only profitable national MSO

898

1,216

-751

303

-705

-1,753-2,000

-1,300

-600

100

800

1,500

DEN Networks Hathway WWIL

EBITDA PAT(Rs m)


Strong management team – a critical success factor DEN is steered by a strong management team with personnel having worked with industry leaders including SET Discovery, IndusInd Media, Tata Sky, etc and media business experience for over a decade. Sameer Manchanda, the promoter, has been in the media business for 25+ years with expertise in broadcasting and distribution verticals. He is accredited for starting IBN18 – the TV18 group company owning successful properties like CNN IBN, IBN7 and Colors. As a Joint MD of IBN18, he played a key role in roping in international partners like CNN and Viacom. The execution of the past two years is also a testimony of the capability of the management. S N Sharma, who heads the operations, has been in the business of handling LCOs for 23 years. Given that cable business is heavy on execution, a strong management team would be a key differentiating factor in the coming years.

Exhibit 7: DEN’s management team

Name Designation Experience Sameer Manchanda Promoter 25 years+ of experience in media. Jt MD of IBN18. Anuj Gandhi CEO 14 years of experience in media industry - SET Discovery, IndusInd Media S N Sharma President, Operations 23 years of experience in media industry - Hathway, IndusInd Media Vikas Bali President, Digital Services 14 years of experience in media industry - Tata Sky, Star India Navroz Behramfram CTO 25 years of experience in media and telecom - Tata Sky, Hathway Cable Mohammad Azhar President, Strategy and 15 years of experience in strategy and financial planning – Access Business Development Financial Services Rajesh Kaushall CFO 13 years of experience - PwC, Lucent Technology, Tekelec Systems

Commendable feat of being the first MSO to turn

profitable

Management team with vast experience across cable and DTH platform

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Changing Tack: Digitization the way forward

Having acquired critical mass (reach of 10m and a 1.1m paying subscriber base) and raised Rs3.6bn of public equity, DEN’s focus is shifting from ‘customer acquisition’ to ‘digitization’ and ‘monetization’. While digitization would reduce the risk of losing LCOs (or subscribers), monetization would happen through higher declaration rather than ARPU growth. We expect DEN’s overall paying subscribers to increase from 1.1m now to 3.8m (including 1m primary points) and the overall digital subscriber base to increase to 3.5m by FY13.

Balance sheet funded for growth While Rs2.8bn of funds initially raised from IL&FS and EMSAF have been utilized for subscriber acquisitions, DEN has recently raised Rs3.6bn through public issuance. These funds are planned to be largely utilized for upgrading the existing infrastructure as also towards digitization. Of the total proceeds, Rs1.6bn has been earmarked for Set Top Boxes and Rs250m for cable broadband infrastructure. DEN is also expected to meet its capital commitment of Rs600m+ payable on past acquisition. The low debt component further gears up the healthy balance sheet of DEN, which has demonstrated best value creation till date as compared to peers.

Exhibit 8: Objects of issue

Rs m Development of cable infrastructure and services 2,100 Digital STB 1,650 Head Ends - digital and analogue 150 Coaxial fibre network 150 Upgradation cost 150 Cable broadband network 250 Acquisition of content and broadcasting rights 100 Loan repayment 400 General purpose expenditure 525 Total 3,375 Source: Company RHP

Digitization – the only way to secure customer base DEN had forayed into digital cable in February 2008 through its brand ‘Digitelly’. DEN has already digitized 0.4m subscribers so far. Having taken the secondary point acquisition route, the biggest challenge for DEN going forward would be to secure the LCOs under independent operators acquired by DEN. Given the increasing penetration of DTH as also fear of losing out LCOs to competitors, DEN will step up its aggression on seeding of STBs. Digitization would make LCO acquisition expensive for other MSOs as also secure the primary point to avoid switchover to the alternate digital platform – DTH. With Rs1.6bn lined up for digitization and increasing acceptance from LCOs, we expect DEN to add digital subscribers at the pace of 50,000 per month in FY11, further increasing to 125,000 per month by FY13. We expect DEN to have 3.5m digital subscribers by FY13.

Rs3.6bn of recent fund raise through IPO gives DEN adequate capital…

…of which Rs1.6bn would go in funding digitization

As ‘digitization’ becomes the only way to secure

subscriber base…

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Exhibit 9: Digital subscriber base scale-up

0.2 0.20.4

1.0

1.9

3.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

FY08 FY09 FY10 FY11E FY12E FY13E

Digital subscribers (m)


Declaration-led monetization Digitization in the near term may not necessarily translate into monetization, as we expect little change in declaration levels in the initial stage. To avoid LCO resistance in seeding Set Top Boxes, DEN is not pushing aggressively on this count. This implies that while DEN would continue to collect for as many subscribers as earlier in the near term, digital STBs seeded may be disproportionately higher vis-à-vis the declared customer base. The monetization would initially happen only in the form of upfront revenues on seeding of STBs (Rs1,000 per unit at present). Revenues from rentals on STBs, however, are unlikely to be material in the near term. Nevertheless, once DEN manages to digitize 25-30% of the households under an LCO and plugs the option for the LCO to switch to another MSO, it will be in a position to start pushing for higher declarations. Paying subscribers under a secondary point, we believe, would increase by just 0.2m in FY11 and gather steam only in the subsequent years. We expect DEN’s overall paying subscriber base to increase from 1.1m now to 3.8m by FY13, including 1m primary subscribers. Of the additional 2.7m incremental paying subscribers, 1m would be through the inorganic route and the remaining on the back of improved declaration levels.

Exhibit 10: Growing paying subscriber base

0.7 0.8

0.10.9

0.2

1.1

0.31.9

0.5

2.7

1.0

0.0

1.0

2.0

3.0

4.0


Secondary subscribers (m) Primary subscribers (m) (m)


As MSOs’ focus is on seeding STBs first, ARPU

growth to happen gradually

…DEN to scale up to 3.5m digital homes by FY13E,

from 0.4m in FY10

Digitization to enhance ‘declaration’ to 3.8m by

FY13E

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IDFC Securities

Acquisition strategy – ‘the Comcast model’ Consolidation in the cable industry is imminent and the journey of Comcast, world’s largest cable operator, suggests that inorganic growth is an important component of the business strategy. We see the Indian cable industry also moving towards consolidation, which would throw up significant acquisition opportunities for leading operators. As digitization accelerates on DTH as well as the cable platform, smaller cable operators would take a hit. While lack of capital to digitize would result in shift of subscribers to DTH, independent operators would tend to see pressure on carriage revenues as well. This would thereby jeopardize business economics of smaller independent players and trigger consolidation. We expect DEN to spend Rs3bn on 0.86m primary and 0.5m secondary subscriber acquisitions over the next three years. Also, given that not all players are adequately funded and threat of DTH is at the prime, acquisition costs have also come down from the peak of Rs7,000 per primary point in 2008 to ~Rs5,000 with scope to move further down.

Business Economics Set to Improve Markedly

DEN is the only profitable MSO in India – and that reveals the inherently poor economics of the business. Though the steep rise in carriage fees witnessed over the past two years has been a boon for cable operators, we expect a fundamental improvement in economics driven by better declaration levels and a stronger revenue model (rental income, broadband income, advertising potential, etc). The entire benefit of the imminent first round of cable digitization, we believe, will flow to cable operators. In this backdrop, we expect DEN’s overall revenues to grow to Rs19.6bn, operating margins to improve to 26% and PAT of Rs2.1bn by FY13.

Declaration and a stronger revenue model in cable business We expect DEN’s cable business revenues to register 43% CAGR as declared subscriber base increases from 1.1m now to 3.8m by FY13E and with emergence of other revenue streams like STB rentals, and digitization and broadband revenues. Carriage revenues are likely to show a steady 5% CAGR over this period. We expect DEN’s cable business revenues to grow from Rs4.5bn in FY10 to Rs13.2bn by FY13.

Exhibit 11: 43% revenue CAGR… …with contribution growing faster


3,446

4,519

5,915

8,405

13,150

0

3,500

7,000

10,500

14,000


Cable business(Rs m)

Subscription51%

Digitization fees &rentals15%

Carriage fees20%

Broadband 10%

Advertsiing & VAS4%

43% CAGR in cable revenues over FY10-13E

to Rs13.2bn

DEN to spend Rs3bn over FY10-13E on acquiring

0.86m primary points and 0.5m secondary points

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IDFC Securities

Subscription-led revenues – Basic + Rentals + STB sale We expect 60% CAGR in DEN’s subscription revenues to Rs8.8bn over FY10-13 with 51% CAGR in basic cable revenues to Rs6.8bn. Growth in basic cable revenues would be driven by improved declaration, whereas we expect a limited 5% CAGR in ARPU. Also, ARPU will increase gradually as the focus would initially be on digitization. Besides basic video revenues, DEN is expected to garner Rs1.9bn of revenues in STB rentals and digitization fee by FY13 (Rs168m in FY10). While the industry claims to be charging rentals on every STB seeded, we believe DEN would be able to collect rentals from only 40-50% of the homes in the face of LCO resistance. DEN is expected to generate Rs1.2bn of revenues as one-time digitization fee (the upfront Rs1,000 it receives per STB at the time of installation). We expect slow pick-up in VAS revenues, with negligible contribution to overall revenues.

Exhibit 12: 60% CAGR in subscription revenues over FY10-13E

0

2,500

5,000

7,500

10,000

FY10 FY11E FY12E FY13E

Subscription revenues STB Rentals Digitization fees VAS(Rs m)


Broadband revenues – a gradual pick-up Broadband is typically a key revenue driver for the cable industry globally. Of the total 62m cable subscribers in USA, 42m subscribe to the high-speed internet and broadband services (i.e. 50% of the total broadband connections are serviced by cable operators). Comcast, the largest cable operator in the country, is also the largest broadband player. In contrast, India – while being low on broadband penetration (just 3%) – has only 10% of the connections being serviced by cable operators. Going forward, we expect cable operators to play a relevant role in driving broadband penetration, but we also foresee stiff competition from wireless broadband and WiMax. DEN has earmarked Rs250m from the IPO proceeds for scaling up the broadband business and we expect DEN to add 0.7m subscribers (revenues of Rs1.3bn) by FY13. Scalability of broadband operations is critical to the business given the high profitability (45-50% operating margin).

Subscriber led revenues to grow at 60% CAGR with basic pay growing at 51%

CAGR

Broadband revenues at Rs1.3bn by FY13E with

0.7m subscribers

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IDFC Securities

Exhibit 13: India too low on penetration… …but set to grow rapidly

Source: IDFC Securities Research, Industry estimates

Carriage fees – growth to be slow but steady While DEN has adequately capitalized on the consolidation benefit by garnering high carriage fees, growth would only be gradual from here. Contrary to general perception, we believe carriage fees will sustain – though the form may change to placement or advertising revenue share. While industry carriage revenues may stagnate, the stream would get concentrated in the hands of a few large MSOs. Post digitization too, carriage revenues would prevail as broadcasters will have to pay to be a part of the basic package of cable operators. We expect DEN’s carriage revenues to grow from Rs2.2bn in FY10 to Rs2.6bn in FY13.

Advertising revenues – potential upside Cable operators in the US are able to generate high revenues through advertising on local cable channels as also a share of advertising revenues from broadcasters (in lieu of placement fee). In India, advertising forms an insignificant part of operators’ revenues, though we expect this stream to multiply on the back of improved local-centric businesses like retail and better saliency post consolidation. Having consolidated 67 operators in the past two years, DEN is well placed to market advertising slots across its local cable channels. While we are building in only Rs420m of advertising revenues by FY13E, we see considerable upside risk to these numbers.

Even a marginal delta in declaration a major boost to profitability While declaration levels would improve gradually, even a marginal rise has the potential for a marked increase in cable operators’ profitability as content cost payout would lag the growth rate in subscription revenues. We expect content cost increase for DEN to be at 33% over the next three years as against subscription revenue CAGR of 51%. This would drive substantial improvement in the company’s cable business margins. For instance, a shift from 10% declaration levels to 12% in a market of 10,000 subscribers would mean that operating profit would increase from Rs1.36m to Rs1.7m (up ~30%). Profits would increase by 2.3x if declaration levels double to 20%.

99

84

7

0

25

50

75

100(m)

China US India


0.0

3.5

7.0

10.5

14.0

2.23.0

5.5

7.2

8.7

10.3

12.0

(m)

2006 2007 2008 2009 2010 2011 2012

30%

70%

3%

Penetration

Carriage fees to consolidate with few

large MSOs

If Indian cable industry tracks global trends,

advertising revenues offer significant upside

Retention of declaration gain – content cost increase of 33% CAGR vis-à-vis 51%

CAGR in subscription revenues

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IDFC Securities

Exhibit 14: Improving economics with better declarations

Declaration levels 10.0% 12.0% 15.0% 18.0% 20.0% 25.0% Paying subscribers 1,000 1,200 1,500 1,800 2,000 2,500 Average ARPU per month 160 160 160 160 160 160 Subscription revenues (Rs m) 1.9 2.3 2.9 3.5 3.8 4.8 Carriage Revenues - Rs m 1.9 1.9 1.9 1.9 1.9 1.9 Total Revenues 3.8 4.2 4.8 5.4 5.7 6.7 Content Cost and placement cost - per sub 165 138 112 95 88 85 Total content and placement cost 1.98 1.99 2.02 2.05 2.11 2.55 Other operating costs 0.48 0.48 0.50 0.52 0.52 0.53 Total Costs 2.5 2.5 2.5 2.6 2.6 3.1 Operating Profit / (Loss) 1.36 1.73 2.26 2.79 3.11 3.62 Source: IDFC Securities Research

Operating leverage at the fore – 36% margins by FY13E With substantial operating leverage gains led by higher declarations, new revenue streams and stable content cost, we expect DEN’s cable business operating margins to expand from 14.6% in FY10 to 36% in FY13. Three key contributors to operating leverage gains would be upfront digitization revenues (one-time revenue booking as against STB amortization over five years), content cost (down from Rs145 per month to Rs125) and faster growth in the high-margin broadband business. We expect 30% CAGR in overall operating costs over FY10-13 as against a higher 43% revenue CAGR in the cable business. This implies operating margin improvement from 14.6% to 36% by FY13 and overall EBITDA of Rs4.7bn (higher than existing revenues).

Exhibit 15: Sharp improvement in margins… …cost structure


Star-DEN JV – a steady contributor As on-ground collection improves and India becomes the largest digital homes market (86m subscribers by 2015E), pay revenues of broadcasters would improve substantially. However, we maintain that the first round of monetization gain in the cable business would go to operators and not to broadcasters. Thus, we build in only 12% revenue CAGR for Star-DEN to Rs6bn (50% share of DEN) over FY10-13E. We expect Star-DEN JV to generate 6.8% margins and PAT of Rs310m by FY13.

