Investing in Digital India

Transcription

1 Investing in Digital India The Dynamics of Mandatory Addressable Digitization December 6, 2011 Investing in Digital India I

2 Contents 1. Executive summary 4 2. The digital mandate and its impact 6 3. Prospects for cable operators International experience About Media Partners Asia 24 II Investing in Digital India

3 List of exhibits Exhibit 1: The dynamics of digitization: Benefits and challenges 5 Exhibit 2: India digitization plan 6 Exhibit 3: A third of India s TV homes have digital TV 7 Exhibit 4: Analogy between cable industry and movie exhibition sector 7 Exhibit 5: International markets: Consolidation and digitization lead to industry growth and value 8 Exhibit 6: LCO operating margins are >50% today 9 Exhibit 7: Government of India loses >US$1 bil. pa to underdeclaration 9 Exhibit 8: Projected subscribers in the National Broadband Plan 10 Exhibit 9: Digital cable TV will be affordable 10 Exhibit 10: Sensitivity of MSO to LCO revenue sharing in digital cable 11 Exhibit 11: Channel C&P fees have grown rapidly while subscription fee growth has been modest 12 Exhibit 12: Growth in Zee cable subscription fees has been minimal compared with DTH 12 Exhibit 13: Sub fees boost profits towards content investment 12 Exhibit 14: Valuations for cable/pay-tv companies in global markets 13 Exhibit 15: US cable stocks outperformed after Exhibit 16: MSO economics in digital cable 15 Exhibit 17: Number of permitted TV channels in India 16 Exhibit 18: FY 2011 C&P revenues for major MSOs in India 16 Exhibit 19: Comparison of reach amongst major MSOs 17 Exhibit 20: Phase I capex requirements for national MSOs 17 Exhibit 21: Debt to equity ratio for major MSOs 18 Exhibit 22: Comparison of digital subs amongst MSOs 18 Exhibit 23: Broadband subscriber base of major MSOs in India (2011) 19 Exhibit 24: Hathway proforma P&L for cable TV & broadband 19 Exhibit 25: International markets: The regulatory path to digitization 20 Exhibit 26: Digital cable conversion trends, international markets 21 Exhibit 27: Digital cable TV ARPU dynamics, (3-year CAGR, %) 21 Exhibit 28: Multiple product sales in Taiwan cable 22 Exhibit 29: Cable business based on the growth of broadband digital bundles 22 Exhibit 30: Broadband is a key contributor to cable company revenues (FY 2011) 23 Exhibit 31: Cable leads US broadband net additions 23 Investing in Digital India III

4 1. Executive summary Substantial benefits for industry and consumer The government mandate to digitize cable networks across India over four phases should be executed with success due to shifting market dynamics, positive regulatory developments and broad support from all industry stakeholders. Digitization will bring a significant transformation to the TV industry with a positive impact also on the nascent broadband market. The current size of India s cable sector is already ~US$4.5 bil., yet there is significant scope for future growth considering low levels of digital and broadband penetration. Furthermore, with over 60,000 local cable operators (LCOs) the industry is highly fragmented, limiting ARPU growth and the adoption of new technologies. In conclusion, there are major levers of growth to leverage as the industry consolidates and digitizes. Within the next three years, Media Partners Asia (MPA) analysis indicates major scope for last-mile consolidation by cable multi-system operators (MSOs) as well as M&A amongst MSOs. The rationale for consolidation amongst six direct-to-home (DTH) pay-tv operators will also grow while the digital mandate gives these platforms and DD Direct, the free DTH service, ample opportunity to gain market share in metropolitan areas. All of these groups, along with broadcasters, will be able to participate fully in India s high-growth consumption story. We highlight key benefits and issues: A boost for the government and the economy. If the current analog cable distribution model remains in place and digital cable penetration remains limited, the potential cumulative value of the tax receipts lost by the government would reach US$11 bil. over the next decade or >US$1 bil. pa. The government therefore has sufficient incentives to push digitization and can also accelerate the process by offering tax incentives to a potential multi-billion-dollar industry. The government should also grant infrastructure status and tax holidays to the cable sector. These, if granted, will provide better financing terms and improve internal accruals for cable companies, to be ploughed back towards investment in digital infrastructure. At the same time, wider and deeper pools of capital could become available from next year onwards if the government raises the cap on foreign direct investment (FDI) in cable TV from 49% to 74%. Digitization of cable networks should also help the government aggressively pursue India s broadband goals and thereby help to boost economic growth. Potentially, a 10% increase in broadband penetration would increase India s GDP by ~1.5%. As of Sept. 2011, broadband per capita penetration in India was only 1%. In its National Broadband Plan, the Telecom Regulatory Authority of India (TRAI) clearly sees a pivotal role for cable operators in developing broadband infrastructure, with digital network upgrades paving the way for broadband growth. Consumer choice. Digital cable TV will improve the consumer experience and resolve legacy issues from analog cable services. Consumers will gain: (1) More TV channels; (2) Attractive tiering options with differentiated content across local, regional and niche genres; (3) A better viewing experience; and (4) Improved quality of service. Digital cable TV will also be affordable for the consumer. As per international benchmarks, spending on pay-tv typically accounts for ~5% of GDP per capita. In this context, digital cable TV in India will be affordable given heavy subsidies on STBs (currently subsidized at ~60-70% by MSOs), which will ensure that consumer spends fall within the 5% benchmark. Consumers will also benefit from new competition as digitization in metros ensures that seven DTH satellite platforms (including free service DD Direct) compete for customers with digital cable operators. A cable transformation but not without challenge. About US$8 bil. in investment is required