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THIS DOCUMENT MAY NOT BE DISTRIBUTED IN OR INTO THE UNITED STATES, CANADA, AUSTRALIA OR JAPAN.
November 7, 2007 The Pixarof India
DQ Entertainment (DQE), a Hyderabad (India) based animation production
company, is on a fast growth path; with the companys revenues and net profits
expected to grow at a three-year (FY07-FY10) CAGR of 49.4% and 194.2%respectively. This growth is likely to be driven by a strong, confirmed order book
of USD 50.3mn and USD 44.3mn of orders in final stages of negotiations.
Further, with DQE entering into co-production, the revenues from licensing and
distribution are expected to give further fillip to its financial profile from FY09E
onwards.
The key investment highlights are
Strong order book to inflate revenues and net profits: DQE has a
strong order book of USD 50.3mn executable over the next eight-ten
quarters. The company is also in final stages of discussion for contracts
worth USD 44.3mn, executable over the next ten-twelve quarters. With astrong order book and order pipeline, DQE is expected to post a three year
(FY07-10E) revenue and net profit CAGR of 49.4% and 194.2%
respectively.
Entry into Co-production: During the next 10-12 quarters, DQE, along
with some of the worlds leading producers, plans to invest USD 13.6mn in
the co-production of TV series. This would shore up the companys
revenues and net profits significantly, as the company would benefit from
the licensing and distribution revenues.
Expanding EBITDA margins:DQEs enhanced focus on the high-margin
3D animation, VFX and game assets development as well licensing anddistribution revenues from the co-production series is likely to translate into
an EBITDA margin expansion from 27.8% in FY07 to 46.5% in FY10E.
Presence across the animation spectrum: DQE has a presence across
the animation spectrum, from the traditional 2D and 2D Digital animation to
3D Animation & VFX and game asset service.
Marquee client names: DQE works with some of the worlds leading
animation companies/producers such as Walt Disney Television
Animation, Nickelodeon, Electronic Arts and Method Films.
Year-end Sales YoY EBITDA YoY NP YoY RoE RoCE
March (USD m) (%) (USD m) (%) (USD m) (%) (%) (%)
FY06 10.8 - 2.3 - (0.2) - - 7.8%
FY07 15.2 41.6% 4.2 86.3% 0.5 - - 12.3%
FY08E 24.2 58.8% 7.4 73.7% 1.3 155.1% 8.2% 7.0%
FY09E 36.2 49.7% 14.4 94.8% 5.8 344.1% 16.9% 12.5%
FY10E 51.4 41.9% 23.9 66.7% 13.5 132.1% 30.6% 22.6%
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Investment Rationale
Presence across the animation spectrum:DQE has a presence across
the entire animation spectrum from the traditional 2D and 2D Digital
animation to 3D animation and VFX and across all platforms like
Television, Direct to Home Video, Feature Films. DQE in FY07 also
entered game assets development for Ingame Animation, Full Motion
Video for Xbox 360, Playstation III, other console games & online/mobile
game services. Such an integrated presence enables the company in
garnering a sizable portion of its clients business, while reducing the
downside risk, if there is any shift towards any one form of animation. In
line with the increasing popularity of 3D and gaming animation, the
company plans to enhance its focus on these businesses. DQE, however,
would continue to work on 2D animation, albeit at a slower pace.
Robust order book shows good revenue visibility:DQEs current orderbook stands at USD 50.3mn executable over the next eight-ten quarters
(see chart 1). The order book in the 2D, 3D, and gaming animation is
USD 5.7mn, USD 36.9mn, and USD 7.7mn respectively. The order book
is expected to increase further, as the company finalises its negotiations to
sign orders of around USD 44.3mn executable over the next ten-twelve
quarters. This, in our opinion, shows good revenue visibility for the
company, going forward. The current order book (confirmed and in serious
pipeline) is expected to facilitate the company in achieving our estimated
FY08E and FY09E revenues, and around 70% of our estimated FY10E
revenues. It, however, may be noted that the company is in constant
negotiations with existing and new clients for securing new projects; this
may increase the companys order book further.
Chart 1. Order book (Rs mn)
223 338
1,438 1,229
-459
-
500
1,000
1,500
2,000
2,500
Confirmed in Serious Pipeline
2D Animation 3D Animation Gaming
Mikido under service
production
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Moving up the value chain: Entry into co-production to boost
revenues and profits: Historically, DQE was an outsourced production
company with the animated series IPRs owned by the clients. Therefore, it
was not benefiting from the merchandise and licensing revenues
generated from a successful animated series. However, DQE has now
started co-producing TV series in association with some of the worlds
largest production houses like Marvel Group, American Greetings, and
Classic Media (a part of Entertainment Rights). Initially, DQE started by
co-producing series through sweat equity route and started acquiring
rights primarily for India. After getting initial success, DQE now plans to
invest around USD 13.6mn over the next ten-twelve quarters in the co-
production of animated TV series; these include Iron Man, Pinky and
Perky, and Casper (Table 1). DQE has already disclosed its intentions to
pick up a 20% stake in Method Films and announced the formation of a JV
with Onyx films to co-produce animated movies, and another JV with
Telegael, Ireland a Post production company, to produce a Animated TV
series & movies, and also to create a pre production facility for Television,
Feature Films/ Short Film Production.