14.6

21.7

29.0

36.1

0

7

14

21

28

35

FY10 FY11E FY12E FY13E

EBITDA margins

(%)

Content Cost52.7%

Personnel Cost8.8%

Placement Cost9.0%

Other operational cost

2.9%

Bad Debts1.5%

Administration cost

16.1%

Advertising and selling cost

9.0%

FY13E

Lower content cost and high margin broadband revenues

to drive margin improvement

Star-DEN business to register 12% CAGR over FY10-13E and earn 6-8%

margins

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IDFC Securities

Exhibit 16: Star-DEN – sustained 12% revenue CAGR …and sharper profit growth


Consolidated revenues of Rs19.6bn and PAT of Rs2.1bn by FY13E With 40% CAGR in cable business and 12% CAGR in Star-DEN JV, we expect 29% CAGR in DEN’s revenues to Rs19.6bn over FY10-13. We believe monetization would be gradual, and thus estimate a slower 25% CAGR in revenues in the next two years but a higher 37% revenue growth in FY13. EBITDA margins would improve from 9.8% in FY10 to 26.4% in FY13E. As DEN is expected to invest Rs5.4bn in gross block addition and be aggressive on digitization, depreciation would increase from Rs329m in FY10E to Rs1.2bn by FY13E. The recently raised Rs3.6bn of equity and improving internal cash flows of the business, we believe, will keep interest cost in check. We expect PAT to grow multifold from Rs303m in FY10 to Rs2.1bn by FY13.

Exhibit 17: 29% revenue CAGR… …and PAT of Rs2.1bn by FY13


Rs7.7bn of capex on cards… Funded for growth, and with aggressive digitization and acquisition plans, DEN is expected to invest Rs7.7bn in gross block addition over FY10-13. Of the total, an estimated Rs3.9bn would go towards seeding of Set Top Boxes and Rs3bn in MSO and LCO acquisition.

Revenues

3,676

4,672

5,373

5,910

6,501

0

1,750

3,500

5,250

7,000


(Rs m) Profit After Tax

23

159

203

230

311

0

80

160

240

320


(Rs m)

3,446 4,5195,915

8,405

13,1503,676

4,672

5,373

5,910

6,501

0

5,000

10,000

15,000

20,000


Cable business revenues Star DEN JV(Rs m)

PAT

-151

303 461

908

2,077

-500

150

800

1450

2100


(Rs m)

Expect 7x jump in net profit over FY10-13

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IDFC Securities

Exhibit 18 Gross block addition

Headend10.6%

Set Top Boxes50.2%

Goodwill on acquisition

29.8%

Other Corporate and expenses

1.9%

Broadband Capex7.5%


…DEN funded for the same DEN is expected to invest Rs7.7bn towards digitization, customer acquisition and broadband and would need ~Rs3bn in incremental working capital – which translates into a total capital requirement of Rs10.7bn. We believe DEN is adequately funded for the same with Rs3bn of available funds from IPO proceeds and Rs7bn of cash profit generation. Marginal capital requirement would be funded through debt (currently at Rs1.7bn). While DEN is unlikely to require incremental capital to fund the expected growth, it may need to raise money in case of a large MSO acquisition. We expect DEN to scout for large-size acquisition opportunities as the market starts consolidating.

Valuations & View

We see DEN not only as a survivor in the cable space, but also as a leading consolidator in the market. To grow rapidly, DEN could turn aggressive on acquisition of smaller LCOs/ independent cable operators as also large national/ regional operators. Given DEN’s aggressive approach towards growth and its proven execution capabilities, we initiate coverage on the stock with Outperformer.

We have valued the cable business on EV/ subscriber basis, which has been arrived at on the basis of months of ARPU. Economics of individual subscribers suggest that a secondary point can be valued at 29 months, primary point at 32 months and broadband subscriber at 36 months of ARPU. As per this method, primary point subscriber for DEN is valued at US$210 as against Comcast’s valuation of $3,500 per subscriber as the latter has ARPU 12x that of DEN. Deploying this valuation methodology on DEN’s 2.7m secondary points, 1.05m primary points and 0.7m broadband customers in FY13E, we have arrived at an EV of Rs49.7bn and equity value of Rs52.7bn for DEN. We arrive at an 18-month price target of Rs292 for the stock.

50% of capex towards digitization and 40% towards acquisition

Rs3bn of available IPO proceeds and Rs7bn of cash

profit generation sufficient to fund growth

Outperformer with 18-month target price of

Rs292

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IDFC Securities

Exhibit 19: Valuation – target price of Rs292

Secondary Pt Primary Pt Broadband Star DEN Total Number of subscribers 2.72 1.05 0.7 ARPU 350 300 300 Month of ARPU 29.0 31.8 36.4 EV / subscriber 10,166 9,530 10,928 Enterprise value 27,651 10,007 7,649 4,400 49,707 Less: Debt (2,500) Equity value 52,707 Number of shares 130.5 Per share value (Rs) 400 Minority stake (%) 27 Target price (Rs) 292 Source: IDFC Securities Research

Key Risks

The cable industry is exposed to multiple risks. Risks pertaining to CAS implementation and funding of players having already played out in the previous round, execution and monetization remain the key monitorables this time. LCOs need to be aligned with the digitization theme while competition from DTH is another threat. In our view, DEN faces the following key risks:

Losing out LCOs to competition While DEN has so far opted for secondary point (MSO) acquisitions, other MSOs may poach its LCOs. This, we believe, has the potential to disrupt the business economics for DEN. However, faster digitization may lead to a disproportionate increase in LCO acquisition costs – which would diminish the risk of LCO poaching by other MSOs. This would be a key monitorable for DEN.

Loss of primary points DTH has made rapid inroads into consumer homes and we see the momentum sustaining. In this backdrop, cable players may lose subscribers to DTH. This could will have a material impact on DEN in markets where it owns the primary points.

Entry of new players While the scramble for subscriber acquisition is bound to abate among incumbents as they attain critical mass , new (funded) players would look to aggressively acquire subscribers. Thus, DEN’s existing subscriber base will be vulnerable to acquisition by a competing player. However, with six big players already in the fray, we rule out influx of new players in the sector unless it is opened to FDI. Further capitalization through the PE route is also difficult to come by as, despite committing hefty funds (e.g. Ashmore has invested $140m), existing such investors have yet to break even.

Entry of telecom players Entry of telecom players in the cable space is a potential threat for incumbents like DEN. With existing fibre network provided by telecom players, they are in a position to offer triple play immediately. While unorganized nature of the business has kept telecom players away from the cable industry, a consolidated market may beckon them. A case in point is Comcast, which is feeling the heat of competition post entry of AT&T and Verizon into cable business in the US.

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IDFC Securities

Income statement

Year to Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13ENet sales 7,122 9,191 11,288 14,316 19,651 % growth 763 29 23 27 37 Operating expenses 7,085 8,293 9,736 11,541 14,467 EBITDA 37 898 1,552 2,774 5,184 % change (116) 2,355 73 79 87 Other income 72 65 96 101 115 Net interest (100) (194) (253) (278) (296)Depreciation 160 329 595 863 1,195 Pre-tax profit (152) 440 800 1,733 3,809 Current tax 20 74 200 461 974 Profit after tax (172) 366 600 1,272 2,834 Minorities 21 (63) (139) (365) (757)Net profit after non-recurring items (151) 303 461 908 2,077 % change (36.9) (300.1) 52.3 96.9 128.9

Balance sheet

As on Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13EPaid-up capital 181 1,305 1,305 1,305 1,305 Preference share capital 40 25 - - -Reserves & surplus 1,980 6,039 6,500 7,407 9,485 Total shareholders' equity 2,305 7,555 8,155 9,427 12,261 Total current liabilities 3,088 3,660 2,735 2,439 3,040 Total debt 1,231 1,721 2,196 2,446 2,696 Deferred tax liabilities - 73 73 73 73 Total liabilities 4,319 5,453 5,004 4,958 5,809 Total equity & liabilities 6,623 13,008 13,158 14,385 18,071 Net fixed assets 1,815 5,017 6,377 7,898 10,647 Investments 0 917 100 150 200 Total current assets 4,732 6,918 6,526 6,181 7,068 Deferred tax assets 77 156 156 156 156 Working capital 1,644 3,259 3,791 3,742 4,028 Total assets 6,623 13,008 13,158 14,385 18,071

Cash flow statement Year to Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13EPre-tax profit (152) 440 800 1,733 3,809 Depreciation 160 329 595 863 1,195 Chg in Working capital (143) (847) (1,279) (1,218) (391)Total tax paid (20) (74) (200) (461) (974)Operating cash Inflow (154) (152) (84) 918 3,639 Capital expenditure (1,444) (3,531) (1,954) (2,385) (3,944)Free cash flow (a+b) (1,599) (3,684) (2,039) (1,467) (305)Chg in investments 982 (917) 817 (50) (50)Debt raised/(repaid) 988 505 500 250 250 Capital raised/(repaid) 392 4,867 (25) - -Misc 86 (3) - - -Net chg in cash 849 768 (747) (1,267) (105)

Key ratios

Year to Mar 31 FY09 FY10 FY11E FY12E FY13E EBITDA margin (%) 0.5 9.8 13.7 19.4 26.4 EBIT margin (%) (1.7) 6.2 8.5 13.3 20.3 PAT margin (%) (2.1) 3.3 4.1 6.3 10.6 RoE (%) (7.1) 6.1 5.9 10.3 19.2 RoCE (%) (4.3) 8.8 9.7 17.1 29.6 Gearing (x) 0.5 0.2 0.3 0.3 0.2

Valuations

Year to Mar 31 FY09 FY10 FY11E FY12E FY13E Reported EPS (Rs) (8.3) 2.3 3.5 7.0 15.9 Adj. EPS (Rs) (8.3) 2.3 3.5 7.0 15.9 PE (x) n/a 85.4 56.1 28.5 12.4 Price/ Book (x) 1.6 3.4 3.2 2.7 2.1 EV/ Net sales (x) 0.5 2.8 2.4 2.0 1.5 EV/ EBITDA (x) 90.1 28.2 17.2 10.3 5.7 EV/ CE (x) 0.9 2.7 2.6 2.4 2.0

Shareholding pattern

Promoters53.7%

Foreign18.2%

Non-promoter corporate holding16.5%

Institutions3.1%

Public & others8.5%

As of March 2010

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IDFC Securities

Price performance

Bloomberg: DITV IN 6m avg daily vol. (m): 4.81-yr High/ Low (Rs): 54/31 Free Float (%): 35.2

Reason for report: Upgrade to Outperformer

Rs45

Mkt Cap: Rs47.9bn; US$1.03bn

OUTPERFORMER

Dish TV Bottom’line of sight’

Dish TV has been the pioneer of DTH in India and the industry leader; yet, we have had a negative bias on the stock for the last three years even as the DTH industry has grown multifold. Over the period, while intensifying competition and a weak balance sheet have stretched the gestation period and led to 5x increase in SAC for Dish TV, the stock has underperformed the broader market by 50%+. However, the competitive landscape is easing and the recent Rs15bn fund-raise by Dish TV will allow it to embark on a ‘profitable growth’ trajectory. We expect the 5.7m net (6.9m gross) subscriber base to scale up to 8m by FY13. Also, we expect Dish TV finally turning PAT-positive by Q4FY12 on the back of fixed content-cost deals and with operating leverage coming into play. We upgrade Dish TV from Neutral to Outperformer with an 18-month price target of Rs61 per share. Competitive intensity giving way…: The six-player Indian DTH market is the most competitive in the world. Dish TV, despite having a head-start and being the leader, has been the most susceptible to competition due to its weak balance sheet. Profitability has been elusive due to aggressive consumer subsidies (Rs2,500 per subscriber) and increasing churn rates. However, DTH penetration has exceeded expectations and growth rates would remain high – this, we believe, will obviate the need for further price wars to acquire customers. …volume-led growth ahead though ARPU to remain subdued: Dish TV, with a funded balance sheet (Rs11bn of rights issue and $100m of private placement), is well placed to sustain aggressive subscriber acquisition (8m net subscribers by FY13E). However, subsidies for new subscribers and an inherently price-sensitive subscriber base (cable-dark areas) would keep ARPU under check for Dish TV (<Rs140 in FY11 and improving only from FY12). Overall, revenues are expected to witness 28% CAGR to Rs22.5bn by FY13. Operating leverage to drive profitability; PAT-positive in Q4FY12E: As per customer acquisition cost stabilizes at ~Rs2,500, Dish TV enters into fixed content-cost deals and operating leverage sets in, we expect Dish TV to turn PAT-positive by Q4FY12. With aggressive scale-up of DTH services, easing competition and operational turnaround, we recommend Outperformer and assign an 18-month price target of Rs61.

Key valuation metrics

Year to 31 Mar FY09 FY10 FY11E FY12E FY13ENet sales (Rs m) 7,374.7 10,853.1 13,279.9 17,548.8 22,491.9 Adj. net profit (Rs m) (4,893.4) (2,612.3) (2,600.6) (463.1) 1,916.2 Shares in issue (m) 948.0 1,065.0 1,065.0 1,065.0 1,065.0 Adj. EPS (Rs) (5.2) (2.5) (2.4) (0.4) 1.8 % change n/a n/a n/a n/a n/aPE (x) n/a n/a n/a n/a 25.0 Price/ Book (x) (6.6) 12.2 36.3 56.0 17.3 EV/ EBITDA (x) (28.3) 58.6 28.2 10.8 5.9 RoE (%) 87.5 204.5 (99.3) (42.6) 105.6 RoCE (%) (141.6) (23.6) (18.9) (0.6) 46.4

75

90

105

120

135

25-Ju

n-09

25-Ju

l-09

25-A

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9

25-S

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9

25-O

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25-N

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25-D

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25-Ja

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25-M

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Dish TV India Sensex




JUNE 2010

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IDFC Securities

INVESTMENT ARGUMENT Dish TV maintains leadership with its 5.7m net subscriber base (industry

size of 20m homes) by FY10; accounts for 22-23% of incremental market

Six players already in the fray; competitive intensity appears to be past the peak and irrational price wars unlikely

While ARPU subsidy will persist and churn rate for Dish TV remains high at 9-10% p.a., scale of operations to help contain subscriber acquisition cost

Balance sheet now funded; Dish TV well placed to stay competitive and expected to attain base of 8m net subscribers by FY13

Profitability in business to be driven by operating leverage coming into play with expanding subscriber base; we turn positive on the stock

Pain of the past stretched gestation

While having a positive bias on DTH industry, our negative bias on Dish TV – industry pioneer – stemmed from the deteriorating economics with entry of funded players like Airtel Digital, Tata Sky, Sun Direct, Reliance ADAG Big TV and Videocon d2h. Being the incumbent, Dish TV was most susceptible to these risks, particularly with an inadequately funded balance sheet in a business driven by heavy subsidies. Our thesis played out with break-even point getting extended to 5m subscribers, as against broad estimates of profitability setting in at 3m subscribers. Also, subscriber acquisition cost jumped by 5x and churn rate increased from 0.5% per month to 0.9%.