to digitize the entire market. The requirement is about US$300 mil. for Phase I, which we believe can be funded adequately amongst the national MSOs (see Section 4). Phase I represents ~10% of the analog cable universe in India. For cable MSOs, we expect a 6x increase in subscriber revenues though not without at least a 20% churn in cable s customer base to DTH. With addressable digital deployment, subscriber declaration levels will increase from 15% currently to 100%, while the retained ARPU will increase by 6x, after assuming a 30% base case revenue share with the LCO. Additional drivers and differentiators will come from bundled broadband and high-definition (HD) services. Broadband will reduce the payback period on overall capital employed towards digitization. Under a bundled digital and broadband business model, the payback period could be reduced by a year to 24 months, as opposed to 36 months under a standalone digital cable TV proposition. The main challenges, apart from managing subscriber churn to DTH operators, are: (1) Carriage and placement (C&P) fees will drop by about 20 50%; and (2) Incentivizing revenuesharing agreements have to be struck with LCOs in order to drive digital set-top boxes (STBs) into the home. Cable operators will also be required to gradually transition their business model to a new ecosystem with the consumer as the focal point. The challenge of transitioning from a current B2B business to a B2C franchise is not be underestimated. MSOs will eventually look at exploiting their strength of locality by increasing investment to create channels and content with local relevance (i.e. news, events, infotainment, movies on demand). Overall, mandatory digitization will result in consolidation of the cable industry. Larger operators will be keen to acquire the last mile as valuations for LCOs drop and operators successfully develop skill sets and necessary infrastructure as they transition to a B2C model. DTH opportunity. Phase I digitization in the four key metros presents a potentially good opportunity for DTH operators to grab high-arpu customers and increase the platform s reach in larger TAM meter markets. MSOs envisage about 15 20% churn in cable subs to DTH though some suspect this could grow to 30% in the early stages of Phase I deployment. Subsidized HD offerings will also act as a key differentiator for DTH players as cable has yet to roll out HD services (with the notable exceptions of Hathway and Digicable). 4 Investing in Digital India

5 Broadcasters. Digitization will help boost subscription revenues for broadcasters and reduce dependence on advertising. Improved economics will also help broadcasters launch niche channels with a premium focus while C&P fees will fall in certain markets and moderate in others. At the same time, consumer adoption of certain programming tiers and specific channels (over others) will ensure healthy competition, while broadcasters will also be under pressure to produce content with differentiation, premium quality (potentially advertising-free) and with local relevance. Investors. Upon successful implementation of the digital mandate, gradual consolidation of LCOs will become inevitable. This will shift the industry profits and value to centralized distribution platforms and broadcasters. Furthermore, the corporatization of distribution will bring new scale to the TV business with improved systems to raise transparency. This should result in significant value creation for investors with valuations and multiples of cash flow likely to steadily grow in public and private markets. India s pay-tv distribution market is on the cusp of a highgrowth value phase similar to North America between 1998 and 2003, Korea during , and Taiwan during Valuations for these companies in these markets during the high-growth value stage typically averaged 12 16x one year forward EBITDA, versus the current trading average of 9-10x for India s listed cable/pay-tv entities. We assume similar or higher valuations for companies in India subject to successful execution. Most investors, especially strategic companies, will likely take a wait-and-see approach, potentially making their bets after Phase I is completed. Exhibit 1 The dynamics of digitization: Benefits and challenges Stakeholders Benefits of digitization Practical challenges MPA viewpoint Government Recover tax leakages of >US$1 bil. pa and improve tax receipts in the long term from ARPU growth and VAS. Enables cable operators to use digital infrastructure to offer broadband, thereby increasing broadband penetration and boosting economic growth. Consumers Better viewing experience. Attractive tiering and a-la-carte options. More channels. New and better services (broadband, HD, ondemand and personalized) and strong QoS. Cable MSOs MPA base case assumes a 6x increase in subscription revenues. Source: Media Partners Asia Bundled broadband will boost revenues and profits as well as provide competitive differentiation. Local Cable Operators Now equipped to compete against DTH services. Scalability to business from cross-selling other services. DTH Operators Further boost to volume growth. Access to high-arpu urban consumers. Broadcasters Boost to domestic subscription revenues. C&P costs will reduce, boosting profits to be reinvested into producing improved and differentiated content. Financial Investors Investment options in larger, more stable and scalable businesses with a clear path to value creation. Strategic Investors Access to a high-growth market and better scaled assets with more stable revenue streams. Technology Service Providers Potential US$3 bil. opportunity for technology service providers. The IT sector will also benefit as MSOs develop a B2C model, requiring a host of customer care services. Limited scope to offer financial incentives, as it needs to tackle important impending issues sensitive to the economy. Mandatory one-time expense on STB/CPE (although subsidized). Transitioning from a B2B to B2C business. Revenue-share arrangements with LCOs. Change in marketing from consumer pull to consumer push. Increase in competitive intensity may increase SAC. Lack of a two-way return path for broadband. Surge in new channel launches will intensify competition. Broadcasters will need to increase spends on