ZEE on January 22 received a communication from Sony Pictures Networks India, purporting to terminate the Merger Agreement dated 21st December 2021, and seeking a termination fee of USD 90mn on account of alleged breaches by ZEE of the terms of MCA, invoking arbitration and seeking interim reliefs against ZEE.

Why Sony called off the merger? 

Sony hascalled off the mergeralleging breaches by ZEE of the terms of MCA, invoking arbitration and seeking interim reliefs against ZEE. ZEE has denied all the assertions raised by Sony on the alleged breaches under the terms of the MCA, including their claims for the termination fee. ZEE mentioned that the company took all steps in line with the Merger Cooperation Agreement, approved by its shareholders and all regulatory authorities and has consistently worked towards the implementation of the mentioned scheme in the interest of the shareholders. ZEE also mentioned that it held several deliberations and good faith negotiations with Sony, with a view to consider an extension (six months) of the merger completion timeline, that did not materialise.

Any legal steps being taken by Zee? 

Zee is evaluating all the available options and will take all the necessary steps to protect the long-term interests of all its stakeholders, including by taking appropriate legal action and contesting Sony India’s claims in the arbitration proceedings.

Possible outcome of the event 

Zee will continue to evaluate organic and inorganic opportunities for growth, leveraging the intrinsic value of its assets. Zee has clearly mentioned that Mr. Punit Goenka agreed to step down in the interest of the merger and proposals in this regard were discussed, including for appointment of a director on the Board of the merged company, in the best interest of Zee’s directors and shareholders. Hence, the actual reason of Sony terminating the merger remains unknown; however, we believe that Mr Punit Goenka demanding a higher non compete fee in place of stepping down from the merged co CEO or demand for a new CEO candidate, apart from Sony’s current CEO (Mr NP Singh), could be the probable reasons for Sony backing out

Over the near term, we foresee valuations of Zee to be under pressure, as merger with Sony was the key driver for valuations to move up over last two years. With the merger being called off - the worst-case TP for Z could be in the range of INR 130 (including sports losses) and INR 170 (ex-sports losses - assuming Z does not fulfil sports rights commitment with Disney). Further, this move will also lead to multiple legal hurdles like 1) battle with Sony over the non compete fee, 2) legal proceedings if Zee does not fulfill contract wirh Disney (sports contract) and 3) ongoing legal proceedings by various creditors of the Essel group (Axis Finance, IDBI Bank etc )

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• We believe the above termination will have a negative impact on both parties, as both companies are going through stiff competition from digital media and face a potential threat from the merger of RIL/Disney over the near term
• Z has reported a muted performance in terms of growth and profitability over the last two years, as revenue growth has converged to 2.2% (FY20-24E) and EBITDA margin dipped to 10.2% (9MFY24E), due to 1) losses in the OTT segment and 2) lower growth in linear TV segment
• Z had also signed a contract with Disney for sub franchise of sports (ICC tournaments) rights on the linear TV side; we had estimated annual losses of approx. INR 15.2bn due to the same in FY25 and beyond, due to 1) hefty content cost, 2) lower sports ad revenue and 3) cricket content being available free on OTT. Z may not fulfil its commitment on the same (has a cash balance of mere INR 6bn, vs a potential contractual obligation of INR 40 bn per year) as the above was a strategic decision which could reap benefits due to Z/Sony merger. There could be a negative impact of a penalty/legal proceedings on the above for Z, however PAT will see a positive impact due to absence of sports losses in FY25 and beyond.
• We believe Z will see a sharp de-rating of PE valuation multiples towards at least 10x one year fwd. or lower, due to the merger potentially being called off, as 1) linear TV growth has converged sharply , 2) Z may not have any potential to scale up OTT offering in a highly fragmented market, 3) lower profitability - EBITDA margin ex sports losses could converged towards 14% and 4) any further write offs on the inventory side or matters pertaining to related parties creditors or not honouring the sports contract with Disney (ICC tournaments - Z could have potentially paid half of the USD 3bn value for TV rights)
• There is also some likelihood of the shareholders - top five shareholders owning ~30% of Z put together, who may work together to do the deal with Sony and without Mr Punit Goenka; however, the process is time consuming (6-12 months) and may lead to multiple legal hurdles between the promoter and institutions; there is also a potential of a local Indian conglomerate buying out Z, if at all, which too could provide some respite to valuations
• However, over the near term, we foresee valuations to be under pressure, as merger with Sony was the key driver for valuations to move up over last two years
• With the merger being called off - the TP for Z could be in the range of INR 130 (including sports losses) and INR 170 (ex-sports losses - assuming Z does not fulfil sports rights commitment with Disney).
  
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