Dish TV – the pioneer of DTH industry Dish TV has been a pioneer of DTH industry in India. Having commenced its operations in 2005, Dish TV had already reached 1.5m subscriber base before onset of competition from Tata Sky (launched in 2006). And by the time Sun Direct launched its services, Dish TV had already secured a 2.7m subscriber base.

Exhibit 1: Dish TV at advent of newer competition

01.5

2.7

3.9

4.7

5.8

6.9

0

2

4

6

8

Launch of Tata Sky

Launch of Sun Direct

Launch of Reliance ADAG

Launch of Airtel

Launch of Videocon

(m)

Apr

-05

Jul-0

5

Oct

-05

Jan-0

6

Apr

-06

Jul-0

6

Oct

-06

Jan-0

7

Apr

-07

Jul-0

7

Oct

-07

Jan-0

8

Apr

-08

Jul-0

8

Oct

-08

Jan-0

9

Apr

-09

Jul-0

9

Oct

-09

Jan-1

0


Dish TV has had a head-start in the DTH industry…

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IDFC Securities

Inadequately funded balance sheet in a subsidy-driven industry… Unlike most other DTH markets globally where competition is typically confined to a duopoly, Indian DTH industry is relatively much over-populated with six players in the fray. Given non-exclusivity of content, aggressive customer subsidy has been the only way to drive DTH penetration. Our key concern on Dish TV pertained to lack of capital (Rs1.7bn of net worth and Rs1.9bn of debt in FY07). With entry of deep-pocketed players like Tata Sky (Tatas and Newscorp), Bharti Airtel and Reliance ADAG (two of the largest telecom players), the concern took shape of crisis.

…pressure points were evident High competition in a non-exclusivity content scenario imminently led to a manifold rise in subscriber acquisition cost as also the churn rate. Also, with analogue ARPU of just US$4, growth has to be subsidy linked. Unlike the broad market estimates of this business turning around with a 3m subscriber base, we anticipated a longer gestation period. On the expected lines, subscriber acquisition cost increased from ~Rs500 at the time of Tata Sky’s launch to Rs2,500 now. Average ARPU has fallen from Rs164 in Q4FY08 to Rs135 and churn rate for Dish TV has increased from 0.5% per month three years ago to 0.9% currently.

Exhibit 2: Subscriber acquisition costs are up 5x over three years

0

750

1,500

2,250

3,000 (Rs m)

Q1FY07 Q1FY08 Q1FY09 Q1FY10 Source: IDFC Securities Research

While subscriber base increases to 5.7m, gestation period stretches The pace of subscriber addition for the industry as well as Dish TV has surprised us on the positive. With digital cable not making much head-way in the past four years and $2.5bn of cumulative fund infusion over this period, DTH industry has scaled up to 20m subscribers. Dish TV too has kept pace with the industry to reach 6.9m gross and 5.7m net subscribers. Dish TV currently accounts for 33% of the gross subscriber base and 20% of the incremental market. However, gestation period has extended far beyond the initial estimates of the management. Unlike expectations of operational break-even at 3m subscribers, Dish TV achieved operational break-even only on achieving 6m gross and 5m net subscribers. Notably, the company incurred Rs5.7bn of cumulative loss and Rs11.4bn of net loss over FY07-09.

…but lost to competitiondue to lack of sufficient

capital

Intense competition led to Dish TV’s average ARPU

falling from Rs164 to Rs135 and churn rate

almost doubling to 0.9%

Dish TV currently accounts for one-third of

the 20m subscribers in DTH industry

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IDFC Securities

Exhibit 3: Rapidly growing subscribers… …but stretched gestation period

Source: The Company

Times are ‘changing’

We believe competitive intensity is past its peak in the DTH industry. With addition of ~8m subscribers annually in the industry, we expect Dish TV to add 2.3m net subscribers by FY13 as it has a funded balance sheet. However, we expect growth to be volume-led, while ARPU will remain subdued on account of aggressive subscriber addition and Dish TV’s existing profile of customer base. We expect 27% CAGR in Dish TV’s overall revenues to Rs22.5bn over FY10-13.

A funded balance sheet on Rs16bn of fund raise A strained balance sheet due to heavy subsidies and competition from deep-pocketed players was Dish TV’s biggest competitive disadvantage in the past three years. As of end-FY09, Dish TV had Rs6bn of negative net worth and Rs11.5bn of debt (6x higher than in FY07. However, Dish TV has raised Rs11bn through a rights issue over FY09-10 (largely promoter-funded) and $100m through GDR issuance to Apollo Management. Of the Rs16bn raised, Dish TV has already utilized Rs2.4bn towards repayment of debt from a group company. Dish TV currently has Rs9bn of debt and Rs6.5bn of cash on books. With a funded balance sheet, Dish TV is back in the reckoning.

Exhibit 4: Improved balance sheet health post fund raise

547

(568)(4,710) (6,475)

3,920263 1,9305,445

11,492

9,492

(10,000)

(5,000)

0

5,000

10,000

15,000

FY06 FY07 FY08 FY09 FY10E

Total Shareholder's Fund Total Debt(Rs m)


(1,690)(2,128) (1,884)

845

(2,386)

(4,140)

(4,893)

(2,612)

(6,000)

(4,000)

(2,000)

0

2,000

FY07 FY08 FY09 FY10

EBITDA Net Loss(Rs m)

1.9

3.0

5.1

6.9

1.7

2.5

4.3

5.7

0

2

4

6

8

FY07 FY08 FY09 FY10

Gross Net(m)

Balance sheet concerns addressed with Rs11bn of

rights issue and $100m of GDR

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IDFC Securities

Expect 4.4m gross and 2.3m net new subscribers by FY13… As DTH industry adds 19m subscribers over FY11-13 and grows into a 39m homes market by FY13, Dish TV is expected to add 4.4m subscribers by FY13 to take its gross tally to 11.3m. We expect Dish TV to add 2.3m net subscribers to a base of 8m by FY13. Notably, churn rates are at 10% per annum, which we believe are set to taper to 8.5% in FY11 and 6% by FY13. We conservatively build in gross addition of 2m subscribers in FY11 as against management guidance of 2.5m subscribers.

Exhibit 5: Dish TV’s subscriber growth continues… …as industry adds 19m homes in next three years


…though ARPU growth to be subdued Given that Dish TV has been the pioneer of DTH in India and had initially targeted cable-dry and rural areas, its blended ARPU of Rs135 per month is the lowest after Sun Direct. While the renewal ARPU is at Rs160 per month, newly added customers pay only Rs35 per month for 3-6 months initially. As the industry continues to grow at the cost of ARPU (subsidization), we do not expect any substantial increase in blended ARPU. Also, we believe VAS services will pick up only gradually. We expect ARPU to increase materially only from FY12 (~Rs140 in FY11, Rs162 in FY12 and Rs200 in FY13). Success of HDTV would also be critical for upside potential to our ARPU assumptions.

Exhibit 6: ARPU improvement from FY12 onwards

143 138 140

162

200

0

50

100

150

200

(Rs m)


Average ARPU (net sub)


5.1

6.9

8.8

10.3

11.3

4.3

5.7

6.97.7 8.0

0

3

6

9

12


Gross subscribers Net subscribers(m)

0

10

20

30

40

FY09 FY10 FY11E FY12E FY13E0.0

10.0

20.0

30.0

40.0Industry size (Rs m - LHS) % market share (RHS)

Dish to have 8m net subscribers by FY13E

ARPU to remain stagnant at Rs140 in FY11, only to

improve from FY12 onwards

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IDFC Securities

We expect 27% revenue CAGR over FY10-13 While ARPU growth would be only gradual, Dish TV’s volume-driven growth will lead to more than doubling of basic subscription revenues to Rs18.9bn over FY10-13. Further, growth would come in from rental revenues accounting with Rs950 per connection out of the Rs1,590 currently charged at the time of installation apportioned as rental over 36 months. We expect Dish TV to garner Rs2.6bn of rental revenues in FY13. We also expect higher advertising revenues of Rs800m in FY13. With this, we estimate 27% CAGR in overall revenues over FY10-13 to Rs22.5bn. We believe advertising and VAS revenues can potentially spring a positive surprise. Globally, players like BSkyB and DirecTV garner 3-5% of revenues from advertising.

Exhibit 7: 29% CAGR in subscriber-based revenues (FY10-13E) Revenue pie (FY13E)


Operating Leverage: Dish PAT-positive by Q4FY12E

While a six-player race will keep industry ARPU under check, Dish TV is well on track to turn PAT-positive by Q4FY12 on the back of operating leverage in the business, stable subscriber acquisition cost, fixed content-cost deals and lower interest cost burden. We expect Dish TV’s EBITDA to grow 9x over FY10-13 to Rs7.4bn and PAT of Rs2.1bn in FY13.

Changing economics with fixed content-cost deals Being the largest DTH player and paying Rs3.8bn of content cost (12-13% of the subscription revenues collected by the Indian broadcast industry), Dish TV has leverage to negotiate with broadcasters. In this direction, most broadcasters (barring Sun TV) have already agreed to enter into fixed content-cost deals (though entailing annual revisions) with Dish TV. Thus, we expect 19% CAGR in Dish TV’s content cost (annual revision and addition of new pay channels) against 29% CAGR in ARPU over FY10-13. Stable content cost, while bringing the component down from 44% of revenues in FY10 to 35% in FY13E, will also reduce customer acquisition cost (as ARPU-linked subsidy drops). The lower subsidy, we believe, will allow Dish TV to go aggressive on subscriber acquisition.

6,246

1,002

8,542

1,476

10,862

1,870

14,383

2,449

18,884

2,634

0

6,000

12,000

18,000

24,000

FY09 FY10E FY11E FY12E FY13E

ARPU Rental(Rs m)

ARPU83%

Teleport and trading

1%Rental12%

Advertising and bandwidth

4%

We expect overall revenues to grow to

Rs22.5bn in FY13

We expect 19% CAGR in Dish TV’s content cost

against 29% CAGR in ARPU over FY10-13

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IDFC Securities

Exhibit 8: Improving gross margins with fixed content-cost deals

3,2703,764 4,469

5,303

6,49252.4

44.1 41.136.9

34.4

0

1,750

3,500

5,250

7,000

FY09 FY10E FY11E FY12E FY13E0.0

15.0

30.0

45.0

60.0Content cost (Rs m - LHS) % of ARPU revenues (RHS)


Subscriber acquisition cost to stabilize While competition will keep advertising spends elevated (Rs1bn in FY11E) and ARPU under pressure, we expect subscriber acquisition cost to remain stable at Rs2,500 as economies of scale set in. Further, savings would come in from the fixed content-cost deal structure as subscriber additions do not entail substantial incremental content cost. As all the six players are already well-entrenched, irrational pricing wars are unlikely. Given non-exclusivity of content, aggressive price would only increase the churn and will be detrimental for the entire industry. Also, two of the key operators – Airtel Digital and Big TV – are facing immense cash flow pressure in the core telecom business, and would be averse to playing a price war in DTH business as it would increase the bleed.

Exhibit 9: Stabilizing subscriber acquisition cost

Economics Basic offer - Rs1,690 Current Receipts 1,690 Costs STB, dish and other hardware 2,750 Dealer margin 225 VAT 115 Activation charge 200 Advertising cost per sub 800 Total cost 4,090 Net subsidy (2,400) Source: IDFC Securities Research

EBITDA growth by ~9x over the next three years Dish TV stands to realize operating leverage gains from here on three counts – (i) fixed content-cost deals (900bp of savings); (ii) 39% of overheads being nearly fixed in nature (transmission cost, transponder cost, advertising cost, and administration & personnel cost); and (iii) price-led growth as ARPU increases from Rs135 to Rs200 by FY13. While economics of the existing consumer base are improving, losses on new customer addition too are shrinking. We expect EBITDA to grow from Rs845m in FY10 to Rs7.4bn by FY13 – a 4x margin jump from 7.8% to 32.9%. Profitability could further improve if the proposed license cost rate changes from 10% to 6%.

Economies of scale and fixed content-cost deals to cap subscriber acquisition

cost

Economics of existing consumer base improving

and losses on new customer addition

shrinking

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IDFC Securities

Exhibit 10: Margins to improve multifold… …as operating leverage sets in


Exhibit 11: Economics of new and existing subscriber base post fixed content-cost deals

Economics - per month Existing New Blended Proportion 80% 20% ARPU 160.0 35.0 135.0 Rentals 26.4 26.4 26.4 Total subscriber based revenues 186.4 61.4 161.4 Content cost 80 0 64.0 Transmission cost 15 0 12.0 Employee cost 10 0 8.0 Advertising cost 12 28 15.2 Selling and distribution cost 63 12.7 Administration cost 10 0 8.0 Total operating costs 127.0 91.3 119.9 EBITDA per subscriber 59.4 (29.9) 41.5 Source: IDFC Securities Research

We expect PAT of Rs2.1bn in FY13 Improved cash profit generation from the business would result in interest cost savings. This, coupled with the exponential growth in EBITDA, would make Dish TV PAT positive by Q4FY12E. We expect Dish TV to turn PAT positive on full-year basis in FY13 and report Rs2.1bn of net profit for the year.

Exhibit 12: Dish TV to turn PAT positive in Q4FY12… …and FY13 to be the first full year of net profits


(4,000)

(1,000)

2,000

5,000

8,000

FY09 FY10E FY11E FY12E FY13E(30.0)

(12.5)

5.0

22.5

40.0EBITDA (Rs m - LHS) EBITDA margins (% - RHS)

0

40

80

120

160

(Rs m)


Content Transmission Others goods & services

Employee & admin Advertisement S&D

PAT

-1,200

-650

-100

450

1,000(Rs m)

Q3FY09 Q3FY10 Q3FY11E Q3FY12E Q3FY13E

PAT

-5,000

-3,000

-1,000

1,000

3,000(Rs m)


Strong EBITDA growth and lower interest costs to drive

profitability

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IDFC Securities

Valuations & View

A funded balance sheet, easing competitive pressure and visibility on profits – all our historical concerns pertaining to Dish TV stand addressed. We expect Dish TV to turn PAT-positive in Q4FY12 and estimate PAT of Rs2.1bn in FY13E. In this light, we change our call on the stock from Neutral to Outperformer.

Based on the methodology that we have adopted to value C&S businesses, we value Dish TV at EV/ subscriber of Rs8,451 (33 months of ARPU in FY13E). Using this valuation matrix on Dish TV’s projected 8m net subscribers by FY13, we arrive at an 18-month price target of Rs61 per share.