branding and marketing. Will need to produce differentiated content to cater to digital consumer. Risk of dilution as the industry goes through its early gestation period. No controlling stake without higher FDI cap in cable and DTH satellite operators. Outside of a few national MSOs, the market at large is highly fragmented, unorganized and lacks financial muscle. Most seek vendor financing and have a reasonable probability to default. Considering the current macroeconomic environment, it is fair to assume limited tax rebates from the government. Government should encourage foreign investors by increasing the cap on FDI in pay-tv from 49% to 74%. Consumer spend on CATV as a percentage to per capita GDP is lower than the international average of ~5%. Intense competition will further improve affordability. Consumers will have choice of free and pay DTH in addition to digital cable. Rules of the game are favorable to attain profitable growth. However, the key risk lies in the execution. Break-even period in standalone digital service is 36 months; reduced to 24 months when digital cable is bundled with broadband. Expect a sharp drop in profits and valuations if digital challenge is not met and DTH gains significant market share in the metros. Delay in break-even period for operators. Growth in domestic subscription revenues is important to attain the next leg of profitable growth particularly for incumbents. Broadcasters will also see upside from technologically advanced content (i.e. HD). We expect valuation multiples for both broadcasters and distribution companies to expand, due to strong earnings growth and stability in revenue profile (less dependence on advertising revenues). India s pay-tv distribution industry is on a cusp of a highgrowth value phase similar to North America and Korea. Valuations for cable/pay-tv operators in these markets during value phases was 12-16x forward EBITDA. Taiwan cable companies that have embraced DTV still trade at >10x in the private market. In due course, consolidation will help address the practical issues faced by vendors. Investing in Digital India 5

6 2. The digital mandate and its impact In November this year, India s Union Cabinet approved an Ordinance mandating addressable digitization of cable networks in key metros, starting in June 2012 with a Phase I rollout to ~10 mil. homes in Delhi, Mumbai, Kolkata and Chennai. The government on Nov tabled the Cable TV Networks (Regulation) Amendment Bill 2011 in Parliament, clearing the path for digitization. The bill, piloted by the Ministry of Information & Broadcasting (MIB), seeks to digitize the entire cable sector by Dec. 31, The impact on India s US$7 bil. TV industry could be transformational. In this section, we evaluate the mandate and summarize the impact on key stakeholders. Third time lucky Having tried and failed in 2003 and 2007, the 2011 government mandate to digitize India s cable networks should be executed with greater success due to a change in market dynamics and positive regulatory developments. Mandatory addressable digital deployment technically implies that each set-top box (STB) must be equipped with a conditional access card or system (CAS) and include billing and subscriber management systems (SMS). This is important because out of the 8 mil. STBs seeded into cable homes thus far, more than 3 mil. are without CAS. The emphasis on addressable deployment, absent in 2003 and in 2007, is important as it: (1) Helps improve transparency and reduce revenue leakage across the value chain; and (2) Provides consumers with improved quality of service through SMS functionality. We highlight key aspects that should make for improved execution: All-inclusive and universal. With the new mandate, there are no particular zones selected for digital deployment all homes fall into the category in specified metros and cities. In addition, all channels (both pay and free-to-air) will be made available via the STB, not just the pay channels as previously planned. Finally, the MIB has fixed analog sunset dates for various cities (see Exhibit 2) with a phase-wise switch-off. Exhibit 2 India digitization plan Phase Areas Implementation date No. of cities Phase I Four metros - Delhi, Mumbai, Kolkata and 30 June Chennai Phase II All the cities having a population over 31 Mar mil. Phase III All other urban areas (municipal 30 Sept n/a corporations/municipalities) across the country Phase IV Rest of India 31 Dec n/a Source: MIB Price regulation. The retail pricing of digital cable TV services will be left to market forces with a floor price established at Rs150 (US$3.3) per month. Previously, there were price caps on channels (i.e. Rs5 per channel), limiting upside for broadcasters and distribution platforms, while there were other regulatory intrusions on retail pricing and revenue sharing across the value chain and STB schemes/promotions. Wholesale pricing on digital cable is likely to be capped at 42% of analog cable rates, following DTH regulations implemented by the Supreme Court in Shifting market and structural dynamics. Four years on from 2007, there have been a number of key developments which should help kick-start digital cable deployment: Industry support. Consensus building amongst cable MSOs and broadcasters has grown significantly with broad support towards the implementation of the digital mandate. Moreover, both groups recognize the importance of incentivizing LCOs, while LCOs are slowly recognizing the value of the digital imperative in the context of DTH competition and growth. Broadcasters are also supportive as each of the key groups understands the importance of generating stable subscription revenues with the need to reduce reliance on advertising. The key will be to work closely with operators to market viable channel packages to the consumer. Improved capitalization and scale. MSOs have better access to capital markets than in 2003 and in 2007 with Hathway and DEN both listed. According to MPA analysis and interviews, all major national MSOs are adequately funded for Phase I digital deployment (see Section 3). The cost of digital software and hardware has also fallen since 2007, ensuring STBs plus the CA card cost about US$30 40 per unit in total including duties, compared with US$60 three years ago. A number of the