Indian entertainment companies are making a beeline to get themselves corporatised. It is time entertainment company-watchers understand how to evaluate them. Here are excerpts from the Standard & Poor's Movies and Home Entertainment Survey dated 11 May, 2000 which should be an excellent guide.There is a tidal wave quietly lashing the Indian entertainment industry. Players are increasingly biting the bait of corporatisation. Rating agencies are preparing themselves for that day: most of them have already put in place rating programmes for Indian entertainment companies.Identify the category
How do rating agencies elsewhere go about evaluating entertainment companies? To begin with, rating agencies identify the category an entertainment company belongs to. This is to understand an entertainment company's place in the value chain. Rating agencies then look at the entertainment company's competitive advantages and limitations and whether it has adequate finances to create new products and survive failures.
The type of assets an entertainment company has and the businesses it is in determines its category. Broadly, entertainment companies fall into any of these three categories: content creators, packagers and pipeline companies.
Content creators produce movies, music shows on TV and music albums. To succeed, these content-creating companies must have adequate financing and the means to deliver their products to the public.
Packager companies schedule what consumers are going to see or hear. TV networks, for instance, which provide their own inhouse-produced shows such as news and sports, and also programmes produced by others fall into this category.
Pipeline companies include movie theatres, cable systems and video stores which deliver entertainment products to consumers. One important factor to be considered while evaluating these companies is their capital spending plans.
Prominent players in the industry generally have multiple businesses and thus might fall under more than one category. Each of their operations may be attractive in itself, but it is important to see if value is being added by having various assets under the same corporate roof. So, it is essential to look at opportunities available to the company to build brands and cross-promote its assets.
Success factors
A number of factors have a bearing on the likely fortunes of an entertainment company. Here are a few of them:
Copyrights to big-name characters
While evaluating a provider of film entertainment products, it is important to consider whether the company owns the copyrights to any of the popular characters or brand names. Now that the consumer has so many entertainment choices, developing a brand has become important.
New technology
New delivery systems help to increase demand for various types of entertainment, while also causing shifts in how consumers spend their money. How well is the company fielding new technology? Is this technology likely to be a boon or a bane for it? These factors might be highlighted more than current profitability.
Management
As it is the case with all companies, management quality is a key success factor in entertainment companies too. A seasoned management team having performed well relative to their peers both during good and bad times is looked at favourably. So is a situation where top executives own stocks in the company. Analysts also look at top managers' track record at that entertainment company and compare it with others in the industry.
Access to capital
While evaluating an entertainment company that has sizable capital requirements, analysts look at the size of debt, the quantum of cash it currently has and its cost of borrowing. How much operating cash flow is likely to be available to service debt? Is the company in a good position to refinance that debt or borrow more in future?
Selling equity is another means for raising capital. Analysts look for a well-managed company to sell shares when market conditions for its stock are good and to repurchase when the stock appears underpriced.
Size of operations
Is big beautiful? Large entertainment companies tend to have economies of scale, with overheads supported by a bigger revenue stream and spread over a larger asset base compared to smaller firms. They are also likely to have stronger purchasing power and greater clout with potential consumers.
A principle advantage of big established entertainment companies is the cash flow provided by large libraries of older products. Analysts are generally wary of companies that bet on one or two unproven films, television shows and other entertainment products. Consumer response is difficult to predict here and so it is preferable to spread the risk across a slate of creative efforts.
Diversification
Analysts also look favourably at diversified entertainment companies. For, a slowdown in one may be offset by improving conditions elsewhere. But, diversification should not dilute the focus of top management or its core strength.
Small companies have their own advantages. They may be nimbler while responding to market conditions. To the extent its management is more entrepreneurial in spirit, a small firm is less likely to be bogged down in multilevel decision-making process.
Supply and demand
Success of entertainment products such as movies is likely to be affected by the balance or imbalance between the amount of programming being produced and the level of interest or demand for such programmes, both from consumers and the companies that deliver the programmes to the public via theatres and television networks.
If movie production, for instance, is growing, particularly among the major entertainment companies, it may become more difficult to get theatre screen space. Also, if more films are being made, price for creative talent might go up which might necessitate higher marketing expenditure to differentiate it from its competitors.
Financial analysis
Analysis of an entertainment company also involves scrutiny of its financial statements. What needs to be looked at in those financial statements?
Revenue and customer base: What is the customer base and how diverse is it?Growth prospects: Is the entire industry's revenue pie growing or is the company's growth primarily going to depend on taking the market share from its competitors? Are there sales opportunities in overseas markets?One-time factor: Are there any one-time factors to consider that might have inflated or deflated revenues and profits? Earnings can be unsustainably high because of any asset sale, or unusually low because of a restructuring charge or an one-time writedown of an asset's value.Cash flow: How healthy is the cash flow? Reported earnings may not be an accurate reflection of a company's cash flow generation or financial strength. Some expenses on the income statement such as depreciation, amortization and write-downs are likely to be non-cash items which require no cash outlay.With movies and television shows, there may be a period of several years between the start of production and the time, if ever, when the project begins to generate a positive cash flow. Analysts look at the company's balance sheet to get an idea of the level of investment in movies or television shows which is yet to be recognised as costs in the company's income statements.
Asset valuation
While looking at the balance sheet of an entertainment company, analysts try and find out whether the values reported are accurate measures of assets' total worth. Intangible assets such as brand names and management quality are not reflected in the financial statements. At the same time, the value of some assets may be overstated, such as those obtained through an acquisition or an investment in a costly film that will actually turn out to be a failure.
What one understands from these excerpts is this: evaluating an entertainment company calls for special analytical skills and acumen. For, entertainment companies operate in an environment where success is determined largely by a host of intangibles and a slew of variables.