Table 1. Co-Production Series
Co-Producers Series
Method Films France, Lux Animation ,Marvel Group, USA Iron Man
Classic Media, USA/Entertainment Rights, UK, Moonscoop,
France
Casper
American Greetings, USA Maryoku Yummy
Inde Kids/GO-N Productions, France and BBC Large Family
Lupus Films, UK and BBC Pinky and Perky
American Greetings/Mike Young Productions, USA Twisted Whiskers
With production work assured to DQE, it is likely to recoup its investments
even before the release of the series. Further, the company is expected to
benefit from the distribution and merchandising of these IPRs; this would
increase the companys revenues and profits considerably. Revenues
from the production part of the value chain are expected to start accruing
from FY08E onwards; the licensing and distribution revenues, however,
are expected from FY09E onwards, as most of the co-produced series
would be broadcasted from FY09E onwards. It may be noted that it
typically takes four-six quarters for any animation series to be broadcasted
after the commencement of production.
Marketing and distribution of its co-produced series enabled DQE to post
marginal revenues of USD 0.05mn in FY07. We expect these revenues to
increase to USD 1.8mn and USD 5.9mn in FY09E and FY10E
respectively, in line with the broadcast of most co-produced projects from
FY09E onwards.
Casper TV series being co-
produced along with Classic
Media, USA and Entertainment
Rights, UK
Pinky & Perky being co-
produced along with
Lupus Films, UK and BBC
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Expanding EBITDA margins: DQE plans to reduce its exposure to
manpower- intensive and lower margin 2D animation, and enhance its
focus on 3D and gaming animation. The margins in the 2D animation
business are also lower, as the company outsources some part of its work
to Philippines. The share of high-margin 3D and gaming business is
expected to increase from 53.4% and 14.2% in FY07, to 58.9% and
17.2%, in FY10E respectively, enhancing the companys margins. The
increasing share of revenues from marketing and distribution of its co-
production assets is also expected to support the companys EBITDA
margins. The share is expected to increase from 0.3% in FY07 to 11.5% in
FY10E. DQEs EBITDA margins are therefore likely to increase from
27.8% in FY07 to 46.5% in FY10E (Chart 2).
Chart 2. Revenue breakdown and Margins
Large and talented workforce: Currently, DQE employs more than 2,300
employees across India and through a subcontractor in Philippines. The
companys large and talented manpower enables it to handle several
projects for multiple clients. During the next one year, DQE plans to
increase its employee strength by another 400, to service its expanding
order book. For this purpose, the company has developed and patented
an online ERP solution. This helps the company in resource management,
production planning, management of pipeline and production schedules,
and quality control. The scalability of the ERP solution can be gauged
from its ability to simultaneously handle more than 21 projects, with
reporting requirements to the customer of at least daily.
Benefiting from own training facility:NASSCOM (National Association
of Software and Services companies: a trade body and the chamber of
commerce of the IT and software services industry in India) estimates that
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
FY05 FY06 FY07 FY08E FY09E FY10E
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
2D Animation 3D AnimationGaming Marketing & DistributionEBITDA Margin
Todd World co-produced
with Mike Young
productions, USA for
Discovery Kids nominated at
2007 Day Time EMMY
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there would be a demand-supply gap of around 10,000 animators in India
by the end of 2010 (see chart 3). Foreseeing this mismatch, DQE has set
up its own training facility that could train 680 animators in a year. In order
to further develop the talent pool across India, the company, in association
with local state governments, has established training schools in the
states of Madhya Pradesh and Rajasthan; it plans to set up training
centers in two more states: West Bengal and Andhra Pradesh. Together,
these training institutes would have the capacity to train 800-1000
animators a year. DQE would also have the first right of refusal to employ
these animators.
Chart 3. Demand and Supply gap
Source: NASSCOM
Marquee client names: DQEs client list includes some of the biggest
animation production houses in the world like Walt Disney Television
Animation, Nickelodeon, Marvel, and Cartoon Network. The company has
been doing business with these clients for the past several years, lending
credibility to the company. DQE has also successfully executed multiple
projects with these clients, thus showcasing the quality of its work.
Further, in the co-production space, the company has tied-up with big
production houses like Marvel and Method films. This would help the
company in owning some of the worlds best properties (animated
characters).
Revenues and PAT to grow at a three-year CAGR of 49.4% and
194.2% respectively:Historically, DQEs revenues have grown at a two-
year CAGR of 50.0%, from USD 6.8mn in FY05 to USD 15.2mn in FY07.
During the same period, the companys bottomline has increased from a
loss of USD 1.0mn in FY05 to a profit of USD 0.5mn in FY07. Currently,
DQE has an order book (confirmed and in serious pipeline) of USD
94.6mn to be executed over the next eight-ten quarters. In addition, the
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
2007 2008 2009 2010
-
2,000
4,000
6,000
8,000
10,000
12,000
Demand Supply D-S Gap (RHS)
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company is in constant negotiations in securing further orders. Given the
current and potential order book position, we expect the company to report
a three year (FY07-10E) revenue and net profit CAGR of 49.4% and
194.2% respectively. The companys revenues are expected to increase
from USD 15.2mn in FY07 to USD 51.4mn in FY10E. Further, net profits
are expected to increase from USD 0.5mn in FY07 to USD 13.5mn in
FY10E (see chart 4). It may be noted that our estimates are based on
average Rs/USD rate of Rs 39.0 for FY08E, FY09E and FY10E.
Chart 4. Trends in Revenues and Net Income
-10
0
10
20
30
40
50
60
FY04 FY05 FY06 FY07 FY08E FY09E FY10E
Revenues Net Income
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Business Summary
DQE, a Hyderabad-based company focused on outsourced animation
production, is one of the largest animation company in India. It has capabilities
in 2D Traditional & Digital animation, 3D& VFX animation, and Game Asset
Services. Its competitors in India include Crest Animation, Color chips, and
UTV Toonz among others (see table 2).