MSOs (i.e. Hathway, DEN) are also ordering digital STBs in larger volumes (i.e. >1 mil. pa), which helps bring costs down to US$30 per unit or lower. The key going forward is MSO execution along with investments in marketing and customer service. At the same time, wider and deeper pools of capital could become available from the next year onwards if the government raises the cap on foreign direct investment (FDI) in cable TV from 49% to 74%. DTH growth. In 2007, consumers had limited exposure to the benefits of digital TV. Digital TV penetration of total TV homes in the country was 7% in 2007, but has since grown to 33% (see Exhibit 3), driven largely by a 30 mil. aggregate net subscriber base across six direct-to-home (DTH) satellite pay-tv platforms, and mil. homes through the free platform DD Direct from Doordarshan. The growth of DTH has provided consumers not only with choice but also quality through improved viewing experience, more channels and new services such as HDTV, pay-per-view (PPV) and digital video recorders (DVRs). At the same time, DTH operators have worked closely with broadcasters to program and retail attractive packages of channels at competitive prices with tiered and a-la-carte options. DTH operators have benefited through subscriber growth and, more recently, improved ARPUs while broadcasters have gained through subscription revenues as DTH operators spent a combined ~US$350 mil. on pay-tv content in Investing in Digital India

7 Exhibit 3 A third of India s TV homes have digital TV Digital subs (mil.) % DTH Free mil.) DTH Pay (mil.) Digital Cable (mil.) Digital Pen./TVHH (%) 7% Source: Media Partners Asia 14% 20% 27% 33% 35% 30% 25% 20% 15% 10% National Broadband Plan. Another key pull towards the digital mandate is the National Broadband Plan, which as per recommendations from the Telecom Regulatory Authority of India (TRAI), prioritizes the role of cable operators in driving broadband growth across India. A key means to achieve this end is digitization, which will help develop two-way cable networks and allow cable operators to offer broadband services bundled with digital cable TV services. Broadband will help improve the payback periods for cable operators offering digital services, as we explore in Section 3. This has also been the norm in international markets (see Section 4). Pricing and financing. For successful on-the-ground execution, the Ordinance gives the right of way to cable operators, subject to certain conditions. However, in the month since the approval of the Ordinance, there has been limited activity on the ground. This is because the industry still awaits clarity on certain critical aspects, particularly: (1) Pricing for the basic tier digital package; and (2) The number of free-to-air channels to be included under the basic tier package as well as key genres for the basic pack. For now, cable operators are modeling and strategizing with sensitivity analysis on parameters of pricing, cross-selling products (cable TV, broadband and HDTV, see Section 3), and funding options. The approved Ordinance also makes it obligatory for every cable operator to maintain a profile of subscribers through SMS in addition to bringing in addressability. This would imply more incremental capital expenditure on digital STBs as well as an upgrade of infrastructure across LCO nodes to create an entire telecom-like ecosystem for customer care services. About Rs400 bil. or US$8 bil. in investment would be 5% 0% required to digitize the entire analog market. The requirement is about US$300 mil. for Phase I, which we believe can be funded adequately amongst the national MSOs. Yet Phase I represents only ~10% of the analog cable universe in India. At some point, the government will need to step in to facilitate financing through tax incentives and raising FDI limits. Encouraging investment from foreign strategic players will bring in financial support and expertise, and help boost industry consolidation. Granting infrastructure status to cable operators will also be important as it will help companies secure funding and credit at favorable rates. Consolidation and digital to drive growth The current size of India s cable sector is approximately Rs270 bil. or US$4.5 bil., an already significant size. Yet, there is a significant scope for future growth considering low levels of digital and broadband penetration. There is also scope for increases in cable TV penetration as only 60% of India s households have TV sets. Furthermore, with over 60,000 LCOs the industry is highly fragmented, limiting ARPU growth and adoption of new technologies. In conclusion, there are major levers of growth to leverage as the industry consolidates and digitizes. Within the next three years, we see significant scope for last-mile consolidation by MSOs (i.e. vertical M&A) and also see some scope for horizontal M&A amongst MSOs as Phase II and Phase III digital deployment get underway. The rationale for consolidation amongst six DTH operators will also grow. Significant scale through consolidation is important as it helps operators to: (1) Reduce the cost of capital expenditure on digital and broadband technologies; (2) Increase bargaining power on content and reduce programming costs as a proportion of total revenues; and (3) Bring new synergies and cost savings to marketing and customer service. Taking a top-down approach, India s GDP is on a steady upward trend (both on relative and absolute basis), witnessing a J-curve growth across various consumer discretionary sectors. In a domestic context, the analogy can be drawn from a relatively smaller Indian exhibition industry, wherein multiplexes have been able to monetize footfalls in various ways, benefiting key stakeholders (see Exhibit 4.) Benchmarking various parameters to international markets also suggests a profitable and scalable growth in the coming years with plenty of investment opportunities for both financial and strategic investors (see Exhibit 5). This has certainly been the case in the US, Korea, Taiwan and Japan where digitization, broadband growth and FDI have helped drive the overall growth and profitability of the cable industry. Exhibit 4 Analogy between cable industry and movie exhibition sector Consolidation of Indian exhibition industry through multiplexes