Prime Focus: Buy

An investment can be considered in the stock of Prime Focus, a company focussed on the post-production and visual effects segment of the media sector. At the current market price of Rs 770, the stock trades at about 26 times its 2007-08 earnings per share.

Although absolute valuations are on the high side, limited competitive activity in the domestic visual effects space and a steady demand environment promises greater earnings visibility compared to other players in the media sector. Its presence in a niche and high-margin business is likely to make the stock a good exposure within the media sector.

While the stock has weathered the recent market correction well, it remains vulnerable because of its relatively small market capitalisation. Investors can consider taking exposure in small lots and use declines linked to market weakness to accumulate the stock.

Buoyant domestic operations

Corporatisation of the film industry, increasing production budgets, experimentation by film-makers and the changing tastes of Indian audiences in favour of action/fantasy/suspense films as against the traditional family drama are factors that have created a fine setting for the post-production and visual effects industry. With an integrated presence across post-production activities and a geographical spread across markets, Prime Focus is well-placed to cater to this trend.

Since its IPO in May 2006, Prime Focus has beefed up its domestic operations. It has completed the expansion of its Mumbai facility and opened a new facility in Chennai. It has also acquired a post-production outfit in Hyderabad. It is now well-placed to cater to demand from the Tamil and Telugu film industries, which are equally prolific in film releases.

There is a high degree of visibility on the demand side. While the fortunes of Bollywood may have changed in 2007, with few films making it in the box office, Prime Focus has continued to record a robust growth in revenues and profits. Being in the post-production business, the company does not bear the risk of the content gaining popularity with an audience. It can also count on steady orders from the Indian film industry, which churns out hundreds of movies a year, irrespective of how the economy does, as the demand for entertainment remains inelastic. The frenetic activity in broadcasting and the rising trend in television advertisement spends also augur well for its business.

Prime Focus' stand-alone revenues (numbers include only its domestic operations) have been growing at a brisk 40-50 per cent in recent quarters. The trend is likely to sustain, with the South beginning to make a more active contribution to its revenue stream. However, with Prime Focus' acquisition of the London-based VTR and its associated outfits, its Indian operations now account for less than 30 per cent of its consolidated revenue of nearly Rs 200 crore.

Overseas operations

Part of the offer proceeds helped fund Prime Focus' acquisition of VTR, a 20 million pound post-production outfit. The loss-making unit was subsequently re-structured. Within seven months of its takeover, Prime Focus has managed to turnaround VTR. The impact of the acquisition has boosted its overall revenues, but has temporarily impacted profitability, with consolidated margins hovering in the 30 per cent range compared to the high 50s earlier. However, Prime Focus hopes to initially get at least 10-15 per cent of VTR's projects outsourced to India where it can undertake the same work at a fraction of the cost. This could improve VTR's margins, even as the outsourcing order flow adds to the company's Indian revenues.

The company has managed to integrate its acquired facilities and has completed its first project with the film "28 weeks later", a sequel to the horror/thriller movie "28 days later". It is now working on a couple of more features with VTR. An improvement in VTR's profitability will enhance its consolidated margins and earnings as well.

Gaining access

Even as it consolidates its newly acquired international business, Prime Focus is scouting for other acquisitions and has an eye on Los Angeles, as it will give it access to the biggest market for post-production.

The company is also considering the inorganic route to growth for its ready access to international clients.

As special effects and editing require a close interaction with the client, it makes sense to operate through a company that already has an established presence in the market.

A presence in overseas market will strengthen the demand for Prime Focus's services domestically, especially from international players such as Fox and Walt Disney, which are increasing their focus in India.

While international operations will help expand its revenue base considerably, the domestic operations are likely to contribute the most to growth in the near-term.

Post-production services in overseas market are not as lucrative as they are in India, because of the higher employee costs.

Also, being a more mature business, it is likely to witness a more sedate revenue growth than in India where the use of visual effects is in a nascent stage. Therefore, any slowdown in growth in domestic operations will impact consolidated numbers.

Further, inorganic growth will also bring with it the usual risks of successfully integrating operations.