Table 2. DQE Competitors
No. ofEmploye
es
2DAnimation
Flash 3DAnimation
Major Clients
Anirights Infomedia Pvt Ltd 165 Yes Yes Yes Warner Bros., Disney
Color Chips 350 Yes Yes Penta TV, Albert Tross Productions
Creative Media PulseTechnologies
45 Yes Yes Digital Motion Picture, Toyota
Crest Animation 409 Yes Yes Mike Young Productions, Blitz Games
Escotoonz Animation 120 Yes Yes Yes Porchlight Ent., Funbag
Frame Flow 70 Yes Cinesite UK, Sony Pictures Imagework
Graphiti Multimedia 75 Yes Nickelodeon, Everest
Green Gold Animation 75 Yes Yes Cartton Network, Excel Home Videos
Maya Entertainment 150 Yes Yes BBC, Nickleodeon
Paprikaas Animation Studios 120 Yes Yes Digital Dream, Richochets
Toonz Animation 500 Yes Yes Yes Walt Disney Singapore, Cartoon
NetworkUTV Toons 739 Yes Yes Yes Funbag, TV12 Singapore
Source: NASSCOM report on animation and Gaming In India
DQE initially was largely undertaking production part of the animation value
chain, with pre-production and post-production undertaken by the client.
However, it has now started co-producing animated TV series for global
audiences, thus owning its IPRs. The company is currently working with the
some of the worlds largest animation production houses like Marvel, American
Greetings, Nickelodeon which have broadcasters like BBC, Cartoon Network,
Discovery Kids, Nickelodeon, etc. The company has won major awards for its
production like 2007-day time EMMY award won in the category of
outstanding special class animated program for the second season of TV
series Tutenstein, which was co-produced with Porchlight Entertainment,
USA and DSC Kids, USA.
DQE also plans to enter the pre-production and post-production part of the
animation value chain, thus becoming a complete end-to-end animation studio
(see chart 5).
Tutenstein: 2007 Day time EMMY
award won in the category of
outstanding special class
animated program
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Chart 5. Animation value chain
Over the years, DQE has executed projects in the entertainment segment for
leading animation production companies like Cartoon Network, Walt Disney
Television Animation, Nickelodeon, and Method Films.
2D Traditional animation
DQE started its business in the 2D traditional animation space; over the years,
the company has executed successful projects for prestigious production
houses like Porchlight Entertainment and Gruppo Alcuni. The magnitude of
DQEs business in the 2D space could be gauged from the completion of more
than 5,148 minutes of animation production, spanning 2.9mn man hours,
during the past three years. Table 3 outlines some of the 2D animation
projects executed by the company:
Table 3. 2D animation projects completed till now
Currently, for its 2D animation business, DQE employs 300 people in India and
another 350 in Philippines (through subcontractor). The company outsources
majority of the art work in the 2D animation space to the sub-contractor in
Philippines. Though sub-contracting has increased DQEs operating costs, it
has helped the company in tapping the talent pool in Philippines; the countrys
Project Client Type
Petpals-II Grupo Alcuni, Italy Series
Jetgrooves Method Films, France Series
Curious George NBC-Universal, USA Series
Ronwhite Sony Entertainment, USA Series
Ratman Stanameni Srl, Italy Series
Choose your own Adventure Mike Young Production, USA DVD film
INVESTOR
DEVELOPMENT
& PLANNING
PRODUCTION HOUSE POST PRODUCTION CUSTOMER
FILMS
TV SERIES
GAMING
HOMEVIDEO
MUSIC VIDEO
COMMERCIALS
EDUCATIONAL
MUSIC VIDEO
CHOICE OF ANIMATION
TECHNIQUE AND
SOFTWARE
2D TRADITIONAL OR2D DIGITAL OR 3D
PRODUCTION POST-PRODUCTIONPRE-PRODUCTION
SA LES & DISTRIBUTIO N
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manpower is much ahead of its Indian counterparts in terms of quality and
productivity in the 2D animation space.
In line with the increasing preference of 3D animation over 2D animation
across the world, DQE has enhanced its focus on 3D animation. Not
surprisingly, the share of 2D animation revenues to DQEs total revenues hasbeen falling over the years. However, the company would continue to execute
projects in the 2D animation space. Currently, DQE has a confirmed order
book of USD 5.7mn and contracts of USD 8.7mn in serious pipeline.
3D & VFX animation
DQE entered the 3D animation business in FY05 and has since grown at a
two-year CAGR of 68.9%, from USD 2.9mn in FY05 to USD 8.1mn in FY07.
Over the years, DQE has executed projects for Direct-to-home DVDs and TV
series for some leading animation company like Walt Disney Television
Animation and Nickelodeon. In the past three years, DQE has completed 2,071
minutes of 3D animation encompassing 1.85mn man hours. Table 4 outlinessome of the projects executed by DQE in the 3D animation space.
Table 4. 3D animation projects
The company now plans to enter into the co-production of 3D animated TV
series with some of the leading producers like Method Films and Mattel. The
entry into co-production, we believe, would help the company in increasing its
production revenues. Moreover, DQEs marketing and distribution revenues
would also increase as it would co-own the IPR of the TV series.
In the 3D animation space, DQEs confirmed order book stands at USD
36.9mn, with orders of USD 31.5mn in serious discussion. This order book also
contains the production revenues expected from the series co-produced by
DQE.