Consolidation of Indian C&S industry Adoption of new technology Digital cinemas and screening of 3D movies garner x of normal multiplex ATPs. Offering digital and HD STBs with option for DVRs. Addressability Addresses black ticketing and tax leakages. Addresses leakages in subscription revenues. Choice of content to consumers Multiple movies screened, encouraging investments towards new genres of film content. Encourages launch of new niche channel genres. Growth in pricing Pricing of exhibition industry has substantially improved. Today, multiplexes represent Can charge premium pricing for offering more channels ~10% of around 11,000 screens (multiplex and single-screen theaters), but account for with differentiated content and improved signal quality. ~35% of domestic box office collections. Cross-selling of services Monetize footfalls for advertising revenues and foray into allied entertainment businesses. Cable TV + HDTV + Broadband Source: MPA analysis Investing in Digital India 7

8 Exhibit 5 International markets: Consolidation and digitization lead to industry growth and value USA large MSOs UK 1980s 50+ players Late 1980s Japan Pre 1993 Source: Media Partners Asia Year Triggers Year Key events during consolidation 1994 DTH launches 1996 US West Inc acquisition of Continental Cablevision 1996 The Telecommunications Act and cable rate deregulation 1998 AT&T buys TCI in US$48 bil. deal 1997 Digital cable launches 2001 AT&T merged its cable business with Comcast, creating world's largest operator with 22 mil. subscdribers 2005 Digital cable passes 30 mil. subs 2010 Comcast buys NBCU DTH gained market share 1991 Rights granted to cable companies to offer telephony with TV services 686 players 1993 Regulation eased, companies allowed to own more than one operator Taiwan 1980s 600+ players Korea Late 1990s Government's mandate for complete digitalization by FDI increased to 100% Government's thrust towards digitization; FDI at 60% Full scale launch of digital cable 1,000 players 2000 Government mandate for consolidation creating 108 players 2001 Government mandate for digitization 1994 International CableTel acquired Insight Communications Country Year Preconsolidation Late 1990s NTL acquired Comcast UK, ComTel, Diamond Cable, and Cable & Wireless NTL acquired Telewest Global Virgin acquired NTL and rebranded it Virgin Media Larger MSOs acquired small cable operators 2000 J:COM and TITUS Communications merge, with Liberty and Microsoft emerging as major investors in partnership with local conglomerate Sumitomo Larger MSOs acquired local cable operators Year Postconsolidation 2011 Top 5 players: 85 % market share of total CATV subs 2011 Virgin Media: 95% market share of total CATV subs 2011 Top 3 players: 65% market share of total CATV subs 2010 Top 4 players: 80% market share of total CATV subs 2004 Carlyle acquires kbro 2005 Macquarie buys stake in Taiwan Broadband continued consolidation 2006 MBK buys stake in CNS 2009 Tsai family buys kbro 2010 Want Want consortium buys stake in CNS Various MSOs merge with regional cable operators 2003 Goldman Sachs buys into C&M, largest cable MSO 2002 Launch of DTH 2006 Carlyle group invests in cable Cable FDI increased to 49% Full-scale launch of digital cable 2007 Macquarie Group and MBK Partners acquire all of C&M 2010 Consolidation continues; top 5 players: 75% market share of total CATV subs Growth trajectory Cable (CATV & BB) industry revenue grows at 9% CAGR ( ) Average operating margin of 40% Cable (CATV & BB) industry revenue grows at 5% CAGR ( ) Average operating margin of 37% Cable (CATV & BB) industry revenue grows at 9% CAGR ( ) Average operating margin of 43% Cable (CATV & BB) industry revenue grows at 9% CAGR ( ) Average operating margin of 50% Cable (CATV & BB) industry revenue grows at 10% CAGR ( ) Average operating margin of 42% Digital pen./ cable TV subs Cable broadband market share 85% 55% 98% 25% 80% 15% 10% 16% 30% 20% 8 Investing in Digital India

9 Impact of digitization on key stakeholders Digitization and consolidation of the pay-tv landscape will have a significant impact on players across the value chain. Below we evaluate some of the quantitative and qualitative impact on key stakeholders: Government. Over the last five years, the DTH sector has brought in addressability and more importantly served the government s objective of reaching consumers in remote, cable-dark areas (i.e. rural areas, small towns). And, while subscription revenues for the DTH sector have grown by 150% CAGR CY , it has paid ~30% of these revenues to the government in the form of taxes (service and entertainment taxes and licence fees), excluding the customs duty payable on import of hardware equipment. In the cable market, legacy systems residing in TAM meter markets have carved out a business model depending heavily on carriage and placement (C&P) fees. As a result, cable operators have not been incentivized to invest in digital infrastructure. This means that only 6% of total cable TV homes have been digitized as of Dec At the same time, during the past five years, MSOs have benefited from C&P fees and LCOs have profited from underdeclaration in the analog marketplace (as illustrated in Exhibit 6). Exhibit 6 LCO operating margins are >50% today LCO economics (per month) Remarks Total subs per LCO 1,000 ARPU Rs 176 Declaration % 15 Revenue to LCO Rs 176,000 Declared revenue Rs 26,400 Service 10.3% Rs 2,719 Applied only on declared revenue. Entertainment Rs16 per month Rs 6,400 LCOs pay e-tax on ~40% of their subscriber base, as per our discussions with the industry. Content cost (or as passed to MSO) Rs 26,400 SG&A 25% Rs 44,000 Operating income Rs 96,481 OPM % 55 Income 33.99% Rs 4,919 Net profits Rs 91,562 NPM % 52 Source: MPA analysis Furthermore, if the current analog cable distribution model remains in place and digital cable penetration remains limited, the potential cumulative value of the tax receipts lost by the government will reach ~Rs480 bil. or US$11 bil. (over the period FY 2012 to FY 2020), exceeding the Rs400 bil. investment to be borne by the industry to bring in digital-led addressability across India (see Exhibit 7). The government therefore has sufficient incentives to push digitization and can also accelerate the process by offering tax incentives to a potential