That proved a timely call as the share price immediately started an upmove and, at 243p, is now back to around the level of my original buy-in price. The shares are also at a very important juncture as a close of 246p or above would signal a triple top break-out on the company’s point and figure chart (3 points). In turn, this would provide the platform for a run up back towards the share price high of 310p which was hit just before the company postponed its US listing last May. It is a major share price move I expect to happen especially as the 14-day RSI is not yet overbought, the MACD is positive and above its signal line and the share price is not overextended above its 20-day nor 50-day moving averages. Clearly others have been thinking the same way and not without good reason.
Attractive valuation
The driver for the latest rerating can be partly attributed to comments from chief executive Jyoti Deshpande at the time of the company’s results in early November. At the time he noted that: "Post the upcoming US elections and holiday season, Eros intends to re-launch the US listing process beginning with the updating of the public filing with the SEC and hopes to take the transaction to its logical conclusion thereafter… the board continues to believe that the listing will give Eros a strategic advantage, access to additional equity capital and liquidity as well as trading with a more comparable peer group with broader analyst coverage."
In my view, the potential upside from a US listing is not yet in the price since Eros shares only trade on a forward PE ratio of 9.5 based on an increase in full-year adjusted pre-tax profits from $64.9m to $69.5m in the 12 months to 31 March 2013, as analysts predict. That would generate EPS of around 41 cents, or 25.6p at current exchange rates. I think that US investors would find that a very enticing valuation when Eros re-launches the US listing process since, based on a peer group analysis, the company is currently only being valued on 8.2 times cash profits, falling to 7.4 times cash profits for the financial year ending 31 March 2014, once you factor in net debt on the balance sheet to calculate the company's enterprise value (market value plus debt). This compares favourably with all the US content providers and represents a hefty 25 per cent valuation discount to corporations like Dreamworks Animation and Lionsgate Entertainment which both trade on around 10 times enterprise value to cash profits.
Game changing joint venture
I also feel that with equity markets in buoyant mood and investors happy to play the 'risk on rally' then there is a real opportunity for Eros to get the float away this time, having sensibly pulled it last summer when markets were falling out of bed. That is not wishful thinking either because since those financial results were released Eros has announced a game changing joint venture with US premium network operator HBO which, in my view, will significantly increase the appeal of the company's shares to US fund managers.
This landmark agreement not only brings the best of Hollywood and Bollywood together, but means that Eros is ideally placed to tap into the rapid growth forecast in the digital pay-tv (direct-to-home satellite and cable) markets in India. In fact, driven by the growth in the middle classes, who spend far more on entertainment, analysts at KPMG predict digital pay-tv audiences in India will rocket from around 65m this year to 161m by 2016.
So, in order to capitalise on this opportunity, the company is launching two new premium advertising-free movie channels, HBO DEFINED and HBO HITS, to bring digital-only, advertising-fee film and TV content channels to the growing pay-TV market in India. The channels will feature Indian movie content in a new premium movie window shortly after its theatrical release as well as all film content from Warner Brothers and Paramount. These channels will be co-branded and revenues will be based on a share of subscription fees from carrying networks.
Currently, both HBO Asia (a joint venture between Time Warner and Paramount) and Eros provide movies to network operators in India in the pay-TV window, which is between 3 to 12 months after the theatrical release (Hollywood movies tend to be longer). Media analyst Patrick Yau at broking house Peel Hunt points out that “the new venture will create a window that starts immediately for Indian film content (US movies will follow later) following the theatrical release in the window before existing satellite broadcast. This will be the first opportunity for Indian audiences to see any Indian film on TV after its theatrical debut and will be a key part of the channels’ marketing.” In other words, by shortening the lead in times for release of movies to the pay-tv market the joint venture has a massive marketing pull over other players to attract customers willing to pay to view films at a much earlier date than was previously possible. And the financial rewards from this joint venture with HBO Asia could be massive as Mr Yau calculates that net profits could ramp up from $3m on a net subscriber base of 800,000 in the financial year to March 2014, to $16.5m the year after (net subscriber base of 2.2m), and $43.3m in the year to March 2016 assuming net subscribers of 3.6m out of a total pay-tv market of 169m in India that year.
It’s worth noting, too, that Eros has a free ride here as there are no ongoing costs for the company since HBO Asia and Turner International India (also owned by Tim Warner) will run the day-to-day management of the channels. Eros contribution to the joint venture will be providing a quota of new movies and library titles as well as marketing and local expertise.
Catalysts for a rerating
It's the scale of the potential upside from this HBO Asia joint venture that will be of keen interest to US fund managers when Eros starts its IPO roadshow again ahead of a listing on the New York Stock Exchange. True, we are awaiting an announcement on when that will happen, but frankly I don't see much point waiting any longer because I expect Eros shares to rerate very sharply indeed once the company formally announces the NYSE IPO is back on track. For instance, even if the company is rated in line with US peers on 8.6 times 2013/14 cash profits (to enterprise value), then this implies Eros' equity is worth well north of 300p a share. Price on a bid offer spread of 243p to 247p, I rate Eros shares a short-term trading buy and have a three-month target price of 300p.
Finally, I will be producing an online exclusive column on Wednesday 16 January which will be available on my home page.