Project Client Type
A series for season 1 comprising of
26 episodes of half an hour show
and followed by season 2 of the
series
Walt Disney Television Animation,
USASeries
A DVD based on the TV seriesWalt Disney Television Animation,
USA
DVD
Film
Barbie Diaries-DVD Curious Pictures,USA/Mattel USA
DVD
Film
SkylandMethod Films France/ Nickelodeon
EuropeSeries
Donkey Ollie Series (I, II & III) Car Angel Production, USADVD
Film
Geo Track Sony, USA/Mattel USA Series
Shipwrecked Adventures
of Donkey ollie- a full
length animated CGI, co
produced with Car Angels
won The Accolade
Honorable Mention Award
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Gaming
Benefiting from its strength in the 3D animation business, DQE entered the
gaming business in FY07 and reported revenues of USD 2.2mn during that
year. Currently, it has an order book of USD 7.7mn and orders of USD 4.1mn
in serious pipeline to be executed over the next two years.
In the gaming business, DQE focuses on asset development rather than
programming. DQE has signed a contract for outsourcing development of arts
and cinematic part of the gaming content with Electronic Arts one of the worlds
largest gaming companies; the companys operations are spread across the
U.K., Canada, Hong Kong, and the U.S.
Industry Overview
Animation industry is one of the fastest growing industries in the world as the
rapid advancement of technology has made computer animation available to
the masses. The growth in the animated entertainment has expanded with the
increase in the broadcasting hours by the cable and satellite TV, and with the
growing popularity of the internet. Earlier, the animation series were typically
targeted at children. In recent years, however, animated series for teenagers,
adults, and families are being produced by TV stations. The success of The
Simpsonand King of the Hillare major examples of successful animated series
aired on prime-time TV in markets such as the U.S, Canada, Japan, France,
U.K., and Germany.
Market Size: AnimationThe global animation industry (from the demand perspective) is estimated at
USD 59bn in 2006 and is expected to grow at a six-year (2004-10) CAGR of
7.7% to USD 80bn by 2010. The market share of the global entertainment
sector stood at 74% in 2006, and is expected to increase to 77% by 2010.
Most players in the global animation industry are estimated to record a profit
margin of around 20%. On an average, the animation industry spend 40% of its
cost on the development of animation content. Animation companies like DQE
cater to this market of outsourced production. NASSCOM estimates that the
global animation development market is expected to grow at a six-year (2004-
10) CAGR of 8.6%, from USD 21bn in 2004 to USD 34.4bn by 2010 (see chart
6).
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Chart6. Global Animation Industry, Developers Perspective (USD bn)
Source: NASSCOM report on animation and gaming industry in India 2007
The growth in demand is expected to be led by the entertainment segment,
whose market share in the global animation content development is expected
to increase from 75% in 2006 to 77% by 2010 (chart 7).
Chart 7. Market shares in the global animation content development
Source: NASSCOM report on animation and gaming industry in India 2007
Market Size: Gaming
The worldwide gaming market (from a developers perspective) is estimated to
grow at a six-year CAGR of 16.6% from USD 5.3bn in 2004 to USD 13.3bn in
2010 (Chart 8).
-
5
10
15
20
25
30
35
40
2004 2006 2008 2010
CAGR 8.6%
2006
Entertainm
ent, 75%
We-Designing,
16%
E-
education,
9%
Entertainment We-Designing E-education
2010
Entertainm
ent, 77%
E-
education,
9%We-
Designing,
14%
Entertainment We-Designing E-education
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Chart 8 . Global Gaming Market Size, developers Perspective (USD bn)
Source: NASSCOM report on animation and gaming industry in India 2007
It is estimated that 60% of the gaming companies currently outsource and it is
expected to increase to 90% by 2008. The increase in outsourcing is being
driven by the transition towards next generation consoles, which has increased
the need for better graphics and higher budgets for game development.
The Indian Animation Industry
The Indian animation development industry is expected to grow at a six-year
(FY04-FY10) CAGR of 26.6%, from USD 211mn in 2004 to USD 869mn in
2010 (see chart 9). It is estimated that of the total revenues generated by the
companies in India, approximately 70% is derived from outsourced projects,
particularly from the U.S. and European companies.
Chart 9. Indian Animation development market
Source: NASSCOM report on animation and gaming industry in India 2007
-
2
4
6
8
10
12
14
2004 2006 2008 2010
CAGR 16.6%
-
100
200
300
400
500
600
700
800
900
1,000
2004 2006 2008 2010
CAGR of 26.6%
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India caters to majority of the global content development work for TV and
broadcast segment. Further, the production function of animation development
is primarily outsourced. Activities outsourced in the production stage include
creating an animation of the character, where the movements are already
defined at the pre- production stage. Lately, Indian companies have started
securing projects in the post- production stage; this trend is expected to gather
momentum, going forward (see chart 10).
Chart 10. Demand for animated content in TV/Broadcast (USD mn)
Source: NASSCOM report on animation and gaming industry in India 2007
The demand for animation in fully animated movies is increasing both in the
domestic and foreign markets (see chart 11). Further, many global companies
have now started looking at off-shoring as an option to develop the animated
content. The major reason for the growth in this segment is the lower cost for
production. The cost of producing a full-length animated movie in the U.S. is
USD 100-175mn; in India, however, the same work can be completed at USD
15-25mn (Source: NASSCOM). Since only 10% of the animated movies are
commercially successful, cost control becomes critical. Given its cost
advantage, India has emerged as a preferred offshore destination among
animation companies.