Exhibit 13: Fair value of Rs61 based on EV/ subscriber of 33 months ARPU

Valuations Number of subscribers (m) in FY13 8 ARPU (Rs/ month in FY13) 260 Months of ARPU (as per individual customer economics) 33 EV / subscriber (Rs) 8,451 Enterprise value (Rs m) 67,607 Less: Debt (Rs m) 3,000 Equity Value (Rs m) 64,607 Number of shares (m) 1,065 18-month fair value per share (Rs) 61

Key Risks

Faster-than-expected subscriber addition We are building in 2m gross subscribers incrementally for FY11E. Faster subscriber acquisition, though positive in the longer term, will hit near-term profitability.

Irrational pricing by competition Any price war in the DTH industry could lead to deterioration of business economics – cost of subscriber acquisition as also the churn rate. However, we do not anticipate aggressive price wars as the market is now fairly well-populated and players continue to incur huge losses. Also, unlike in telecom where there is no content cost, DTH industry has a base content cost.

.

We value Dish TV at EV/ subscriber of Rs8,451…

Any further price wars and faster than expected

customer acquisition are key risks to our numbers

…and assign an 18-month price target of Rs61 per

share – ~40% upside from here

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IDFC Securities

Accounting Policy

Revenue Accounting

Of the Rs1590 received upfront at the time of customer activation,

Rs950 is accounted as rental revenue over a period of 3 years

Rs300 is accounted as upfront activation charge forming a part of subscription income

Rs225 is paid as dealer margin, corresponding cost is a part of Commission (selling and distribution cost)

Rs115 is accounted for VAT

Amortization Hardware – Set top Box and dish cost is amortized over a period of five years

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IDFC Securities

THIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK

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IDFC Securities

Income statement

Year to Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13ENet sales 7,375 10,853 13,280 17,549 22,492 % growth 79 47 22 32 28 Operating expenses 9,259 10,008 11,450 12,973 15,093 EBITDA (1,884) 845 1,830 4,575 7,399 % change (11) (145) 116 150 62 Other income 14 229 75 60 80 Net interest (727) (643) (602) (482) (220)Depreciation 2,289 3,044 3,903 4,616 5,130 Pre-tax profit (4,886) (2,613) (2,601) (463) 2,129 Deferred tax 7 (0) - - -Current tax - - - - 213 Profit after tax (4,893) (2,612) (2,601) (463) 1,916 Net profit after non-recurring items (4,893) (2,612) (2,601) (463) 1,916 % change 18.2 (46.6) (0.4) (82.2) (513.7)

Balance sheet

As on Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13EPaid-up capital 948 1,065 1,065 1,065 1,065 Reserves & surplus (7,423) 2,855 254 (209) 1,707 Total shareholders' equity (6,475) 3,920 1,319 856 2,772 Total current liabilities 16,311 17,965 19,429 20,226 20,462 Total debt 11,492 9,492 6,992 3,992 1,992 Deferred tax liabilities 6 6 6 6 6 Other non-current liabilities 80 80 80 80 80 Total liabilities 27,889 27,543 26,506 24,304 22,540 Total equity & liabilities 21,414 31,463 27,825 25,160 25,312 Net fixed assets 13,345 14,506 14,367 12,195 8,558 Investments 0 0 0 0 0 Total current assets 8,069 16,957 13,459 12,966 16,755 Working capital (8,242) (1,008) (5,970) (7,261) (3,708)Total assets 21,414 31,463 27,826 25,160 25,312

Cash flow statement Year to Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13EPre-tax profit (4,886) (2,613) (2,601) (463) 2,129 Depreciation 2,289 3,044 3,903 4,616 5,130 Chg in working capital (240) (163) 416 617 74 Total tax paid - - - - (213)Operating cash inflow (2,837) 268 1,718 4,770 7,120 Capital expenditure (6,032) (4,205) (3,764) (2,444) (1,493)Free cash flow (a+b) (8,870) (3,937) (2,046) 2,326 5,627 Debt raised/ (repaid) 6,047 (2,000) (2,500) (3,000) (2,000)Capital raised/ (repaid) 3,051 13,006 0 0 0 Misc 67 0 (0) 0 -Net chg in cash 294 7,070 (4,546) (674) 3,627

Key ratios

Year to Mar 31 FY09 FY10 FY11E FY12E FY13E EBITDA margin (%) (25.5) 7.8 13.8 26.1 32.9 EBIT margin (%) (56.6) (20.3) (15.6) (0.2) 10.1 PAT margin (%) (66.4) (24.1) (19.6) (2.6) 8.5 RoE (%) 87.5 204.5 (99.3) (42.6) 105.6 RoCE (%) (141.6) (23.6) (18.9) (0.6) 46.4 Gearing (x) (1.8) 2.4 5.3 4.7 0.7

Valuations

Year to Mar 31 FY09 FY10 FY11E FY12E FY13E Reported EPS (Rs) (5.2) (2.5) (2.4) (0.4) 1.8 Adj. EPS (Rs) (5.2) (2.5) (2.4) (0.4) 1.8 PE (x) n/a n/a n/a n/a 25.0 Price/ Book (x) (6.6) 12.2 36.3 56.0 17.3 EV/ Net sales (x) 7.2 4.6 3.9 2.8 1.9 EV/ EBITDA (x) (28.3) 58.6 28.2 10.8 5.9 EV/ CE (x) 10.5 3.7 6.2 10.0 9.0


Promoters64.8%

Foreign17.0%


Institutions5.8%

Public & others7.5%

As of March 2010

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IDFC Securities

Hathway Cable (Hathway) is the largest MSO in India with ~15% share of the paying and 30%+ share of the digital subscriber base. With Concept (last mile consolidation), Capital (USD60m of initial funding and Rs4.8bn from recent IPO) and Credibility (management bandwidth) in place, we expect Hathway to capitalize on the ongoing digital boom in India and accrete its digital base to 4.7m subscribers by FY13E. This, coupled with sustained customer additions (Rs2.4bn earmarked for acquisitions), would help Hathway attain a 4.1m paying subscriber base (1.6m in FY10) and 32% revenue CAGR to Rs17.1bn by FY13E. As Hathway retains the gains of improving declarations in the initial round and higher-margin broadband business registers a strong 49% CAGR over FY10-13E, we see operating profit growing by 5x and PAT of Rs2.1bn by FY13. Initiating coverage with Outperformer and an 18-month price target of Rs274.

The right mix of strategy and funding…: In an industry fraught with inefficiencies (revenue leakage, fragmentation and competition from DTH), Hathway has emerged as the largest MSO with 1.6m paying (including 1m digital) subscribers. Aggressive primary point acquisition (0.5m subscribers) and timely funding from ChrysCap as also from the recent IPO put Hathway at the forefront of the digital cable boom. …to take subscriber base up to 4.1m by FY13E: With digitization now an imperative (4.7m digital subscribers by FY13E) and as inorganic growth continues, we expect Hathway’s declared subscriber base to grow to 4.1m by FY13. While initial monetization will be through upfront digitization revenues and improved declaration levels, ARPU-led growth would only be gradual. This, coupled with 1.4m broadband subscribers by FY13E, would drive 32% revenue CAGR for Hathway over FY10-13E to Rs17.1bn. Profitability in sight; value to follow: We believe the first round of monetization gains would largely flow to MSOs – and reflect in their lower content cost to subscription revenues. This, coupled with faster growth of the high-margin broadband business, would drive EBITDA margin expansion from 17.1% to 37.1% by FY13E. In view of its sustained leadership, improving dynamics of the cable business and visibility on profitability, we initiate coverage on Hathway with Outperformer and an 18-month price target of Rs274.

Key valuation metrics Year to 31 Mar FY09 FY10 FY11E FY12E FY13ENet sales (Rs m) 6,634 7,361 8,950 11,956 17,057 Adj. net profit (Rs m) (623) (580) 291 871 2,103 Shares in issue (m) 111 143 143 143 143 Adj. EPS (Rs) (5.6) (4.1) 2.0 6.1 14.7 % change n/a n/a n/a 199.2 141.4 PE (x) n/a n/a n/a n/a 11.9 Price/ Book (x) 5.5 3.2 3.0 2.5 1.9 EV/ EBITDA (x) 31.8 21.3 11.1 7.6 4.6 RoE (%) (18.1) (10.1) 3.6 9.5 18.3 RoCE (%) (1.4) 0.6 7.4 14.8 26.3

60

75

90

105

120

24-Feb-10 24-Mar-10 24-Apr-10 24-May-10 24-Jun-10

Hathway Cables and Datacom Sensex

Price performance

Bloomberg: HATH IN 6m avg daily vol. (m): -1-yr High/ Low (Rs): 246/175 Free Float (%): 33.5

Reason for report: Initiating coverage

Rs176

Mkt Cap: Rs25.1bn; US$537.2m

OUTPERFORMER

Hathway On a new ‘way’!




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IDFC Securities

INVESTMENT ARGUMENT Hathway, the largest cable operator in the country with 1.6m paying

subscribers, is well placed to make the most of the imminent digitization drive

Survival in the toughest times on the back of the right strategy, adequate funding and management bandwidth, reflects Hathway’s forte

With the growth environment becoming more conducive (improving declarations and picking up digital trend), Hathway is well placed to witness 2.5x growth in paying subscriber base by FY13E

Hathway’s focus on primary point acquisitions and broadband penetration would translate into a superior margin profile compared to peers

With revenue CAGR pegged at 32% and EBITDA CAGR of 69% over the next three years, we see value in Hathway

Hathway: The right ‘way’!

The Raheja Group forayed into India’s cable distribution landscape in 1995 through Hathway. Over the last decade and a half, Hathway has survived the intense competition in the industry to emerge as the largest cable distribution company in India. With ~15% share of India’s fragmented paying subscriber base and ~30% share of digital cable subscriber base (1m subscribers in FY10), Hathway is best placed to capitalize on the theme of digitization unfolding in the country.

Survival to leadership… Among the earlier entrants in the cable industry – Hathway, WWIL and InCable, Hathway has displayed strong resilience by way of execution to become the largest cable distribution company in the country. This is evident in the fact that Hathway has grown 2x faster than peers and now accounts for 1.2x aggregate revenues of the two players. While the incumbent leader is now facing competition from new players such as DEN and Digicable, we believe Hathway’s proven track record demonstrates the inherent capabilities of a winner.

Exhibit 1: Hathway – far ahead of peers


15

20

36

0

10

20

30

40

WWIL Hinduja Ventures Hathway

Revenue CAGR over last 4yrs

(%)

0

2,000

4,000

6,000

8,000

FY07 FY10E

WWIL Hinduja Ventures Hathway(Rs m)

Hathway, the only incumbent to have

weathered competition from DEN and Digicable

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IDFC Securities

Hathway has a paying subscriber base of 1.6m customers and total reach of ~8m subscribers, making it the largest MSO in the country. Hathway garners revenues of Rs7.3bn as against DEN, the second largest MSO with revenues of Rs4.5bn.

Exhibit 2: Leadership in terms of paying subscriber base… …reflecting in revenues


…with 3Cs at work – Concept, Capital and Credibility We see merit in Hathway’s execution ability to survive the tough business environment (under-declaration and aggressive acquisitions) to become the largest player. Hathway is a unique mix of the three Cs – Concept, Capital and Credibility. While primary point acquisition has helped Hathway garner a higher declared subscriber base, timely capital from promoters, NewsCorp and ChrysCapital has supported inorganic growth. Further, we take comfort in the strong management team and promoter backing in this business. Exhibit 3: Hathway – a perfect mix of three Cs


ConceptRight strategy –

Last mile consolidation

CredibilityManagement bandwidth

CapitalAdequately funded

C’s

ConceptRight strategy –

Last mile consolidation

CredibilityManagement bandwidth

CapitalAdequately funded

C’s

1.6

1.1 1.1

0.7

0.5

0.0

0.4

0.8

1.2

1.6

Hathway DEN Networks Digicable WWIL InCable

No. of paying subscribers(m)

7.3

4.5

3.12.73.0

0.0

2.0

4.0

6.0

8.0

(Rs bn)

Hathway DEN Networks Digicable WWILInCable

Revenues

Primary point acquisition, timely funding and

management credibility – right mix for Hathway

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IDFC Securities

Pan India presence and last mile consolidation Of the $4.8bn that the end consumer pays for cable viewing, 80% goes undeclared and is retained by LCOs. With a view to get access to the under-reported revenues, Hathway resorted to the primary point acquisition strategy. Primary point acquisition gives access to the entire revenue base and thereby offers a shorter payback period. While the upfront capital requirement per primary point acquisition is substantially higher at Rs5,500-6,000 (Rs7,000 at peak), Hathway was adequately funded for acquisitions. Hathway has now attained a direct customer base of 0.5m.

Exhibit 4: Primary point acquisition – two sides of the coin


With regards the price of acquisition, we believe primary points have been valued at 25-30 months of ARPU. Assuming a locality of 10,000 subscribers at a value of Rs4,500 per subscriber, Hathway’s payback period would be 2.9 years as against 3.7 years in case of secondary point acquisitions, even at an upfront outlay of 7x. Exhibit 5: Primary point acquisition offers a shorter payback

Economics Secondary point Primary point Customer acquisition cost - per sub 600 4,500 Number of subscribers 10,000 10,000 Total acquisition cost (Rs m) 6.0 45.0 Declaration levels 12.0% 100.0% Paying subscribers 1,200 10,000 Average ARPU per month 160 190 Total subscription revenue collection (Rs m) 2.3 22.8 Carriage Revenues - Rs m 2.3 5.7 Total Revenues 4.6 28.5 Content Cost and placement cost - per declared sub 165 200 Total content and placement cost (15% declaration) 2.38 4.8 Other operating costs as % of subscription revenues 25% 35% Other operating costs 0.58 8.0 Total Costs 3.0 12.8 Operating Profit / (Loss) 1.6 15.7 Payback period 3.7 2.9 Source: IDFC Securities Research

Pros Cons

100% declaration day one Need for higher upfront capital

Access to the entire share of LCO -margins ~50%

Risk of DTH – more pinch on the profits

Higher ability to digitize Higher need to digitize

Pay back of just over 2 years No scope for further improvement in declaration levels

Pros Cons

100% declaration day one Need for higher upfront capital

Access to the entire share of LCO -margins ~50%

Risk of DTH – more pinch on the profits

Higher ability to digitize Higher need to digitize

Pay back of just over 2 years No scope for further improvement in declaration levels

Hathway has 1.6m subscribers pan India,

including 0.5m primary points

Though higher capital outlay, primary point

acquisition has a superior payback period

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IDFC Securities

While the focus remained on primary point acquisition, Hathway also acquired secondary points through stake purchase in more than 21 MSOs over the last three years. For instance, Hathway has acquired a 51% stake in the cable TV arm of the Dainik Bhaskar Group – Bhaskar Multinet – having 0.12m subscribers. Other acquisitions include a 50% stake in Gujarat Telelinks (the largest MSO in Gujarat with 0.25 subscribers) for an estimated consideration of Rs850m and two large MSOs in Maharashtra. Secondary point acquisition strategy was to extend the reach and the economics were justified by the healthy carriage fee revenues. Hathway currently has 0.8m paying secondary point subscribers.

