A blockbuster merger of PVR and Inox

In an unanticipated event, the boards of PVR and Inox have approved an all-stock amalgamation. The consolidated entity will have 1,546 screens, implying a market share of 16-17% in total screens (including single screens) in India and a 44%-50% share within multiplex screens (based on pre-pandemic multiplex screens of 3500). Additionally, the merged entity would have a ~40% share in net box office collections (NBOC). Inox promoters will also bring in all the owned real estate, giving the merged entity an opportunity to divest in future to raise capital. In our view, the merger will create a large entity with better negotiating power across the length of business partners and better cost management as well. While management has highlighted that CCI approval will not be required, we believe that the merger will undergo some scrutiny from the regulators, given the dominance of these companies.

Key contours of the deal:

1) Share swap ratio- 3 shares of PVR for 10 shares of Inox. 2) Shareholding- Post the merger, the promoters of PVR and Inox are likely to have 10.6% and 16.7% holdings in the merged entity, respectively. 3) Board construct- Mr. Ajay Bijli will be MD of the merged entity and Mr. Pavan Kumar Jain will be the non-executive chairman of the board. The board of directors of the merged company would be reconstituted, with the total board strength of 10 members and both the promoter families having equal representation on the board with two board seats each. 4) Branding- The combined entity will be named as PVR INOX Limited; branding of existing screens will continue as PVR and INOX separately, while new cinemas to be opened after the merger will be branded as PVR INOX.  

Synergies:

In our view, the merged entity will have revenue synergies from 1) advertisements and 2) convenience fees (better negotiating power with aggregators – BMS and PayTM). Costs- 1) rent negotiations with overlapping mall owners; 2) rent on incremental properties. We believe rental negotiations will happen in the medium term. Additionally, PVR and Inox have been growing and fighting for premium locations, which led to higher rentals – now the same will get rationalized; 3) F&B sourcing along with vendor consolidation, and 4) savings in corporate overheads. We believe that the merged entity might want to use its muscle power to negotiate a lower revenue share with movie distributors, but it could be tricky. In total, we estimate revenue and cost synergies of Rs1.1bn for each, resulting in EBITDA accretion of Rs2.1bn. We have not assumed any savings on rental and film distributor share.

Potential Challenges:

CCI approval is perhaps the key aspect of the merger, given the dominance of these companies. The company has highlighted that CCI approval would not be required, possibly since the merged entity has revenue of less than Rs10bn (CCI in 2017 had notified that merged entities with less than Rs10bn revenue would be exempted). There will be many markets where the merged firm can potentially overshoot the stated market share threshold or have a monopoly kind of scenario. In such a case, the merged entity might also let go of low-yielding properties, if CCI becomes a hurdle. The other challenges include organisational cultural differences and significant delays in the approval process.

Valuations:

We believe that a seamless execution of the merger will attract a valuation premium, backed by scale of operations, better RoIC, lower competition and potential synergies. The merged company’s net debt/EBITDA would be <1x (on FY23E), providing huge scope for rapid expansion going forward. Based on the above arguments, we now ascribe a 13.5x EV/EBITDA multiple vs. 12.3x earlier to arrive at a TP of Rs2,230 for PVR and Rs665 for Inox and retain Buy on both the companies. Our pro-forma FY24E EBITDA incorporates merger synergies of Rs2bn. Key risk to our calls: 1) another Covid wave; 2) structural increase in the revenue share to producers/distributors and lower content windowing; 3) lack of high-quality content; 4) faster-than-expected shift of eyeballs to OTT platforms; and 5) regulators rejecting the merger.