multi-billion-dollar industry. Exhibit 7 Government of India loses >US$1 bil. pa to underdeclaration Potential government revenue breakdown Total pay-tv HHs mil Total industry size Rs mil. 297, , , , , , , , ,188 Analog cable TV HHs mil Analog cable ARPU/mo. Rs Analog cable industry size Rs mil. 189, , , , , , , , ,511 Official subscriber declaration % of analog subs Declared analog subscription revenue Rs mil. 28,442 29,719 30,427 31,020 31,483 31,718 31,911 31,891 32,017 Service tax system on Rs mil. 16,601 16,688 16,453 16,169 15,832 15,401 14,973 14,471 14,059 subscription revenues Declared subs for e-tax payment % E-tax system Rs16/mo. Rs mil. 10,169 10,004 9,763 9,499 9,212 8,923 8,639 8,358 8,089 Income tax system 33.99% on Rs mil. 30,130 30,288 29,863 29,347 28,736 27,953 27,176 26,265 25,517 assumption of 55% OPM for LCO Total govt. tax evasion due to underdeclaration Rs mil. 56,900 56,979 56,078 55,015 53,780 52,278 50,789 49,094 47,664 Source: MPA analysis Investing in Digital India 9

10 Essentially, the government should move on important recommendations made by TRAI to grant infrastructure status and tax holidays to the cable sector. These, if granted, will provide better financing terms and improve internal accruals for cable companies, to be ploughed back towards investment in digital infrastructure. Furthermore, improved bank financing terms will help boost digital cable deployment in Phase III and Phase IV markets, as national cable MSOs have limited presence in these areas and the financial burden will be assumed by smaller, independent cable operators. Digitization of cable networks should also help the government aggressively pursue India s broadband goals and thereby help to boost economic growth. According to the World Bank, a 10% increase in broadband penetration increases GDP of a developing country by ~1.5%. As of Sept. 2011, broadband per capita penetration in India was 0.9% (versus 12% for China and 9.2% for Brazil), suggesting a massive potential to improve broadband infrastructure with a positive impact on India s GDP. In its National Broadband Plan, TRAI clearly sees a pivotal role for cable operators in developing broadband infrastructure, given the fact that there are more last-mile cable subs in India than fixed line connections, and upgrading cable to digital status will pave the way for broadband. TRAI s recommendations target 71 mil. and 154 mil. broadband connections by the end of 2012 and 2014, respectively, with cable having a 40 50% market share. Therefore, pushing cable digitization is in the government s interest as it helps boost broadband penetration with modest additional capital expenditure for cable companies. Exhibit 8 Projected subscribers in the National Broadband Plan Wireline broadband Wireless Total broadband subscribers (mil.) broadband subscribers (mil.) subscribers (mil.) Year DSL BB Cable BB Total Total Total Source: TRAI Consumers. Consumer demand, including the willingness to pay and affordability, will be critical for the success of mandatory addressable digitization. Encouragingly, since 2007, consumer adoption of digital pay- TV services on DTH has grown at exponential rate. With respect to the digital cable mandate, both government and industry stakeholders will have to work together to create consumer awareness. Digital cable services will invariably give consumers the opportunity to resolve some of the issues they have faced with legacy analog cable systems. Consumers will also have more choice amongst multiple digital networks: digital cable, a free DTH platform (DD Direct) and six pay DTH platforms. Consumers will also have an immediate benefit of choice with more channels, a better viewing experience, attractive tiering options and improved quality of service. In due course, favorable economics to launch niche channels will result in segmentation of genres, bringing more relevant and targeted content to viewers. Despite consumer willingness to pay for the digital STBs (at a modestly subsidized cost) in recent times and the benefit of higher ARPUs, a number of LCOs were unwilling to install STBs into consumer homes as most were unwilling to reveal their actual subscriber base to the MSO. With mandatory digitization, LCOs would be forced to educate and encourage subscribers to install digital STBs or risk losing these customers to DTH. All of this is likely to result in healthy competition between platforms, which should ensure affordable prices for the consumer. As per international benchmarks, spending on pay-tv typically accounts for ~5% of GDP per capita. In this context, digital cable TV in India will be affordable especially considering the heavy subsidy on STBs, currently subsidized at ~60-70% by cable companies (see Exhibit 9). Consumers also have a cheaper option over digital cable and may choose the free DTH service from DD Direct. Doordarshan plans to increase the number of channels offered on its platform to 150 by end of this calendar year and an Exhibit 9 Digital cable TV will be affordable Sensitivity Analysis Average monthly ARPU Rs Annual subscription Rs 2,400 2,400 2,400 2,400 2,400 2,400 2,400 2,400 2,400 2,400 2,400 One-time payment Rs 1,600 1,600 1,600 1,600 1,600 1,600 1,600 1,600 1,600 1,600 1,600 Subsidy on landed cost of STB % 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Total annual payout Rs 2,400 2,560 2,720 2,880 3,040 3,200 3,360 3,520 3,680 3,840 4,000 Assumed exchange rate Rs Total annual payout US$ Per capita GDP 2010 US$ 1,371 1,371 1,371 1,371 1,371 1,371 1,371 1,371 1,371 1,371 1,371 CATV spend as % of per capita GDP % Current average subsidy offered by MSOs in India Consumers annual spend on CATV as a proportion of GDP per capita Source: MPA analysis 10 Investing in Digital India