Exhibit 6: Key secondary point acquisitions Marathwada Cable Network Maharashtra Rajesh Multichannel Maharashtra Gujarat Telelink Gujarat Bhaskar Multinet Madhya Pradesh Source: IDFC Securities Research

Exhibit 7: Paying subscriber base Paying subscriber base

0.6

1.0 1.0 1.10.2

0.4 0.50.5

0.0

0.5

0.9

1.4

1.8

(m)

FY07 FY08 FY09 FY10

Secondary subscribers Primary subscribers


Hathway is estimated to have deployed aggregate cash of ~Rs.4.3bn towards acquisitions. Hathway now reaches 125 cities in India through its cable network (both analog and digital). The company has a total reach of ~8m cable homes across India, supported by 71 analog head-ends, 19 digital head-ends and more than 15,000km of HFC network. Hathway is the leading operator in several key cities such as Mumbai, Delhi, Bangalore, Ahmedabad, Hyderabad, Jaipur, Indore, Bhopal, Baroda and Surat. Hathway’s lead in metros imparts the ability to garner a strong stream of carriage fees. Hathway’s current subscriber base stands at 1.6m paying subscribers including 0.5m primary points.

Hathway also did MSO acquisitions in

Maharashtra, Gujarat, MP

Presence across 123 cities with 71 analog

head-ends and 19 digital head-ends

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IDFC Securities

Exhibit 8: Hathway – truly a national MSO

Source: Company

Early on digital roll-out – driving paying subscriber base While primary point acquisitions helped consolidate the market and secondary point acquisitions helped expand reach, Hathway has focused on seeding of STBs too. With 1m digital subscribers in FY10, Hathway has the largest digital cable subscriber base in India. Of these 1m subscribers, 1/4th are in CAS-notified areas and the remaining under voluntary digitization. While Hathway had net addition of ~60,000 digital points in FY10, it lost a substantial customer base in Chennai to Sumangali Cable Vision, part of Sun TV Group – South India’s largest media group. Primary point acquisition and early digitization have helped Hathway scale up its paying subscriber base to 1.6m in FY10 from 0.77m in FY07.

Broadband strengthens the business model Broadband business is a major revenue contributor for cable operators internationally. In the US, 42m of the total 84m broadband subscribers are serviced by cable operators. Given the better business economics, a broadband offering strengthens the business model of a cable operator. Hathway was the first cable operator in India to have started offering broadband services in 2001, parallel to when cable operators started this service in the US. The biggest challenge in broadband internet business is setting up the city level network, which Hathway already has in place across 17 cities. Hathway has the HFC and optical fibre network laid out with ~1m two-way enabled homes. Of this, Hathway offers broadband services to 0.34m subscribers at an average ARPU of Rs320. Hathway accounts for 4.3% of total 7m broadband connections in India (predominantly commercial users) and >50% share of the broadband market catered to by cable operators. Of the total revenues of Rs7.3bn in FY10, Rs1.3bn accrued from broadband business.

Pan India presence with strong hold in Western and

Southern India

1m of the total 1.6m subscribers are digital

Fibre network in place with 1m two-way enabled

homes…

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IDFC Securities

Exhibit 9: Broadband network across 17 cities

Source: Company

Exhibit 10: Hathway’s broadband subscriber base

0.00

0.05

0.10

0.15

0.20

0.25

0.30

0.35

FY07 FY08 FY09 FY10

Broadband subscribers

(m)

0.12

0.23

0.34 0.34

Source: Company, IDFC Securities Research

Timely and adequate capital Availability of funds has been a key success factor for Hathway with other early entrants like WWIL and InCable having struggled on the count. Since its inception in 1990s, Hathway has seen multiple rounds of funding and is the only cable company in India to have a strategic investor. In 2000, NewsCorp (one of the largest media conglomerates globally with exposure to television distribution businesses like DirecTV, BSkyB, etc) acquired a 26% stake in Hathway for US$75m. Incrementally, in June 2007, ChrysCap invested Rs2.65bn for a 14.63% stake in Hathway. While the initial round of capital infusion by NewsCorp helped Hathway stay afloat in the cable industry and add reach as well as a broadband subscriber base, capital infused by ChrysCap was utilized to acquire subscribers. Further funding came in from Morgan Stanley, Kaup Capital and Arcadia in the form of convertible debentures. In addition, Rs4.8bn has been raised recently through a public issue to fund digitization.

…across 17 cities including Mumbai,

Bangalore and NCR…

…catering to 0.34m subscribers

Multiple rounds of funding from strategic and financial investors has helped Hathway’s

rapid growth

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IDFC Securities

Exhibit 11: Hathway’s multiple round of fund raise

Year Investor Amount invested Equity valuations (Rs bn) (Rs bn) 2000 Newscorp 3.4 12.9 2007 ChrysCapital 2.7 18.0 2009 Morgan Stanley, Kaup Capital, Arcadia 2.4 Convertible debt 2010 IPO 4.8 34.3 Source: IDFC Securities Research

Credibility – management bandwidth Hathway has been promoted by the Rajan Raheja Group, with interests in various businesses such as construction, cement, ceramic tiles, batteries, publishing, apparel retailing, etc. Group companies include Exide Industries (market capitalization of Rs102bn), H&R Johnson Tiles, Prism Cements (Rs27bn), RMC Readymix, Globus Stores and Outlook. Unlike peers WWIL and InCable, promoters of Hathway have demonstrated the commitment to stay invested and keep seeding the business, even in the absence of economic returns for >15 years. K Jayraman, the MD and CEO, has more than 25 years of experience across media, banking and manufacturing businesses and has been heading Hathway since 1998. The management bandwidth has been critical for Hathway’s survival and success in the Indian cable industry.

Exhibit 12: Key members of management team

Name Designation Experience K Jayaraman MD & CEO 25 years including 10+ years in cable industry Milind Karnik President – Finance and Company secretary 24 years of experience D Mahadevan VP - Finance 20 years of experience Jayant Changrani Sr. VP - Broadband 22 years of experience including telecom sector Source: IDFC Securities Research

Rs13bn+ of funds raised in the past decade

Promoters have shown commitment to keep

seeding the business

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IDFC Securities

Hathway: Riding the digital wave

As the Indian cable industry is at the cusp of changeover on the back of digitization (from 3.5m digital cable homes in 2009 to 16m by 2012 and 38m by 2015) and consolidation, Hathway is expected to lead from the front. With Rs4.8bn of recent fund raise, urgency to digitize to secure the subscriber base, 8m of cable reach and on-ground infrastructure in place in the cable as well as broadband space, Hathway is well poised to add 3.7m digital subscribers over FY10-13 (1m currently) and 1m+ broadband homes to its existing base of 0.34m. While digitization would be the focus, Hathway would continue to spend on secondary and primary point acquisitions.

Hathway – highest ‘ability’ + need to digitize Digitization, we believe, is not a choice but compulsion for cable operators to secure their customer base from peer MSOs as well as DTH. The fear of losing subscribers to DTH (which is already a 20m homes market) is more profound in primary point economics. While access to last mile enhances Hathway’s ability to digitize, it is also needed to secure its customer base. Digitization would help secure the end consumer from switching to DTH and digitization of relevant mass (where Hathway reaches through LCOs) would ensure that acquisition of the LCO by another MSO becomes economically unviable. Realizing this urgency, Hathway has started aggressive roll-out of its digital services. While it went slow on digitization in the past few months, delivery of new STBs (at ~$30) by end-Q1FY11 will speed up the process of seeding STBs. We expect Hathway to add 0.8m digital subscribers in FY11 and the momentum to increase to 1.3m in FY12 and 1.6m in FY13. We see Hathway having a 4.7m digital subscriber base by FY13E (25% of the digital cable market). We believe that faster the roll-out of DTH, more is the urgency to digitize the cable platform.

Exhibit 13: Acceleration in digital subscriber addition

0.6

1.0 1.0

1.8

3.1

4.7

0.0

1.0

2.0

3.0

4.0

5.0

(m)


Digital subscriber base


Access to primary points means higher ability as well as greater urgency

to digitize

Expect 4.7x growth in digital subscriber base

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IDFC Securities

Acquisitions to continue – Hathway a market consolidator As digitization picks up pace and smaller MSOs and LCOs feel the heat of DTH ramp-up, the industry is bound to witness consolidation – as seen globally. Not only smaller players, but we also expect large national and regional MSOs to become potential acquisition targets. Hathway (along with DEN Networks), being the largest player and with a strong balance sheet, would be at the forefront of market consolidation. Hathway would continue to take the inorganic route to growth, with primary point acquisition remaining the core of the strategy. Against this backdrop of lower competition, higher acceptance from LCOs and only a handful of funded players, acquisition values have been trending down. We believe acquisition costs have come down from the peak of Rs7,000/ primary point in 2008 to ~Rs4,000.

We expect Hathway to add 0.3m paying subscribers (incremental reach of 2.5m-3m) under the secondary point acquisition route and 1.45m subscribers through primary points. We expect Hathway to spend Rs6bn on acquisitions over the next three years – substantially higher than the Rs2.4bn earmarked as part of the IPO proceeds.

Exhibit 14: Additional subscriber acquisitions

Subscriber acquisition

200

500

750

30

90

180

0

250

500

750

1,000

('000s)

FY11E FY12E FY13E

Primary subscribers Secondary subscribers


Broadband expansion – 1.4m by FY13E With just 7m broadband connections, India is way behind other economies (<10% of broadband connections in USA). Also, the share of cable industry in overall broadband connections is likely to move up from 9% currently (50% in the US). While there is simultaneous competition coming from WiMax and wireless broadband services offered by telecom companies, we see increasing relevance of cable operators in ramping up of broadband. We expect overall broadband connections in India to scale up to 12m by 2012, of which cable operators would reach 2.3m subscribers. Having laid out the fibre network with ~1m homes with two-way connectivity, Hathway is well poised to scale up its broadband internet business. We expect Hathway’s broadband subscriber base to increase from 0.3m now to 1.4m by FY13, which would entail capex of Rs1.5bn (basic infrastructure already been laid). Of this, Hathway has earmarked Rs830m towards broadband business from its IPO proceeds.

Hathway expected to spend Rs6bn towards acquiring…

…1.45m primary points and 0.3m secondary subscribers

Expect ~1m new broadband connection over FY10-13

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IDFC Securities

Exhibit 15: Rapid scale-up of broadband industry in India … as also in Hathway’s broadband base


With Rs4.8bn of recent fund raise, Hathway funded for growth If capital has been one of the key differentiators for Hathway in the past, it would continue to be a driving force going forward as operators would need capital for digitization and driving consolidation. We believe that Hathway would require Rs9bn for subscriber acquisition and STB subsidy up to FY13. Recent proceeds from the IPO would fund the initial two years’ capex with internal cash generation taking over in the subsequent period. In February 2010, Hathway raised Rs4.8bn through an IPO. Of this, as per objects of the issue, Rs2.4bn has been earmarked for customer acquisition (can fund acquisition of ~0.45m primary points) and Rs1.56bn towards funding for digitization (can fund 2m STB subsidies). In addition, Hathway proposes to infuse funds to the tune of Rs830m in its broadband business, and the remaining Rs967m towards debt repayment.

Exhibit 16: Objects of issue

Particulars (Rs m) Acquisition of customers 2,436 Digital capex 1,564 Broadband capex 830 Debt repayment 967 Total 5,797 Source: Company RHP

Rs4.8bn of recent IPO would suffice fund the

future growth plans


0.0

3.5

7.0

10.5

14.0

2.23.0

5.5

7.2

8.7

10.3

12.0

(m)

2006 2007 2008 2009 2010 2011 2012

Broadband subscriber base

0.34 0.34

0.53

0.88

1.42

0.0

0.4

0.8

1.2

1.6


(m)

JUNE 2010

98

IDFC Securities

Monetization and Retention: Time to make profits

As Hathway turns aggressive on digitization and acquisition, monetization in the business is expected to follow soon. While the initial round of monetization would be led by upfront fees, rentals and declaration levels, ARPU would increase only in the long run. As we expect Hathway’s paying subscriber base to rise to 4.1m by FY13, subscription based cable revenues would see 44% CAGR to Rs8.8bn. We expect 32% CAGR in overall revenues to Rs17.1bn. As we expect MSOs to retain the first round of monetization gains and in line with scale-up of the broadband business, we expect Hathway’s operating margins to expand from 17% to 37% by FY13.

Declaration-led monetization – 4.1m paying homes by FY13E More than for monetization, digitization is initially to secure the subscriber base. As operators are focused on rapid STB installation to prevent the onslaught of digital services offered by DTH, they need to protect the economics of LCOs, and hence are unlikely to push for higher declaration in the initial phase. We expect declaration improvement to happen gradually, depending upon the STBs installed in the area and bargaining power of MSOs vis-à-vis LCOs. Also, for Hathway, which controls the last mile to the tune of 0.5m subscribers, seeding of STBs would not make any difference to the paying subscriber base. Hence, overall digital homes may be higher than the paying homes for Hathway.

However, for secondary points, we expect declaration levels to move up as bargaining power shifts in favour of MSOs. We expect the bargaining power to shift in favour of MSOs once critical mass (15-20% of subscribers under a particular LCO) is achieved for digitized customers, thereby leaving alignment with MSO as the only option for the LCO. We expect paying subscribers from existing base to increase from 1.6m currently to 2.4m by FY13 and the overall paying subscriber base to rise to 4.4m with the remaining 1.8m coming from new acquisitions.

Exhibit 17: Increasing declaration levels

0.5

1.0

0.5

1.1

0.7

1.2

1.2

1.4

2.0

2.1

0.0

0.9

1.8

2.7

3.6

4.5

(m)


Primary subscribers Secondary subscribers


Expect 32% revenue CAGR over FY10-13 with 44% CAGR in subscription

revenues

Hathway to push for higher declarations only

after achieving critical mass of STB seeding

Paying subscriber base growth from 1.6m now to

4.1m by FY13E…

JUNE 2010

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IDFC Securities

ARPU – only marginal growth expected With DTH industry subsidizing heavily and average ARPU at <Rs200, we do not expect any major increase in cable ARPU in the next one year. Further, cable operators are also keen to drive digitization. We expect ARPU growth to be only gradual with 5% CAGR over FY10-13E. While we expect ARPU from secondary points to grow to Rs180 by FY13, ARPU in primary points would increase to Rs215 a month. Despite low ARPU growth, we expect 35% CAGR in overall basic subscription revenues to Rs6.9bn by FY13. However, in the long run, we expect a substantial increase in ARPU as new channels launch only on pay mode and digital platform (>10 channels lined up for launch on the digital platform).

