DQE Final Report-Bare

8/7/2019 DQE Final Report-Bare

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DQ Entertainment

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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


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)


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


-

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)


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)


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)


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)


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


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


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



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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

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