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OPINION

Movie time

Movie time
February 21, 2011
Movie time
247p

Established in 1977, Eros produces, acquires and distributes films globally across all platforms including cinemas, home entertainment, television and new media (www.erosplc.com). The company operates in over 50 countries with offices throughout India, UK, US, United Arab Emirates, Singapore, Australia and Fiji. It's a fast growing business and released no fewer than 39 films in Hindi, Tamil and English in the first half of the current financial year. It has a further 50 new films in its pipeline. Eros also continues to build up its valuable library of more than 2,000 titles.

It's a very profitable operation, too, with pre-tax profits surging by a third to $27.9m (£17.3m) in the six months to 30 September 2010 and a recent trading update confirmed Eros is firmly on track to hit analysts' profit forecasts of $50.6m for the 12 months to 31 March 2011. Those profits should produce earnings of 35¢ a share, or around 22p, and if broker estimates prove accurate then we can expect profits to ramp up by a quarter to $63.2m in the 12 months to March 2012, giving EPS of 39.5¢ (24.5p). So with the shares trading at 247p (TIDM: EROS), we can buy into this earnings momentum story on a modest 10 times forward earnings. But the investment case is even more compelling when you factor in a smart demerger Eros completed last autumn of its 100 per cent subsidiary Eros International Media (EIM).

Investors have yet to cotton onto the significance of the initial public offering (IPO) of EIM on the Bombay Stock Exchange (www.bseindia.com) and National Stock Exchange of India. I think they will when Eros publishes its full-year financial results in early June which will reveal significant hidden value in the company's shares. Let me explain.

As part of the IPO, Eros sold 20m shares in EIM, or 21.9 per cent of the equity, at an issue price of 175 rupees per share, to net the company $79m (£49m). It also proved popular with investors, with the issue almost 30 times oversubscribed. EIM currently has a market value of £197m which means that Eros's remaining holding is worth £153m. To put this into perspective, Eros only has a market capitalisation of £283m, so the stake in EIM equates to over half its current share price. Importantly, this is not an inflated valuation as EIM is a very profitable and growing business. In fact, when the company released its third-quarter results to the Bombay Stock Exchange a few weeks ago, it revealed that total income had risen 24 per cent to around £81.4m in the nine months to end-December 2010 and operating profit was up 60 per cent to £20m driven by the release of 64 films. EIM is also de-risking its business model by monetising film content through pre-sale syndication agreements to television and satellite operators. So there will clearly be a good news story to tell here when Eros itself reveals full-year results in June.

Investors will also see a significant improvement in Eros's financial position because, on a pro-forma basis, adjusting for the proceeds of the IPO, the group's net asset value would have been over 20 per cent higher at $401m, or £250m, at the end of September. That means shares in Eros are currently only being valued on 1.1 times book value and it's not as if the company has a highly geared balance sheet, either. The net proceeds of the IPO enabled it to reduce net borrowings to a modest $27.7m (£17.2m) to give gearing of only 7 per cent.

True, around 70 per cent of Eros's shares are in the hands of only three directors including executive chairman Kishore Lulla, which reduces the free float. But I see this as a positive as the board have a significant vested interest in realising value from the company's investments and managing the business to maximise shareholders' returns. It's also fair to say that the shares have marked time since last autumn and have underperformed a rising general market, having traded in a very narrow range of between 217p to 243p since mid-October. Moreover, they are only modestly above the 176p a share listing price when the company floated on the London market in June 2006. However, there was a share price break-out to the upside on Wednesday 16 February. That could prove highly significant after such a long period of consolidation.

So, trading on a modest 1.1 times book value, priced on 10 times prospective earnings and underpinned by the investment in EIM, I rate the shares a strong buy at 247p (price correct at 11am on 21 February 2011). My four-month price target is 300p, but this could prove conservative once investors realise the hidden value of Eros's investment in EIM.