11 additional 100 channels are planned in Meanwhile, in Tamil Nadu, the state government has decided to nationalize cable services by reviving the state-owned cable company Arasu to offer services at highly subsidized rates. Pay-TV operators. The distribution sector at large will benefit from consolidation, while winners will emerge amongst operators with the intent to digitize and the skill to execute, thereby gaining more scale to move up the industry value chain. We highlight key benefits: A new business for cable operators. The impact on cable operators should prove transformational. Traditionally, MSOs have focused on increasing reach through LCO acquisition or JVs, which could be traded in return for higher C&P fees from broadcasters. Digitization will enable operators to transform from a B2B business into a B2C franchise, offering multiple services to the consumers with billing, subscriber management and customer service. MSOs will also be able to leverage their strength of locality to offer new local channels and movies/entertainment ondemand. The biggest risk MSOs face is execution, which is currently difficult to quantify. Successful conversion of analog to digital will enhance the availability of more TV channels, compelling packages and value added services (HD, broadband, DVR and on-demand). This should allow cable operators to boost pricing power and grow ARPUs, especially in terms of generating higher yields from bundled broadband services. However, cable operators will need to make investments to create a new ecosystem including customer payment options, VAS revenue-sharing models and call centers, all of which are currently available in DTH. Analog switch-off also leaves LCOs isolated and exposed if they choose not to digitize. Businesses could collapse and valuations will fall to new lows. LCOs are slowly becoming aware of this risk and are therefore likely to allocate more resources towards network upgrades and stronger partnerships with MSOs. In this context, MSOs will grow scale from an increase in the number of paying subscribers, followed by ARPU growth. The growth and stability of subscription revenues is important as C&P fees will fall for MSOs (see Section 4). We expect the industry to eventually move towards a free pricing model as per the new addressable digital regime. Currently, CAS regions have channel pricing capped at Rs5 per month per channel, though this is not applicable in the new digital regime. Channel pricing on digital platforms is fixed at 42% of analog cable rates. By the time the government implements Phase II of the digital mandate, the weightage of digital platforms will be significant. As a result, pricing will be eventually determined by market forces, and cable consumers too will get a-la-carte and tiered choices of channels and content. In the current phase with the capex borne by MSOs towards investing in STBs and network upgrades, M&A activity will be limited (i.e. MSOs acquiring LCOs). In such a scenario, MSOs will have to rely on secondary points or LCOs to collect subscription revenue for a commission. Revenue-sharing arrangements between MSOs and LCOs is therefore a critical issue which currently lacks clarity. Exhibit 10 suggests the impact of MSO profitability under various revenue-share arrangements with LCOs. Based on our discussions with MSOs, we expect LCOs to retain at least 30% of revenues in Phase I with MSOs at around 35%. Note however that MSOs currently get ~10 15% of share of subscriber ARPU. However, in the digital model, MSOs will have to bear the majority of cost (~90% including STBs, as well as billing and call centers). Exhibit 10 Sensitivity of MSO to LCO revenue sharing in digital cable Common Size P&L Units Analog Digital LCO share LCO share LCO share Remarks (base 45% Monthly subscription revenue Rs % increase in ARPU in digital cable post mandate. Declaration by LCO % Subscription revenue to LCO Rs Our base case assumes that LCOs will take 30% of digital cable sub fees. Subscription revenue to MSO Rs C&P revenue to MSO (net of service tax) Rs Industry discussions suggest C&P revenues will decline by 50%. Content payment to broadcaster Rs MSOs such as Hathway make a ~10% margin on C&P net of content cost. We assume 40% share of sub revenue from consumer in a digitized scenario. MSO gross profit Rs Churn to DTH platform % Assuming a 30% churn of cable subs to DTH will still result in a 2x increase in gross profits for MSOs in our base case scenario. MSO gross profit net of churn to DTH Rs MSO gross profit margin % 55% 33% 30% 27% 24% Note: Excludes STB rental and cost Source: MPA analysis Investing in Digital India 11

12 DTH could capitalize on new opportunity. Within the past six years, DTH operators have grown from a gross subscriber base of less than 500,000 to ~40 mil. as of end-oct. 2011, primarily gaining growth in cabledark areas. Phase I digitization in four key metros offers a good opportunity for DTH operators to grab high- ARPU customers and increase reach in larger TAM meter markets. Based on our discussions, MSOs envisage about 15 20% churn in cable subscribers to DTH. Some operators suspect this could grow to 30% or more in the early stages of Phase I deployment. Subsidized HD offerings will also act as a key differentiator for DTH players as cable has yet to roll out HD services (with the notable exceptions of Hathway and Digicable). HDTV is expected to be a key value driver in the digitization process. MPA analysis indicates that ~1 mil. pay-tv homes will have HD pay services by Mar. 2012, largely through DTH, only 18 months after launch and in spite of a sluggish economy. ARPUs for HDTV are also attractive at about US$6 8 per month on average. Broadcasters. TV content providers and broadcasters will benefit from subscriber addressability. This will help boost subscription revenues and reduce dependence on weekly TRPlinked (TRP = television rating point) advertisement revenues. Broadcasters can also identify and launch dedicated channels for a specific niche which may have smaller advertising potential but can deliver healthy subscription premiums. At the same time, consumer adoption of certain programming tiers and specific channels (over others) will ensure healthy consumer competition in the content marketplace while broadcasters will also come under pressure to produce content with a high level of differentiation, premium quality (potentially advertising-free) and with local relevance. Digitization will also limit the rising cost of C&P fees. In the past six years, C&P fees paid by channels to cable operators have grown from less than US$100 mil. to over US$300 mil (see Exhibit 11). Savings from C&P as well as profits from higher subscription revenues can be reinvested towards better programming, marketing and technologically advanced content in HD and 3D