-
2040
60
80
100
120
140
160
180
2006 2008 2010
Demand from Offshoring Demand from Domesti c Market
CAGR 13.1%
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Chart 11. Demand for animation development in fully animated movies (USD mn)
Source: NASSCOM report on animation and gaming industry in India 2007
Why India a lucrative destination for outsourcing of animation
production?
The global market for animation development is expected to grow at a six-year
(2004-10) CAGR of 8.6%, from USD21bn in 2004 to USD 34.4bn by 2010
(Source: NASSCOM). However, the Indian market for animation development
is expected to grow at a much higher rate of 26.6%. The reasons for India
becoming an attractive destination for outsourcing of animation development
are:
Cost Advantage: India has a significant cost advantage over other
geographies. The low cost, coupled with high quality of animation, has led
global animation companies to outsource their production work to India.Foreign production houses can save up to 60% of the costs by
outsourcing work to India..
In the 2D animation space, however, India still lags behind countries like
Philippines in terms of quality; nevertheless, in the 3D animation space it
is way ahead of Philippines. Indian companies have already secured
outsourcing projects from Philippines and Taiwan by providing services for
half the price charged by the companies in these geographies (see chart
12).
-
10
20
30
40
50
60
70
80
90
2006 2008 2010
Demand from Offshoring Demand from Domestic Market
CAGR 37 .6%
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Chart 12. Offshore Location Attractiveness Index (Cost Factors)(2004)
Source: NASSCOM report on animation and gaming industry in India 2007.
Availability of Talent: India has an abundant talent pool with 3.1mn
graduate pass-outs each year. Further, India accounts for 28% of the total
suitable talent pool available in offshore locations. NASSCOM estimates
that the manpower in the animation industry could grow at a five year
(2005-2010) CAGR of 14%, from 15,060 in 2005 to 28,877 by 2010 (Chart
13).
3.2
0.2 0.3
3. 0
0.20.1
0. 9
0. 20. 3
3.1
0. 2 0.2
-
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Compensation Infrastructure cost Tax and Regulatory
Environment
India China Singapore Philippines
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Chart 13. Expected growth in qualified professionals in the Indian animation
industry (2005-10)
Source: NASSCOM report on animation and gaming industry in India 2007
English Proficiency: Indian animation companies score over other low-
cost countries due to its proficiency in English. Limited or lack of
knowledge on English, resulting in less than perfect understanding of the
international services market, is a major deterrent for the growth of the
animation and gaming industry in other geographies (see chart 14).
Chart 14.Offshore location attractiveness index (2004)
Source: NASSCOM report on animation and gaming industry in India 2007
Note: BPO experience could be stated as understanding of international markets
-
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2005 2006 2007 2008 2009 2010
CAGR 14%
0 .20 .3
0 .5
1.0
0 .10 .1
0 .2
0 .6
0 .5
-
0 .3
0 .3
0 .6
0 .20 .1
0 .2
0 .4
0 .10 .1 0 .1
-
0.2
0.4
0.6
0.8
1.0
1.2
Language Education Size and
Availabilit y of
Labor
BPO
experience
Employee
retention
India China Singapore Philippines
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Table 5. Country competitive landscape
India China Taiwan South Korea Philippines Singapore
Cheap Labor Cheap Labour Cheap Labour Governmental Support Greater familiarity with
western culture
Governmental Support
Availability of talent Collaboration with H
andTaiwan to openup
opportunities
Understanding of
International markets
Cultural Variety Focus on creative and
artistic output
Cultural Variety
English Proficiency Rich Cultural Content Governmental Support Good experience in
animation creation
Technical expertise Government Support
Language Issue Language Issue Lack of private funds Lack capital fo
investment in
sophisticatedequipment
and software to delive
content of global
standards
Animation work mainly
inproductionpart ofthe
value chain
Lack of Creative Talent Highly dependent on
outsourcing work from
China
Animation work mainly
inproductionpart ofthe
value chain
Focus on local content
creation and IPR
Low on IPR creation
Industry hasapproximately 90% of
the outsourcing projects
Training Institutes Development local talentDevelopment local
content
Development 3-D
animation content
Development loca
content
Local Content
Development
To cater increasinglyTo
the animation and
gaming outsourcing
from China
To develop creative
animation content
English language
adaptability
Focusingongettingpre-
production an d
production outsourcing
work in country
Gap between demand
and supply to widen
going forward
Newdestinationsaswell
as established
destinations
Lack of large
experienced local talent
Other outsourcing
destinations like
Philippines and South
Korea.
India and Korea are
major threats
Understanding of
international markets
Strength
Weakness Animation work mainly
inproductionpart ofthe
value chain
Opportunity getting into co-
production and owning
the IPRs
Threat India, Philippines and
Korea are major threats
Philippines, India and
China are major threats
Philippines, India and
China are major threats
Source: NASSCOM report on animation and gaming industry in India 2007
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Financial Summary
DQE has grown from USD 6.8mn in FY05 to USD 15.2mn in FY07, a two-year
CAGR of 50.0%. We expect the company to report revenues of USD 24.2mn
and USD 36.2mn in FY08E and FY09E respectively, supported by (a) strongorder book of USD 94.6mn, and (b) expected revenues from marketing and
distribution of its co-production assets. We further expect the company to post
revenues of USD 51.4mn in FY10E, implying a three-year revenue CAGR of
49.4% (see chart 15).