Exhibit 18: 35% CAGR in basic subscription revenues

Basic Subscription revenues

2.42.8

3.2

4.3

6.9

0.0

2.0

4.0

6.0

8.0

(Rs bn)

FY09 FY10 FY11E FY12E FY13E Source: IDFC Securities Research

…and just 5% CAGR in ARPU…

…would result in 35% CAGR in basic

subscription revenues

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IDFC Securities

Initial monetization through upfront digitization fees and rentals While declaration levels increase only gradually, the first round of monetization would be on the back of upfront activation fees charged at the time of STB installation. Hathway has been charging Rs1,000 per STB so far, but a new procurement deal of cheaper STB purchase would enhance Hathway’s ability to subsidize further and bring down the upfront fees to Rs750-800 to boost the pace of digitization. This will flow down to revenues of Hathway and unlike in the past, when Hathway was apportioning this amount over a 3-year period, it will now charge this as revenues in year-one. We expect this stream to contribute Rs1.1bn to Hathway’s overall revenues by FY13.

Also, while ARPU monetization would happen only gradually, operators are pushing for additional rentals on STBs (Rs20-30 per subscriber per month). While we do not see much success ahead on this front for cable operators, Hathway – with higher primary point access – is better placed to charge rentals. We expect STB rentals to contribute Rs600m to Hathway’s revenues by FY13.

Carriage revenues – a slow and steady rise Hathway garnered carriage fees of Rs3bn in FY10. While incremental growth in carriage revenues would taper, we believe this stream would sustain even post digitization as broadcasters would pay to be on the basic package. Over a period of time, the overall Rs15bn carriage industry would stagnate but will consolidate in the hands of a few large MSOs. We expect 7% CAGR in Hathway’s carriage revenues to Rs3.7bn by FY13.

Broadband internet – expect 49% CAGR over FY10-13 With Hathway’s broadband connection reach increasing from 0.3m currently to an estimated 1.2m by FY13 and ARPU hovering at Rs325 per month, we expect this business to contribute Rs3.9bn to overall revenues by FY13. This would imply a 45% revenue CAGR over FY10-13E.

Exhibit 19: Broadband revenues – Rs4bn by FY13E

1,0471,271

1,478

2,504

4,185

0

1,050

2,100

3,150

4,200

(Rs m)


Broadband revenues


First round of monetization would be through Rs750 of

upfront charge and Rs20-30 on monthly rentals

7% CAGR in carriage revenues over FY10-13E

49% CAGR in broadband revenues over FY10-13E

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IDFC Securities

Overall revenues – expect 32% CAGR over FY10-13 We expect Hathway’s overall revenues to grow from Rs7.3bn in FY10 to Rs17.1bn by FY13, with subscription revenues from cable operations witnessing 44% CAGR to Rs8.8bn. In FY13, 55% of the revenues would accrue from cable subscription, 22% from broadband and 21% from carriage fees. We see potential upside risk to our advertising revenue estimate of Rs370m.

Exhibit 20: We expect 32% revenue CAGR over FY10-13 Segmental revenue contribution trend


MSOs to retain the first round of gains While we expect a 35% CAGR in basic subscription revenues, we do not expect a corresponding increase in content cost, as we expect Hathway to retain a large portion of the declaration-led gains in the first round. Currently, content cost for Hathway is at Rs148 per paying subscriber, which is substantially higher than Dish TV’s Rs75-80. As declaration levels move up, we do not expect a proportionate increase in content cost (23% CAGR over FY10-13E). Thereby, we expect gross margin on subscription revenues to improve from a negative 6% to 20% by FY13.

Exhibit 21: Content cost savings to reflect in profitability


0

1,500

3,000

4,500

6,000


75.0

90.0

105.0

120.0Content Cost (Rs m - LHS) % of subscription revenues (RHS)

0

40

80

120

160


Content cost per paying subscriber

As Hathway retains the gains from better

declaration, content cost growth slower at 23%

Revenues

6,6347,361

8,950

11,956

17,057

0

5,000

10,000

15,000

20,000

(Rs m)

FY09FY08 FY10 FY11E FY12E

37 36 3540 44

44 42 40 29 21

16 18 16 18 22

0

25

50

75

100

(%)


Subscription fee Carriage fee STB rentals VAS Broadband Advertising

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IDFC Securities

A highly profitable broadband business Hathway’s profitability would also improve on the back of rapid growth in broadband business. As against operating margin of 30% in the cable business, broadband business operates at 45-50% margins. With 25% of revenues coming from broadband, it would add an incremental 4% to Hathway’s overall profitability.

Exhibit 22: Scale benefits in broadband business

250 customers 500 customers Cost of equipment 1,100 1,100 City network 1,500 1,000 Drop it capex 500 500 Total capex 3,100 2,600 Upfront charged 500 500 Net subsidy 2,600 2,100 Total subsidy 650,000 1,050,000 ARPU 300 300 Broadband revenues 900,000 1,800,000 Bandwidth cost (%) 20% 20% Bandwidth cost 180,000 360,000 Other cost (%) 35% 25% Other cost 315,000 450,000 EBITDA 405,000 990,000 EBITDA margin (%) 45 55 Source: IDFC Securities Research

Sharp improvement in operating margins ahead With gross margins in subscription revenues improving to $25, Rs1.3bn of revenues coming from STB rentals and Rs3.8bn from carriage fees – which do not have any corresponding costs – and faster growth of broadband business, we expect operating margin of Hathway to increase from 17% currently to 37% by FY13. We expect EBITDA to increase from Rs1.3bn in FY10 to Rs6.3bn by FY13.

Exhibit 23: Multifold increase in operating profits

0

2,000

4,000

6,000

8,000


10.0

20.0

30.0

40.0EBITDA (Rs m - LHS) EBITDA margins (% - RHS)


45-55% margins in broadband business

Lower content cost and faster growth of

broadband to drive margin improvement

JUNE 2010

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IDFC Securities

With a marked improvement in operational numbers and stable interest cost (given the funded balance sheet), we expect overall PAT to grow to Rs2.1bn by FY13 from a loss of Rs705m in FY10. As growth (STBs and acquisitions) will be funded through the balance sheet, depreciation will go up from Rs1.25bn in FY10 to Rs2.4bn in FY13E.

Exhibit 24: Cable business finally turning profitable

PAT

291

871(580)(623)

2,103

-1,000

-300

400

1,100

1,800

2,500


(Rs m)


Business turning profitable in FY11 –

Rs2.1bn of PAT by FY13E

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IDFC Securities

Valuations & View

Hathway, India’s largest MSO, is best placed to capitalize upon the emerging cable distribution opportunity. With profitability finally in sight, digitization a reality and Hathway’s ability of being a consolidator, we initiate coverage on the stock with Outperformer.

We have valued Hathway’s business on the basis of EV/ subscriber and arrive at an EV/ subscriber target on the basis of per subscriber economics. While attaching 32 months of ARPU to arrive at EV/ primary point subscriber, secondary point subscriber has been valued at 29 months ARPU and broadband subscriber at 36 months ARPU. Using this methodology, we have arrived at a fair price of Rs274 per share for Hathway.

Exhibit 25: Fair price of Rs274

Secondary pt Primary pt Broadband Total Number of subs in FY13E (m) 2.1 2.0 1.1 ARPU (Rs / month) 325 300 315 Months of ARPU 29 32 36 EV / subscriber (Rs) 9,440 9,530 11,474 Enterprise value (Rs m) 19,823 18,689 16,265 54,777 Less: Debt (Rs m) 2,500 Equity Value (Rs m) 52,277 Number of shares (m) 142.9 Per share value (Rs) in FY13E 366 Minority stake (%) 25 Per share value (Rs) 274

Key Risks

While Hathway is well positioned vis-à-vis peers and we like its overall business model, the following concerns exist:

Primary points – risk of churn While we see merit in Hathway’s strategy of primary point acquisitions, risk of losing its primary subscribers to DTH players is a threat. Every subscriber lost under a primary point would mean loss at the bottom-line, as the cost structure would remain unchanged. With DTH proliferation happening at a rapid pace, this risk can subside only on the back of faster digitization.

Entry of new players While competition from existing MSOs is receding as players focus on digitization rather than customer acquisition, entry of new funded players could pose a risk. We do not expect any major new entrant until a large funded corporate acquires an existing national MSO or FDI opens up in the sector.

Outperformer rating with an 18-month price target

of Rs274

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105

IDFC Securities

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IDFC Securities

Income statement

Year to Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13ENet sales 6,634 7,361 8,950 11,956 17,057 % growth 60 11 22 34 43 Operating expenses 5,789 6,049 6,435 8,151 10,737 EBITDA 845 1,312 2,515 3,805 6,320 % change (4,183) 55 92 51 66 Other income 98 15 135 149 163 Net interest (431) (550) (419) (364) (364)Depreciation 961 1,245 1,608 1,930 2,381 Pre-tax profit (448) (468) 623 1,659 3,738 Deferred tax 29 - - - -Current tax 88 84 93 415 934 Profit after tax (565) (552) 529 1,244 2,803 Preference dividend - - - - -Minorities (58) (28) (238) (373) (701)Net profit after non-recurring items (623) (580) 291 871 2,103 % change (4.7) (7.0) (150.2) 199.2 141.4

Balance sheet

As on Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13EPaid-up capital 1,114 1,429 1,429 1,429 1,571 Reserves & surplus 1,475 5,495 5,786 6,657 8,760 Total shareholders' equity 3,541 7,903 8,494 9,893 13,060 Total current liabilities 3,245 1,693 1,582 2,029 2,358 Total debt 6,813 4,313 3,313 3,313 3,313 Deferred tax liabilities 175 175 175 175 175 Total liabilities 10,234 6,182 5,070 5,517 5,847 Total equity & liabilities 13,775 14,085 13,565 15,410 18,907 Net fixed assets 9,483 8,666 9,358 11,719 14,137 Investments 210 210 210 210 210 Total current assets 3,952 5,079 3,867 3,352 4,430 Deferred tax assets 130 130 130 130 130 Working capital 706 3,386 2,285 1,323 2,072 Total assets 13,775 14,085 13,565 15,410 18,907

Cash flow statement Year to Mar 31 (Rs m) FY09 FY10 FY11E FY12E FY13E Pre-tax profit (448) (468) 623 1,659 3,738 Depreciation 961 1,245 1,608 1,930 2,381 Chg in Working capital (841) (690) 338 575 (140)Total tax paid (88) (84) (93) (415) (934)Operating cash Inflow (417) 3 2,476 3,750 5,045 Capital expenditure (4,149) (428) (2,300) (4,290) (4,799)Free cash flow (a+b) (4,565) (425) 175 (541) 245 Chg in investments 6 - - - -Debt raised/(repaid) 3,999 (2,500) (1,000) - -Capital raised/(repaid) (41) 4,915 - - 143 Misc 777 - 62 154 221 Net chg in cash 176 1,990 (763) (386) 609

Key ratios

Year to Mar 31 FY09 FY10 FY11E FY12E FY13E EBITDA margin (%) 12.7 17.8 28.1 31.8 37.1 EBIT margin (%) (1.8) 0.9 10.1 15.7 23.1 PAT margin (%) (9.4) (7.9) 3.3 7.3 12.3 RoE (%) (18.1) (10.1) 3.6 9.5 18.3 RoCE (%) (1.4) 0.6 7.4 14.8 26.3 Gearing (x) 1.9 0.5 0.4 0.3 0.3

Valuations

Year to Mar 31 FY09 FY10 FY11E FY12E FY13E Reported EPS (Rs) (5.6) (4.1) 2.0 6.1 14.7 Adj. EPS (Rs) (5.6) (4.1) 2.0 6.1 14.7 PE (x) n/a n/a 86.1 28.8 11.9 Price/ Book (x) 5.5 3.2 3.0 2.5 1.9 EV/ Net sales (x) 4.0 3.8 3.1 2.4 1.7 EV/ EBITDA (x) 31.8 21.3 11.1 7.6 4.6 EV/ CE (x) 2.6 2.3 2.3 2.2 1.8


Foreign19.9%

Promoters66.5%


Institutions9.7%

Public & others1.8%

As of March 2010

JUNE 2010 107

IDFC Securities

NOT LISTEDAirtel Digital Scaling up!

Airtel Digital– part of India’s largest telecom company, Bharti Airtel – has been India’s fastest growing DTH player with a base of 2.8m net subscribers as of March 2010. Accounting for 25% of the incremental market (Airtel Digital adds 0.2m subscribers per month), Airtel Digital currently has 12% share of the market. Positioned as relatively premium services, and with aggressive advertising spends and subscriber acquisition cost at 12-15 months, Airtel Digital is expected to touch 5m subscribers by FY11 and see operational breakeven as it garners 5.5m subscribers. Bharti Airtel has so far invested US$425m in the DTH business (3% of its total capital employed) and incurred losses to the tune of USD250m in FY10. Airtel Digital is likely to be one of the leading players in the DTH space, more so with its premium positioning. Also, being part of a telecom operator and offering broadband services, Airtel Digital would be well poised to offer all the three services (synthetic triple play) – television, internet and telephony.

Part of the largest telecom company in India Bharti Airtel, the flagship company of Bharti Group, is the largest telecom operator in the country and third largest wireless operator in the world with 130m subscribers and presence in all 22 circles. Bharti Airtel has total capital employed of USD14bn and market capitalization of over US$22bn. Extending its presence in wireless technology, Bharti Airtel entered the DTH business in October 2008, a couple of months after the launch of Reliance ADAG’s Big TV.

Deep pockets, aggressive branding and advertising and distribution bandwidth… Given the deep pockets of the group, Airtel Digital has the wherewithal to become a formidable player in the DTH space. Airtel Digital has been among the most aggressive advertisers in the DTH space and has roped in actors and cricketers like Saif Ali Khan, Kareena Kapoor, Gautam Gambhir, etc, besides being associated with major sporting events like IPL. With strong financial backing of the group, Airtel Digital has invested >US$420m so far in the DTH business and is spending ~Rs2bn annually on advertising. However, unlike our earlier belief that Airtel Digital – along with Big TV – would play an aggressive pricing game, Bharti Airtel has priced its offerings in line with peers and has a customer acquisition cost of Rs2,500-3000 (12-15 months of ARPU).

Besides aggressive spends on advertising and branding, Airtel Digital benefits from the vast distribution of its telecom operations that have a reach of 1.2m retail outlets. The DTH business piggy-rides upon the wide distribution reach of the telecom business.

…resulting in 25% share of the incremental market Driven by aggressive brand spending and deep distribution bandwidth, Airtel Digital has scaled its base up to 2.8m subscribers as of March 2010 and accounts for 12% of the market. This makes it the fourth largest DTH player after Dish TV, Tata Sky and Sun Direct. However, Airtel Digital is the fastest growing DTH player in the industry – adding 25% of the total 2m subscribers added quarterly by the industry. Since the launch of Airtel Digital, it has garnered 2.8x the net subscriber addition done by the industry leader – Dish TV. We expect Airtel Digital to add 2.2m subscribers in FY11 to touch a 5m subscriber base. Being a late entrant in the space, Airtel Digital’s churn rate remains low at 0.5% per month. While Airtel Digital is estimated to have done revenues of US$45m in FY10, it is expected to scale up to $150m in FY11.

