We downgrade Sun TV to ?reduce? from ?add? after a 25% outperformance versus the BSE-30 Index over the past six months. We share the Street?s optimism over advertising recovery; robust subscription growth, led by Arasu and digitisation; and sustainable operating margins (~50% in 2QFY13).

But we differ on quantum: FY14E-15E is unlikely to be a repeat of FY10-11 (33% revenue CAGR ex-Sun Pictures) given high ad volumes; market-share losses; and delays in Chennai digitisation. Our robust subs revenue CAGR of over 20% assumes traction in DTH. We increase fair value to R390 (from R360) on aggressive assumptions. We refer to our report, ?A Tale of Two Markets? on the Sun stock, dated September 30, 2011, in which we analysed various business units, the opportunity and risks to the company and potential valuation scenarios for the stock. Even as expectations have not exactly panned out, the positives (the Arasu deal) have negated the impact of a few extreme negatives (Sun Pictures?closure).

However, this does not imply a return to the normal, but a ?new normal?; Exhibit 3 presents trends in 12-month forward valuations and earnings; valuations have normalised, but earnings estimates are still 15% below-peak in September 2011. Nonetheless, ?Sun-set? risks have proven to be unfounded. Sun has lost share across its markets, but there is variance versus our expectation. Sun TV and the Tamil channels lost market share, but not as much as expected (4-ppt loss in Sun TV from a high base of 57%). Conversely, Telugu, Kannada and Malayalam channels lost market share from low levels versus our expectations of relative stability.

Correspondingly, our valuation of non-Tamil BUs has dropped to ~R220 from ~R260. The Arasu deal has helped clear the risk of potential for closure of the Tamil BU; its valuation has increased to ~R170 from R140 (R180 in base-case and R100 in stress-case). The operational risks have not ebbed; our discussion with the competition suggests focus on non-Tamil BUs with relatively low entry barriers.

We downgrade the Sun TV stock to ?reduce? with fair value of R390 led by aggressive ad and subscription growth assumptions in FY14-15 and DCF roll-forward.

Kotak Institutional Equities