Production Revenues
DQE has a strong order book of USD 94.6mn (confirmed and in serious
pipeline) to be executable over the next ten-twelve quarters. This is likely to
translate into production revenues of USD 23.4mn and USD 34.4mn in FY08E
and FY09E respectively. We further expect the company to post production
revenues of USD 45.5mn in FY10E, implying a three-year revenue CAGR of43.7%. Therefore, the current order book, in our opinion, covers FY08E and
FY09E revenues and around 80% of estimated FY10E production revenues;
this shows good revenue visibility for the future.
Marketing and Distribution revenues
Currently, DQE is working on a number of co-production projects that are
expected to be broadcasted from FY09E onwards. As DQE jointly owns the IPR
with other co-producers, it is likely to benefit form the marketing and distribution
of the merchandising, broadcasting rights, and other rights. We expect the
company to post marketing and distribution revenues of USD 0.8mn, USD 1.8mn,
and USD 5.9mn in FY08E, FY09E, and FY10E respectively (see chart 15).
Chart 15.Revenue Breakdown
0%10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
FY05 FY06 FY07 FY08E FY09E FY10E
Production Revenues Marketing and Distribution Revenues
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EBITDA Margins
DQEs EBITDA margins are expected to increase from 27.8% in FY07 to
46.5% in FY10E. The margin expansion is likely to be driven by higher
contribution from the 3D animation & VFX and game asset development
businesses. Higher marketing and distribution revenues is also likely to support
the growth in margins, as most of the revenues generated from licensing and
distribution of its co-production assets would add to its bottom-line, increasing
EBITDA margins.
Depreciation
DQE follows a policy of writing-off its hardware and software costs every three
years. The company is expected to invest USD 9.9mn in the hardware and
software for its animation business over the next three years. Moreover, the
company is expected to spend another USD 4.6mn towards setting up a
campus in a SEZ (Special Economic Zone). Together, these investments are
likely to increase the companys depreciation from USD 2.4mn in FY07 to USD
9.1mn in FY10E.
Taxes
Currently, DQE pays no tax as its profits are exempted under Sec 10A and
10B of Indian Income tax act (see Appendix B); the tax exemptions are likely to
end by March 31, 2009. We, however, expect the company to move to its new
facility in the SEZ where a further tax exemption of five years can be availed.
The government of India in its budget for FY08E has imposed a MAT
(Minimum Alternative tax) of around 11%on the IT-ITES industry. However, the
companies can take a credit for the same on its future tax obligations, and
hence there would not be any impact on the income statement. Therefore, we
have not considered any tax outgo in our future estimates.
Net Income
DQEs bottomline has grown from a loss of USD 1.0mn in FY05 to a profit of
USD 0.5mn in FY07. We believe that this growth momentum would continue,
given the companys strong order book position. We expect DQEs net income
to grow at a three-year CAGR of 194.2%, from USD 0.5mn in FY07 to USD
13.5mn in FY10E.
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Appendix A
Co-Production Contracts:
Each co-production contract may vary depending on the negotiations between
co-producers. A common feature, however, among all contracts is the retention
of the projects IPR by the master licensee and the allotment of exclusive rights
to co-producers to use the IPR in certain geographies for a definite number of
years.
The following is a typical example of a co-production contract. Suppose DQE
enters into a co-production agreement with one of the leading producers say
XYZ (who owns the IPR) and another co-producer ABC.
Budget
The budget of the series is generally divided between the parties, depending
on the negotiations and how much each co-producer can contribute. In theabove example, the budget between the three parties may be divided in the
following proportion:
XYZ: 50%
DQE: 25%
ABC: 25%
Each party is responsible for their share of budget and for any cost overruns
with respect to their obligations.
Scope of Work
Generally, each co-producer is responsible for his own scope of work. Since
DQE has its strength in the production space, it would be responsible for the
production part of the series. Therefore, DQE gets the service revenues for
the part of work done by it.
Licensing and Reserved Rights
The master licensee (in this example, XYZ) is the exclusive, worldwide master
licensing agent for the series and the property in perpetuity. It is entitled to
agency fees of 30% of Gross Licensing Revenues (GLR). GLR means 100% of
all non- refundable amount paid by the distributors/licensees to XYZ arising in
connection with the exercise of the licensing rights.
As a co-producer, DQE would be appointed by XYZ as a sub-agent for thelicensing rights in some geography, say South Asia. DQE would receive its
agency fees, which is 30% of the GLR collected by DQE in its geography.
The net licensing revenues between the three parties are generally distributed
in the same proportion as their share in the budget. Therefore, in the above
example, these revenues would be shared in the following proportion:
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XYZ: 50%
DQE: 25%
ABC: 25%
The net licensing revenues are accrued for a certain period of time, after which
the right to use the IPR shifts back to the master licensee.
Net Licensing Revenues (NLR) means Gross Licensing Revenues (GLR) less
(a) the agency fees for the master licensee (XYZ), and (b) XYZ expenses.
Audio Visual Rights
Audio visual rights of the series are generally divided between the parties for
different geographies and for a definite time period. Each party is entitled to
receive 30% of the Gross AV revenues. The net AV revenues are divided
between the parties in the proportion of their share in the budget.
Appendix (B)
Section 10A and 10B of the Indian Income Tax act
Under Section 10A and 10B of Indian Income Tax Act, the profits and gains
derived by an undertaking located in a free trade zone (FTZ)/ export processing
zone (EPZ)/ special economic zone (SEZ)/ Software Technology Park (STP)/
electronic hardware technology park (EHTP), is exempted from tax for a period of
ten consecutive years from the time it started operations. The same rule applies
to the profits and gains derived by a 100% export oriented unit (EOU) from
exports of articles or computer software. However, the tax exemption is not
available after March 31, 2009.