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Exhibit 1: Bharti – market share

Number of subs (m)

Dish TV30%

Tata Sky25%

Airtel Digital12%

Big TV9%

Sun Direct24%

Videocon0.1%

Better ARPU – led by premium positioning Like Tata Sky, Airtel Digital has positioned itself in the premium segment and though the basic packages entail pricing similar to competition, it enjoys better ARPU over Dish TV, Big TV and Sun Direct. Airtel currently has ARPU of Rs190-200 per month, next only to Tata Sky. While Airtel is now marketing its value-added STB with DVR facilities and also HDTV services, ARPU growth is expected to be subdued as Airtel would be in an aggressive subscriber acquisition mode. Also, VAS services would remain an insignificant portion of the revenues.

Exhibit 2: ARPUs

0

50

100

150

200

250

Sun TV Dish TV Big TV Bharti Airtel Tata Sky

(ARPU / month)

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Exhibit 3: VAS services

Operational break-even at 5.5m subscribers With over 2m subscribers to be added annually and customer acquisition cost of Rs2,500-3,000, Airtel Digital is expected to continue incurring losses at the operating level in FY11 too. In FY10, Airtel is expected to have incurred USD250m of losses in FY10. However, given the fact that ~60% of the costs in the initial period are fixed in nature, operating leverage is expected to set in once Airtel garners a base of 5.5m subscribers (Dish TV reported operating profits once its base crossed 5m subscribers). For Airtel Digital, we believe FY13 would be the first full year of operating profits.

Potential to leverage presence in telecom and broadband While deep pockets and ability to stay invested make Airtel Digital a force to reckon with in the DTH space, we believe the ability to bundle voice and data services as well would be the key differentiator in the long run and platform of competition with digital cable. Bharti Airtel has 130m telephony subscribers in India and a broadband subscriber base of over 1.2m. It has broadband infrastructure laid out across 89 cities in India. Ability to offer all the three services could be a key differentiator in the long run.

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NOT LISTED Sun Direct Shining!

Sun Direct, promoted by Sun Networks – South India’s largest media house – and funded by Astro Malaysia, has achieved a commendable feat of clocking 4.3m net subscribers in just two years of operations. A strong brand (Sun), an invested book of USD600m and aggressive pricing strategy have helped Sun Direct become the third largest DTH player in India with a market share of 24%. Sun Direct has incrementally extended its presence across India and continues to play an aggressive price game. Sun Direct has also recently launched its HDTV services. Sun Direct is estimated to be incurring Rs6bn of annual losses.

A strong parent in the largest South India-based media house Sun Direct is a part of the Sun Group, which is the largest media conglomerate in South India with a 20-channel broadcast business under Sun TV, ~1m paying subscribers under Sumangali Cable Vision and print business under the brand Dinakaran. Sun Direct is an 80:20 JV between the Maran family and Astro Malaysia (which has DTH business in Malaysia). While Astro Malaysia brings in the expertise of running DTH operations, Sun Group has a strong brand franchise in South India. With US$600m invested so far and by leveraging Sun’s equity, Sun Direct was the third player (services launched in early 2008) to enter the DTH space after Dish TV and Tata Sky.

Exhibit 4: Group structure

Third largest DTH player… Within two years of operations, Sun Direct has added as many subscribers as Tata Sky has in the past 3.5 years and 50% higher subscribers than that added by Dish TV since the launch of Sun Direct. With a base of 4.3m net subscribers, Sun Direct has emerged as the third largest DTH operator in India in terms of number of subscribers and continues to account for 20% of the incremental market.

…on the back of Southern dominance and aggressive customer acquisition While dominance in South India have underpinned growth in subscriber base for Sun Direct, the existing broadcast vertical has been leveraged to extend aggressive subsidization on packages. With South India being a regional broadcasting industry and Sun TV Network’s the only pay channels, Sun Direct benefits from optimal content costs. Thus, Sun Direct aggressively marketed an annual package of Rs99 per subscription, while offering similar subsidies on STBs as by other DTH players. Thus, Sun Direct has the lowest ARPU in the Indian DTH industry, estimated to be at Rs75. Sun Direct has backed its aggressive pricing strategy with ample advertising support.

Sun Group

Cable distributionBroadcasting DTH Print

SumangaliSun TV Network Sun Direct Dinakaran

Sun Group

Cable distributionBroadcasting DTH Print

SumangaliSun TV Network Sun Direct Dinakaran

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Moving beyond South and launch of HDTV In the first year of operations, Sun Direct launched its DTH services only in South India. Subsequently, in early 2009, services were launched in other key markets such as Maharashtra (mainly Mumbai), Punjab, Himachal Pradesh, Haryana and Jammu & Kashmir. Though South forms a substantial portion of Sun Direct’s subscriber base, it has gained a pan-India footprint. However, we believe Sun Direct will have to change its pricing strategy in other parts of India. With a view to up its offering in rest of India, Sun Direct has launched HDTV services. With ~1m of the TV sets sold annually being HDTV-compatible, we see a faster ramp up of HDTV. Sun Direct has been the first DTH player to show IPL matches in the high definition format in a tie-up with Set Max for the same.

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NOT LISTEDTata Sky High on value!

Tata Sky, a joint venture between the Tata Group and NewsCorp, has by far created the highest visibility in the DTH space through its superior brand positioning. While Tata is among the most trusted brands in India, NewsCorp is the largest DTH player globally with presence in USA (DirecTV), UK (BSkyB), Japan (Sky Perfect), etc. With an estimated net subscriber base of 4.5m as on December 2009, Tata Sky has a 25% share of the DTH industry. Importantly, Tata Sky has created a differentiated positioning in the market on the back of its premium value-added offering. While Tata Sky is the second largest player in terms of number of subscribers, it is arguably the largest player in terms of revenue base with the highest ARPU in the industry. Tata Sky is estimated to have infused capital to the tune of US$700m till date and an annual bleed of Rs9bn.

Marriage of two strong brands – Tata and Sky Tata Sky was incorporated as an 80:20 joint venture between the Tata Group and NewsCorp. It launched DTH services in 2006 and uses the Sky brand owned by NewsCorp. Not only do these two companies have the financial wherewithal to fund the capital-intensive business (cumulative market capitalization of >USD75bn), they are also two of the strongest brands. While Tata is considered to be a trustworthy brand in India, NewsCorp is leader in DTH space globally with DirecTV in USA and Latin America (21m subscribers), BSKYB in UK (9m), Sky Perfect in Japan, etc. In 2008, the Singapore-based Temasek Holdings acquired a 10% stake in the company, thereby diluting Tata Group’s stake to 70%. Tata Sky is estimated to have infused capital to the tune of USD700m in the business and has an annual bleed of Rs9bn.

Exhibit 1: Company structure

Tata Sky – ‘valuable’ subscribers! Tata Sky has a 25% share in the Indian DTH industry with an estimated base of ~4.5m net and >5m gross subscribers. While rest of the industry was playing the pricing game, Tata Sky has remained focused on creating premium positioning by promoting its product on the back of superior viewing quality. Also, while Dish TV – the then-incumbent – was focusing on cable-dark area for growth, Tata Sky ramped up its operations in metros. Also, ahead of the competition, Tata Sky launched its VAS-enabled service – Tata Sky+. Though Sky+ has only 0.1m subscribers, it has helped Tata Sky enhance its product positioning. As a result of these efforts, Tata Sky has the highest ARPU of Rs220 in the industry (substantially higher than ARPU of Rs135 for industry leader). While the subsidy element on STBs would be similar to competition, a premium positioning has helped Tata Sky attract customers not as price sensitive in the face of quality.

Tata Sky

Tata Group Star Group Temasek

Sky brand name

70% 20% 10%

Tata Sky

Tata Group Star Group Temasek

Sky brand name

70% 20% 10%

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Exhibit 2: VAS services

Largest in terms of revenues While Tata Sky may be the second largest player in terms of subscribers, it is the largest in terms of revenues. Tata Sky ended FY09 with revenues of Rs8bn – Rs6.2bn in subscription revenues and Rs1.8bn from sale of STBs. We estimate revenues of Rs11bn for Tata Sky in FY10 with 20% of these from sale of STBs. Tata Sky is expected to have incurred losses of Rs9bn in FY10 and Rs11bn in FY09. We believe that losses for Tata Sky are higher vis-à-vis competition, given the accounting of STB installation. While Dish TV is giving STBs on rentals and accounting for rentals over a period of three years and depreciating the STBs over five years, Tata Sky is selling STBs upfront. Of the Rs11bn of losses incurred by Tata Sky in FY09, Rs4.8bn would be on account of upfront subsidy on STBs.

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NOT LISTEDDigicable Funding is critical for growth

Digicable, incorporated in 2007, has been set up by industry veteran Jagjit Singh Kolhi, credited with setting up of the country’s leading MSOs such as Hathway, Incable and WWIL. Within three years, Digicable has emerged as the third-largest national MSO with 1.2m paying subscribers and 0.5m digital subscribers. Backed by adequate funding from Ashmore – a London-based private equity fund, Digicable adopted an aggressive secondary point acquisition strategy in order to gather critical mass in the fragmented Indian cable industry. With capital infusion of US$140m till date, Digicable has an estimated reach of >8m subscribers, of which 1.2m are paying and 0.5m digital. With dominance in Punjab, Digicable has relevant presence in markets like Rajasthan, Madhya Pradesh, Andhra Pradesh, Maharashtra, etc. Digicable is estimated to have revenues of Rs3bn+ and net loss of ~Rs1bn. While Digicable has demonstrated the aggression in the first round, funding – critical for digitization of the customer base – emerges as a key monitorable.

Company background Jagjit Singh Kohli is a veteran in India’s cable distribution space. He has earlier set up and managed MSOs such as Incable, Hathway and WWIL. In 2007, Jagjit Singh left the control of WWIL (as CEO) and created his own company Digicable. Further, Ashmore (a US$32bn London-based private equity fund) infused capital into Digicable. Till date, Ashmore is believed to have invested ~USD140m in Digicable.

Among the top three MSOs… Funding support of Ashmore and Jagjit Singh Kohli’s know-how about the on-ground dynamics of the cable/ distribution business have enabled Digicable to go on an aggressive secondary point acquisition spree. Within three years, Digicable has acquired more than 60 MSOs and a reach of 8m subscribers. Of this, Digicable has 1.2m paying and 0.5m digital subscribers. While Digicable has more paying subscribers than DEN, it has revenues of just over Rs3bn as against DEN’s cable business revenues of >Rs4bn. Besides lower revenues, our other concern on Digicable pertains to the aggressive pricing of acquisition – Digicable is expected to have spent 1.5x that invested by DEN. Digicable also has a base of 0.1m broadband subscribers.

…with diversified geographical presence While Digicable started its operations in Punjab and retains dominance in the state with >65% market share, it is also a relevant player in Rajasthan, Madhya Pradesh, Chhattisgarh, Maharashtra, Andhra Pradesh and West Bengal and has operations in Uttar Pradesh, Delhi, Haryana and Uttarakhand. Digicable has established infrastructure in these states with 73 analog and ~30 digital head-ends (more than any other player in the cable space) and has over 28,000km of fibre network in place.

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Exhibit 1: Geographical presence of Digicable

Dominant

Significant

MarginalNo Presence

Capital constraints; a potential buy-out target Till date, Digicable is estimated to have infused capital to the tune of USD140m, funded by Ashmore. While Digicable has acquired critical mass, Digicable needs additional capital to digitize its customer base to protect it from poaching. With operational recovery based on the pace of digitization which, in turn, requires additional capital, we believe Digicable is caught in a vicious cycle. While Digicable has created a strong business model with reach of 8m subscribers, inability to fund losses (and thereby run the business) makes Digicable a potential acquisition target.

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NOT LISTEDYou Telecom Betting on broadband

You Telecom, incorporated in 2001, started operations as a broadband service provider. The company forayed into the cable distribution space three years ago by acquiring a strategic interest in its associate company – Digital Outsourcing Pvt Ltd (DOPL). DOPL has an estimated reach of 1.5m secondary (0.15m paying) and 8,000 primary subscribers. Further, 10% (0.15m) of DOPL’s 1.5m+ subscribers are on the digital platform. Incrementally, You Telecom has a 32% share of the internet broadband market through cable operators in India with a subscriber base of 0.2m. While the first round of funding in You Tube was done by Citigroup Ventures (CVC), it is now looking at Rs3.2bn of a fund-raise through the IPO route (DRHP filed). Of the proceeds, Rs1.6bn are proposed to be deployed for broadband services and Rs980m for cable distribution business.

Company background You Telecom started operations as a provider of high-speed broadband internet services. While broadband internet solutions have been the company’s mainstay, You Telecom forayed into the cable distribution industry in 2007 by acquiring a strategic investment in DOPL – its associate company. You Telecom holds a 36.24% stake in DOPL and operates cable TV services across 10 cities in the country. In Mumbai, it has presence in cable business through a JV with Scod18 (formed by 18 different LCOs coming together). You Telecom has been funded by Citigroup Venture Capital (CVC) to the tune of USD60m.

Cable TV services – small in scale (0.1m digital homes) You Telecom, through DOPL, currently provides analog cable services across 10 cities in India including Mumbai/ Navi Mumbai, Bangalore, Vizag and Nagpur, where the service overlaps with the company’s cable broadband services footprint and network infrastructure. Further, DOPL – like peers – has adopted the acquisition strategy to garner customers. Over the last three years, DOPL has acquired a strategic interest in five MSOs as also last mile connectivity in certain cities. DOPL has an estimated reach of 1.5m secondary and 8,000 primary subscribers, of which 0.15m are paying. You telecom has taken a focused approach in the cable business by going slow on acquisition and first digitizing the existing base before adding new subscribers. You Telecom has so far seeded STBs in 0.15m homes. The company operates its digital cable television services under various brands, including “YOU SCOD18 Digivision” and “YOU Digivision”. In FY09, DOPL made net losses to the tune of Rs481m. However, losses appear to be coming down and were at Rs171m for H1FY10.

Broadband services – the core You Telecom provides high-speed broadband cable internet services to residential subscribers, SMEs and large corporate customers across 11 cities. As of September 2009, You Telecom has a residential broadband internet service subscriber base of ~0.2m subscribers. Further, the network of You Telecom reaches ~1.5m homes, and the company’s residential broadband internet service subscriber base represents an estimated penetration of 13.4% of two-way broadband-enabled homes. As per TRAI reports, You Telecom is estimated to have ~32% share of the cable broadband internet market in India. While margins in the business are currently low at 25%, they would expand exponentially as broadband achieves scale and basic infrastructure cost gets distributed across a larger customer base.

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Exhibit 1: Geographical presence of broadband services

Capital-raise on the anvil In order to further scale up its business, You Telecom is looking to raise Rs3.2bn via the primary market and has filed a DRHP to that effect. The proposed objects of the issue include allocation of Rs1.57bn towards the broadband segment and an aggregate investment of Rs980m for the cable services business.