formats. Pay-TV broadcasters generated only US$425 mil. in subscription fees on cable in 2010, about 11% of the total cable distribution pie. This number is expected to grow significantly in the future as digitization takes shape. Note that broadcasters and content providers derived about US$350 mil. from DTH distribution in The disparity between collections on cable and DTH is exemplified in the trend of subscription revenues retained by Zee Entertainment, one of India s leading broadcast groups (see Exhibit 12). Theoretically, a broadcaster s share in the digital cable environment will increase to 30 40% versus 10 15% (in analog). Large broadcast distribution networks (i.e. Media Pro) have come together to encourage digitization, offering discounted rates in return for improved declarations. Exhibit 11 Channel C&P fees have grown rapidly while subscription fee growth has been modest (CYE Dec.) Pay-TV channel sub Cable carriage & Net cable fees to revenues on cable placement fees pay-tv channels Source: MPA analysis Exhibit 12 Growth in Zee cable subscription fees has been minimal compared with DTH DTH subscription fees Cable subscription fees 1,400 International subscription fees 1,200 1, Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q Source: Company data Rs mil. After 2007, an increase in voluntary digitization through DTH encouraged a wave of new channel launches across genres. This resulted in fragmentation of viewership and ad markets across key TV genres. At the same time, the growth in operating profits of incumbent broadcasters remains highly dependent on domestic subscription revenues (see Exhibit 13). In the past 1 2 years, the growth of DTH subscription revenues for broadcasters has begun to slow due to increasing volumes for DTH platforms and a number of fixed-fee deals. Therefore, the next leg of profitable growth for incumbent broadcasters is dependent on the mandatory addressable digitization of cable networks. Exhibit 13 Sub fees boost profits towards content investment % Margin 35% 30% 25% 20% 15% 10% 5% 0% Source: Company data FY08 FY09 FY10 FY11 Zee s % OPM Zee s % OPM (excluding domestic subscription) 12 Investing in Digital India

13 Investors. Broadcasting is the largest media investment theme available to investors due to the presence of large market cap listed entities such as Zee Entertainment (US$2.6 bil. market value as of end-nov. 2011) and Sun TV (US$2.3 bil. market value). Broadcast business models are leveraged to advertising revenues, which in turn are linked to the short-term rating performance of selected channels and broader macroeconomic trends. Prior to the start of DTH growth back in 2007, a major portion of TV industry value and profitability was leaked on the ground due to last-mile fragmentation. The growth of DTH has breathed some life back into the TV sector though investors have preferred to play the digitization themes mainly through broadcast equities. This is due to long gestation periods and the risk of equity dilution in DTH operators. Upon successful implementation of the digital mandate, gradual consolidation of LCOs becomes inevitable. This will shift the industry profits and value to centralized distribution platforms (MSO/DTH) and broadcasters. Furthermore, the corporatization of distribution will bring new scale to the TV business with improved systems and technologies to raise transparency and accountability. This should result in significant value creation for investors with market valuations and multiples of cash flow that are likely to steadily grow in both public and private markets. This has certainly been the experience for cable operators in key international markets (see Exhibit 14). Most of these operators have undergone a high-growth value phase on the back of digital and broadband. Furthermore, as growth has moderated, both equity investors and M&A-driven investors have tended to favor cable/pay-tv operators in the media space because of the reliance on stable subscription fees and the ability to generate strong cash flows akin to utility companies. Therefore, in the United States and Korea, cable operators continue to trade at a relatively competitive 6 8x one year forward EBITDA, versus 12 16x during their growth phase. In Taiwan, a healthy debt-syndication market combined with strong M&A activity has meant that cable operators have not had to undertake IPOs, especially when fetching valuations as high as 12x forward EBITDA as recently as India offers an attractive entry point for various strategic players if FDI is increased to 74%. Meanwhile, the pay-tv market already offers promise for private equity investors. India is already the second-largest digitized market in the world with 48 mil. digital homes, still only ~30% of total TV households in the country. There is also a huge scope of ARPU growth from pay-tv services, HDTV and broadband. As a result, India s pay-tv distribution market is in a highgrowth value phase similar to North America between 1998 and 2003, Korea between 2003 and 2007, and Taiwan 2005 and Valuations for operators in these markets during their high-growth value stage typically averaged 12 16x one year forward EBITDA versus the current trading average of 9-10x for India s listed cable/pay-tv entities. We assume similar or higher valuations for companies in India subject to successful execution. Partnerships with domestic companies in India will also be important to bring in the next leg of growth for strategic players in mature overseas markets. At the same time, investors will take a wait-and-see approach, potentially acting only after analyzing the results of digital deployment in Phase I. Exhibit 14 Valuations for cable/pay-tv companies in global markets EV/ 1-Year Forward EBITDA (x) : US rate deregulation 1998: US digital cable starts to roll out 2000: US broadband cable starts to roll out Taiwan cable FDI at 60% 2003: Korea cable FDI at 49% 2007: Korea digital cable rollout 2006: Korea cable broadband gains traction Upgraded Taiwan cable infrastructure offers broadband USA average Taiwan average Korea average 2009: Rollout of Taiwan digital cable commences Note: Based on average public and private market valuations for cable and satellite companies Source: Bloomberg; Thomson; MPA analysis Investing in Digital India 13