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Animation
What is it?
Animation could be defined as a process that creates phases of imaginary
action. Under this process, actions are recorded in such a way that they create
an illusion of motion when displayed at a pre-determined rate. The animationvalue chain could be explained by the following figure.
Figure 1. Animation Value ChainIdea Generation
Action
Adventure
FantasyComedy
Sci-fi
Pixilation
Social Awareness / message
Mythology
Music Video
Think Tank Brain storming(Creative, business head,
production control, script
writer, visualizer)
Script Writing
Designing (Casting) Storyboarding
Model Packs Animatics
Coloring / CRM X-sheets
For Production
3D 2D Flash 2D Traditional
3D Modeling Flash Tracing
3D Texturing Flash Coloring
3D Rigging Flash Slicing
Layouts/scene setup Layouts/ Scene setup Layouts/ Scene Setup
Animation Animation Animation
Playblast Cleanups
Technical Check In-betweens
Lighting Scanning
Rendering Linetest Compositing
Ink & Paint
Audio VO Recording
SFX SFX SFX
Music & Effects Recording
Final Composit ing Final Composit ing Final Composit ing
POSTPRODUCTION Editing and Final Mix
PRE-PRODUCT
ION
P
RODUCTION
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Pre Production
Idea: The idea can be generated from any source internal or external. The
think tank of companies brainstorms on the theme and decide on the storyline,
character attitude, personalities and geographic locations for the theme; the
think tank essentially comprises the Creative Director, Visualizer, BusinessHead, and Script Writer. At this stage, companies would usually like to assess
the subject that has the potential of becoming the next big thing. This is done
by presenting the concept to various broadcasters, distributors, and investors,
usually at markets such ANNECY (MIFA), MIPCOM, Siggraph
Script: The script is written using the above information and after incorporating
the merchandise opportunities from this stage.
Storyboard: A storyboard is prepared by the experts from the final draft of the
script.
Designs: Character designing and color scheming is done simultaneously.
Styles and techniques are also explored at this stage.
Voices: The casting for the voices is done keeping in mind the
attitude/personality of these characters. The timing of each scene is
determined only after the scratch dialogue track is recorded. The recording is
done twice: for the scratch voice, to be used for animation and for the final
voice track.
Animatics: This is the process where the storyboard panels are put according
to the audio track and the timing for each scene is determined.
Layout: Layouts are prepared for each scene. It is here that the planning is
done for the environments (3D and 2D plates).
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production
Production process will differ depending upon choice of medium for animation.
The term Computer Animation broadly covers a wide variety of genres and
applications, though the simplest way to break it down is into the categories of
2D and 3D animation. 2D, short for two-dimensional, is sometimes also called
vector animation, and is typically done in programs like Macromedia Flash and
Macromedia Director. 2D animation, true to its name, is rendered in a two-
dimensional space. 3D animation, however, is rendered in a virtual three-
dimensional space, using polygons captured by various virtual cameras to film
the animation. 3D animation is usually done using popular software such as
Maya, 3DS Max, Softimage-XSI. In 2D animation the effect of perspective is
created artistically, but in 3D objects are modeled in an internal 3D
representation within the computer, and are then lit and shot from chosen
angles, before being rendered to a 2D bitmapped frame.
Traditional Animation is a hands-on process; 2D animation is accomplished
by hand-drawing hundreds upon thousands of individual frames only to transfer
them to clear plastic cells, hand-paint them, and then film them in sequence
over a painted background image. This requires a team of artists, cleanup
artists, painters, directors, background artists, and film/camera crews, along
with the storyboard artists and script writers to work out the original concepts;
for large-scale projects, the amount of time, labor, and equipment involved can
be staggering. Typically 1 minute of 2D animation has 1,440 frames and could
involve thousands of drawings (could be up to 15-20,000 drawings for a half
hour episode).
Figure 2: Traditional 2D animation workflow
Source: Mirage Whitepaper
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3D Animation essentially involves Modeling, Texturing, Rigging, Lay outing,
Animating, Lighting and Rendering.
Modeling is the process of forming the shape of the object by developing a
wire frame of any three-dimensional object (either inanimate or living) in the
computer using 3D software. The model describes the process of forming theshape of an object.
Texturingis the process of defining of material, adding detail, surface texture,
colour, and dress up to the 3D models.
Rigging is the process of specifying internal skeletal structure of the model so
that it can be animated by controlling the skeleton of the object.
Layout is the process of staging or placing the objects within a scene. This is
what defines the spatial relationships between objects in a scene including
location and size. The virtual cameras are set to create shots that capture the
emotion and story point.
Animation is the process of providing movements and facial expressions to
3D objects. Animators create key poses by using computer controls. The
computer then creates the in-betweens frames, that the animators adjust as
necessary.
Lighting - Every scene is lit using digital lights. Lighting is used to enhance
the mood and emotion of each cell.
Rendering is the act of converting the 3d files into single frame of film. Each
frame represents 1/24 of a second of screen time.
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Key Management Personal
Tapaas Chakravarti, Chairman and CEO: Tapaas co-founded DQ
entertainment in 1993 and has been instrumental to the growth and success of
the company to date. He is part of several international educational and
charitable organizations. He also sits on the board of the Indo-British
Partnership and is a member of the Young Presidents Association.