Exhibit 2: Objects of the issue

Particulars (Rs m) Broadband capex 1573.9 Increasing stake in DOPL 128.27 Investment in DOPL 850 Working capital 171 Debt repayment 48.4 Total 2771.57

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UNRATEDWWIL Not a ‘hit’!

WWIL, a Zee group company, led the Indian cable industry until 2006 with its overall reach of 6.7m subscribers. However, intense competition over the last three years (from players such as DEN and Hathway) as also the group’s focus on the DTH platform proved detrimental and WWIL lost its leadership position. WWIL is estimated to have a paying subscriber base of 0.7m and revenues of Rs2.7bn in FY10 (same as that in FY08). Further, WWIL was betting big on HITS in order to provide a differentiated offering; however, lack of regulatory framework has impelled WWIL to suspend HITS operations. The recent fund raise of Rs4.5bn, we believe, has been utilized towards funding of loss (Rs1.7bn of net loss in FY10) and repayment of debt to group companies.

Dented by competition… WWIL was formed in March 2006 by the de-merger of the cable business of Zee Enterprises (Siticable). Through its brand Siticable, WWIL has been the pioneer in the cable distribution space. At the time of demerger, WWIL claimed a reach of 6.7m (across 107 cities) and paying subscriber base of ~1m. While WWIL went in for acquisitions in Lucknow, Agra, Indore, Nagpur, etc, competition has managed to eat into its subscriber base. Though WWIL continues to be a strong player in the East, it has lost its clout in western and northern parts of India due to competition from DEN Networks and Digicable. This reflects in a drop in the paying subscriber base to ~0.7m, revenues remaining flat at Rs2.7bn and net loss of Rs1.7bn in FY10. We estimate WWIL’s digital subscriber base at ~0.2m.

…on the back of inadequate capital and promoter’s lack of focus While the element of competition has weighed heavy on WWIL, we believe the reasons for subdued momentum in digitization include lack of capital and limited promoter focus. Also, WWIL has been hit by a frequent change in the management team (two CEOs lost to competition in the past five years). With digitization being voluntary (given the failure of CAS), subsidization became a pre-requisite. Thus, while competition was able to seed in capital for growth, lack of capital led to slower pace of digitization for WWIL. In terms of promoter commitment, our sense is that focus of promoter group has been more on the group’s DTH venture – Dish TV (net base of 5.7m subscribers). While WWIL has recently raised Rs4.5bn by way of a rights issue, we believe the capital would be primarily used to repay group company debt.

HITS – the big bet…not a ‘hit’! In order to provide a differentiated offering, WWIL took an aggressive step towards adoption of HITS (technology. The technology aided in providing a pseudo-DTH offering, wherein LCOs (and not customers) receive signals through satellite which can then be remitted to households via cable. This was done with a view to increase reach without having to set up digital network in multiple cities. WWIL has launched HITS in Lucknow and Bangalore. The license for HITS is with Dish TV (a promoter group company) and WWIL has signed an agreement with Dish TV to use the HITS services. However, lack of regulatory guidelines on pricing, content, etc has prompted WWIL to exit from the HITS platform. WWIL is estimated to have funded losses to the tune of Rs500m towards HITS till date.

We believe that unless WWIL ups its ante on digitization, it would fall prey to increasing consolidation in the space and the onslaught of DTH.

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NOT LISTEDReliance Big TV Yet to gather scale

Reliance Big TV, part of the Reliance ADAG Group, forayed into the Indian DTH industry in 2008 and is part of Reliance Communications. Reliance Big TV is estimated to have deployed capital to the tune of $400m and a reach of ~2m subscribers. While Reliance Big TV was expected to play an aggressive pricing game, the way it did in the telecom space, Big TV’s pricing has been in line with the industry. While current ARPU of Big TV is estimated at ~Rs160 per month, the focus is now on the premium segment through launch of HDTV services and higher-end STBs. Big TV is estimated to have incurred $125m-150m of losses in FY10. While Big TV’s growth has so far been below expectations (Bharti, having launched services two months after Big TV, has over 2.5m subscribers). Reliance ADAG’s presence in telecom, broadband and media business, we believe, could be leveraged to strengthen DTH operations.

Strong corporate backing… Reliance BIG TV is a part of Reliance ADAG, which has business operations across infrastructure, telecom, power, media, financial services, etc. Big TV is a subsidiary of Reliance Communications, the second largest telecom company in India with 105m subscribers. Big TV forayed into the DTH business in 2008 and launched its services on the MPEG4 technology. Reliance Communications is expected to have infused ~$400m into the DTH business since inception and reach of 1.6m subscribers (<10% market share). With a strong balance sheet and distribution width of the telecom business, Big TV was anticipated to play an aggressive price game to garner a higher share of the market. However, aggressive competitive landscape in telecom sector has prompted Big TV to play a rational pricing strategy in this business.

Plans to play a ‘premium’ strategy… In order to increase its relevance in the 21m DTH industry, Big TV is betting on product differentiation and value-added services. Big TV has recently launched an HD DVR set-top box, which is the country’s first product with a dual benefit of High Definition viewing and Digital Video Recorder in a single Set Top Box. With this, Big TV is also offering a universal remote control which can manage up to three devices (TV, STB and any other music/ disc player system). Reliance Big TV plans to roll out its HD DVR STBs across top 100 cities in India at a price point of Rs7,490, and is estimated to spend ~Rs1bn in advertising for the same. With Reliance adopting a strategy to acquire premium customers, ARPUs are at ~Rs160 – 20% higher than industry leader Dish TV.

…and strategic partnership Reliance BIG TV has recently entered into an agreement with Korean major LG Electronics for bundling DTH connections with LG colour televisions. As per the agreement, LG colour TV customers would have a choice to avail of a Reliance BIG TV connection on paying Rs399 as installation charges. The offer, valid till 30 June 2010, would be available across Karnataka, Rajasthan, Punjab, Bihar, Jammu & Kashmir, Tamil Nadu, Gujarat, Uttar Pradesh, Uttaranchal, Himachal Pradesh, Chhattisgarh and Haryana.

Capital and ability to leverage the telecom business is key to future success While ability to stay invested would help Reliance Big TV increase penetration, we believe the ability to bundle voice and data services will be the key differentiator in the long run. Reliance Communications has 105m telephony subscribers in India and a strong broadband subscriber base.

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NOT LISTEDInCable (Hinduja Group) Betting on regulations to act

IndusInd Media and Communication (IMCL), part of Hinduja Ventures (a Hinduja group company), is a cable television and internet service provider under the brand InCable. Though among the early entrants in the cable space with adequate capital post the group’s stake sale in Hutch Telecom India operations, InCable has been conservative in its approach. InCable has also lost substantial share of subscribers to new entrants like DEN and Digicable, and is estimated to have a base of <0.5m paying subscribers. InCable has 0.4m digital and broadband services subscribers. As the management is not keen on digitization in the absence of monetization, it would maintain its conservative stance. InCable is also expected to scout for a strategic partner or capital raise to fund the future digitization needs.

Backed by the Hinduja Group IndusInd Media and Communication (IMCL) is a part of the Hinduja Group, which is a diversified conglomerate with interests across auto (Ashok Leyland – market capitalization of US$1.8bn), financial and oil & gas sectors among others. IMCL is the merged entity of cable, content (INEL) and broadband internet (In2Cable) services of the Hinduja Group. With regards the cable business, the company provides analog cable services under Incable brand and digital cable services under INDIGITAL brand. In FY10, IMCL achieved revenues of Rs3.29bn and net profit of Rs333m.

Analog cable services reach IMCL has a reach of over 8m cable homes and has 6,500km of hybrid fiber optic cable, of which 80% is two-way enabled. Further, IMCL has presence across 27 cities which include key regions such as Mumbai, Thane, Delhi, Noida, Bangalore, Ahmedabad, Vadodra and Belgaum. IMCL’s network comprises >2,400 LCOs.

Exhibit 1: India presence of InCable

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Digital cable – slow on rollout With regards digital cable, IMCL has rolled out its services in Mumbai and Delhi. It is estimated to have installed ~0.4m STBs. In terms of infrastructure, it has established eight digital head-ends in India, covering 12 cities including key metros. While adequately capitalized and backed by the Hinduja Group, IMCL has been relatively slow in ramping up its digital cable services. Our interaction with the management indicates that regulatory action towards mandating digitization, and thereby improved declarations, will be the key for IMCL to aggressively roll out its digital platform. The company is estimated to have ramped up its primary points base to over 0.2m by way of acquisitions. While this would ensure improved ARPU, it would help leverage the subscriber base to offer broadband services as well.

Strategic partnership – on the anvil In order to compete with industry incumbents in digital cable, we believe IMCL is likely to enter into a strategic tie-up. In FY10, IMCL achieved revenues of Rs3.29bn and net profit of Rs333m. A large part of the revenues are expected to be contributed by carriage fees currently, as digitization is yet to pick up for IMCL.

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IDFC Securities

Analyst Sector/Industry/Coverage E-mail Tel. +91-22-6622 2600 Pathik Gandotra Head of Research; Financials, Strategy [email protected] 91-22-662 22525 Shirish Rane Construction, Power, Cement [email protected] 91-22-662 22575 Nikhil Vora FMCG, Media, Mid Caps, Education, Exchanges [email protected] 91-22-662 22567 Ramnath S Automobiles, Auto ancillaries, Real Estate, Oil & Gas [email protected] 91-22-662 22570 Nitin Agarwal Pharmaceuticals [email protected] 91-22-662 22568 Chirag Shah Metals & Mining,Telecom, Pipes, Textiles [email protected] 91-22-662 22564 Bhoomika Nair Logistics, Engineering [email protected] 91-22-662 22561 Hitesh Shah, CFA IT Services [email protected] 91-22-662 22565 Bhushan Gajaria Retailing, FMCG, Media, Mid Caps [email protected] 91-22-662 22562 Salil Desai Construction, Power, Cement [email protected] 91-22-662 22573 Ashish Shah Construction, Power, Cement [email protected] 91-22-662 22560 Probal Sen Oil & Gas [email protected] 91-22-662 22569 Chinmaya Garg Financials [email protected] 91-22-662 22563 Aniket Mhatre Automobiles, Auto ancillaries [email protected] 91-22-662 22559 Abhishek Gupta Telecom [email protected] 91-22-662 22661 Ritesh Shah Pharmaceuticals, IT Services [email protected] 91-22-662 22571 Saumil Mehta Metals, Pipes [email protected] 91-22-662 22578 Vineet Chandak Real Estate [email protected] 91-22-662 22579 Kavita Kejriwal Strategy, Financials [email protected] 91-22-662 22558 Swati Nangalia Mid Caps, Media, Exchanges [email protected] 91-22-662 22576 Sameer Bhise Strategy, Financials [email protected] 91-22-662 22574 Nikhil Salvi Construction, Power, Cement [email protected] 91-22-662 22566 Shweta Dewan Mid Caps, Education, FMCG [email protected] 91-22-662 22577 Dharmendra Sahu Database Analyst [email protected] 91-22-662 22580 Rupesh Sonawale Database Analyst [email protected] 91-22-662 22572 Dharmesh R Bhatt, CMT Technical Analyst [email protected] 91-22-662 22534

Equity Sales/Dealing Designation E-mail Tel. +91-22-6622 2500 Naishadh Paleja MD, CEO [email protected] 91-22-6622 2522 Paresh Shah MD, Dealing [email protected] 91-22-6622 2508 Vishal Purohit MD, Sales [email protected] 91-22-6622 2533 Nikhil Gholani MD, Sales [email protected] 91-22-6622 2529 Sanjay Panicker Director, Sales [email protected] 91-22-6622 2530 V Navin Roy Director, Sales [email protected] 91-22-6622 2528 Nirbhay Singh SVP, Sales [email protected] 91-22-6622 2595 Suchit Sehgal AVP, Sales [email protected] 91-22-6622 2532 Pawan Sharma MD, Derivatives [email protected] 91-22-6622 2539 Jignesh Shah AVP, Derivatives [email protected] 91-22-6622 2536 Suniil Pandit Director, Sales trading [email protected] 91-22-6622 2524 Mukesh Chaturvedi SVP, Sales trading [email protected] 91-22-6622 2512 Viren Sompura SVP, Sales trading [email protected] 91-22-6622 2527 Rajashekhar Hiremath VP, Sales trading [email protected] 91-22-6622 2516

Disclaimer This document has been prepared by IDFC Securities Ltd (IDFC SEC). IDFC SEC and its subsidiaries and associated companies are a full-service, integrated investment banking, investment management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities. This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable. While we would endeavor to update the information herein on reasonable basis, IDFC SEC, its subsidiaries and associated companies, their directors and employees (“IDFC SEC and affiliates”) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance, or other reasons that may prevent IDFC SEC and affiliates from doing so. We do not represent that information contained herein is accurate or complete and it should not be relied upon as such. This document is prepared for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved). The investment discussed or views expressed may not be suitable for all investors. Affiliates of IDFC SEC may have issued other reports that are inconsistent with and reach different conclusions from, the information presented in this report. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject IDFC SEC and affiliates to any registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to a certain category of investors. Persons in whose possession this document may come are required to inform themselves of, and to observe, such applicable restrictions. Reports based on technical analysis centers on studying charts of a stock's price movement and trading volume, as opposed to focusing on a company's fundamentals and, as such, may not match with a report on a company's fundamentals. IDFC SEC and affiliates may have used the information set forth herein before publication and may have positions in, may from time to time purchase or sell, or may be materially interested in any of the securities mentioned or related securities. IDFC SEC and affiliates may from time to time solicit from, or perform investment banking, or other services for, any company mentioned herein. Without limiting any of the foregoing, in no event shall IDFC SEC, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. Any comments or statements made herein are those of the analyst and do not necessarily reflect those of IDFC SEC and affiliates. This document is subject to changes without prior notice and is intended only for the person or entity to which it is addressed and may contain confidential and/or privileged material and is not for any type of circulation. Any review, retransmission, or any other use is prohibited. Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. IDFC SEC will not treat recipients as customers by virtue of their receiving this report. Explanation of Ratings: 1. Outperformer: More than 5% to Index

2. Neutral: Within 0-5% to Index

3. Underperformer: Less than 5% to Index

Disclosure of interest: 1. IDFC SEC and affiliates may have received compensation from the company covered herein in the past twelve months for issue management, capital structure, mergers &

acquisitions, buyback of shares and other corporate advisory services. 2. Affiliates of IDFC SEC may have received a mandate from the subject company. 3. IDFC SEC and affiliates may hold paid up capital of the subject company. 4. IDFC SEC and affiliates, their directors and employees may from time to time have positions or options in the company and buy or sell the securities of the company(ies)

mentioned herein. Copyright in this document vests exclusively with IDFC Securities Ltd

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