Sanjay Choudhary, Sr VP (Finance): Sanjay, head of the finance division at
DQE has more than 12 years of experience in the areas of costing and
accounting, formulation of business models, foreign exchange transactions,
working capital management and IT. Prior to joining DQE, Sanjay has worked
with SK Birla Group, Cosmo Films Limited and Khaitan fans group.
Niranjan Prasad Hanagodu, VP (Corporate Affairs): Niranjan has over 15
years of experience in accounting and finance and has worked with VDO
Mannesman (now Siemens) and Coca Cola, India. He currently heads thecorporate affairs and the costing divisions and facilitates strategic management
decisions in respect of economic activities of the company.
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Financials
Profit & Loss Balance Sheet
USD mn FY06 FY07 FY08E FY09E FY10E USD mn FY06 FY07 FY08E FY09E FY10E
Net Sales 10.8 15.2 24.2 36.2 51.4 Property, Plant and Equipments 4.9 5.9 34.8 34.7 33.8
yoy 58.8% 41.6% 58.8% 49.7% 41.9% Intangible Assets 1.9 4.0 3.5 3.1 2.6Cost of Sales 7.5 9.4 14.3 18.0 23.0 Co-Production Investments - - 4.3 6.7 11.6
% of revenues 69.8% 61.8% 58.9% 49.6% 44.7% Investment in JV's - - 4.4 4.4 4.4
Gross Profit 3.2 5.8 10.0 18.3 28.5 Other non-Current Assets 3.5 4.6 4.6 4.6 4.6
GPM % 30.2% 38.2% 41.1% 50.4% 55.3% Total Non-Current Assets 10.3 14.5 51.6 53.4 57.0
Selling and Distribution Expens 0.2 0.3 0.4 0.5 0.6
% of revenues 1.8% 2.0% 1.8% 1.5% 1.3% Trade and other receivables 2.8 5.6 6.1 9.1 12.9
General and Admn expenses 0.8 1.3 2.2 3.4 3.9 Cash and Cash Equivalents 0.4 0.8 0.7 2.1 5.0
% of revenues 7.2% 8.4% 8.9% 9.3% 7.5% Other Current Assets 0.0 0.0 0.2 0.8 2.4
EBIDTA 2.3 4.2 7.4 14.4 23.9 Total Current Assets 3.3 6.4 6.9 12.0 20.3
yoy 339.3% 86.3% 73.7% 94.8% 66.7%
EBIDTA % 21.2% 27.8% 30.4% 39.6% 46.5% Total Assets 13.6 20.9 58.6 65.5 77.3
Depreciation 1.5 2.4 4.8 7.1 9.1
EBIT 0.8 1.8 2.5 7.2 14.8 Equity (0.3) 0.3 31.6 37.4 51.0
EBIT % 7.2% 12.0% 10.5% 19.9% 28.8% Interest bearing Loans 11.9 4.0 8.0 8.0 5.0
Interest expense 1.0 1.3 1.2 1.4 1.3 Other Non-Current Liabilities 0.4 0.6 1.0 1.3 1.7
Other Income 0.0 0.0 - - - Total Non Current Liabilities 11.9 4.9 40.6 46.8 57.6
PBT (0.2) 0.5 1.3 5.8 13.5
(-) Tax 0.0 0.0 - - - Interest bearing Loans and Liabilities 0.0 12.6 15.0 15.0 15.0
Tax rate 5.7% 0.0% 0.0% 0.0% Other Current Liabilities 1.7 3.3 3.0 3.7 4.6
PAT (0.2) 0.5 1.3 5.8 13.5 Total Current Liabilities 1.7 16.0 18.0 18.7 19.6
NPM -2.0% 3.4% 5.4% 16.1% 26.3%
yoy -79.6% -340.9% 155.1% 344.1% 132.1% Total Liabilities 13.6 20.9 58.6 65.5 77.3
Key Ratios Cash Flow
USD mn FY06 FY07 FY08E FY09E FY10E USD mn FY06 FY07 FY08E FY09E FY10E
EPS (USD) (0.3) 0.7 1.7 7.5 17.3 Net Profit (0.2) 0.5 1.3 5.8 13.5
CEPS (USD) 1.7 3.7 7.9 16.6 29.0 Depn & w/o 1.5 2.4 4.8 7.1 9.1
Others 1.3 1.5 1.1 0.7 (0.3)
Book value (USD) (0.3) (0.0) 20.4 44.3 56.7 Change in WC (0.7) (2.4) 0.8 (1.9) (2.5)
Operating Cash Flow 1.9 2.1 8.0 11.8 19.9
ROCE 7.8% 12.3% 7.0% 12.5% 22.6% Capex (3.1) (3.0) (33.1) (6.0) (6.7)
ROE 8.2% 16.9% 30.6% Strategic Investments - - (8.9) (3.0) (6.0)
Others (2.0) (3.4) - - -
Investing Cash Flow (5.1) (6.5) (42.0) (9.0) (12.7)
Proceeds from borrowings 2.3 3.9 6.3 - (3.0)
Proceeds from issue of capital 0 0 30 - -
Others (0.1) (0.4) (1.2) (1.4) (1.3)
Financing Cash Flow 2.2 3.5 35.1 (1.4) (4.3)
Net inc/ (dec) in cash (1.0) (0.9) 1.2 1.4 2.9
Opening cash 1.4 0.4 (0.5) 0.7 2.1Movement of foreign currency Transla - - - - -
Gain/ (Loss) on forex fluctuations 0.0 (0.0) - - -
Bank Overdrafts - 1.3 - - -
Closing cash 0.4 0.8 0.7 2.1 5.0