VSNL: The (re)evolution continues… - Views on News from Equitymaster

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VSNL: The (re)evolution continues…

Jan 18, 2005

Performance summary
International long-distance (ILD) major, VSNL, has announced mixed results for the third quarter and nine-months ended December 2004. For 3QFY05, while revenues have grown on a YoY basis, profits have declined owing to lower other income and higher depreciation expenses. On the operating front, lower network costs have helped the company to expand its margins.

Financial performance: A snapshot…
(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Sales 7,735 8,271 6.9% 23,854 24,000 0.6%
Expenditure 6,461 6,680 3.4% 20,501 18,447 -10.0%
Operating profit (EBDITA) 1,274 1,591 24.9% 3,353 5,553 65.6%
Operating profit margin (%) 16.5% 19.2%   14.1% 23.1%  
Other income 498 222 -55.4% 1,860 764 -58.9%
Depreciation 428 583 36.2% 1,221 1,698 39.1%
Profit before tax 1,344 1,230 -8.5% 3,992 4,619 15.7%
Extraordinary items 941 679 -27.8% (24) 683  
Tax 476 486 2.1% 1,014 1,730 70.6%
Profit after tax/(loss) 1,809 1,423 -21.3% 2,954 3,572 20.9%
Net profit margin (%) 23.4% 17.2%   12.4% 14.9%  
No. of shares 285.0 285.0   285.0 285.0  
Diluted earnings per share* (Rs) 25.4 20.0   13.8 16.7  
P/E ratio (x)         13.0  
(* annualised)            

What is the company's business?
VSNL is India's largest ILD services provider and was incorporated in 1986 under the Indian Companies Act, 1956 to take over the activities of the erstwhile Overseas Communication Services (OCS). In February 2002, the Government of India divested 26% of VSNL's equity to the Tata Group that now has the management control. Being the pioneer of Internet services in the country, VSNL provides international telecommunication services, directly and indirectly, linking the domestic telecommunications network to approximately 237 territories worldwide. The company operates a network of earth stations, switches, submarine cable systems and value added service nodes to provide international telephony (87% of revenues), telex and telegraph services. The company has also started its DLD (domestic long distance) and broadband services in the country.

What has driven performance in 3QFY05?
Non-ILD services save the day:  Growth in VSNL's non-ILD businesses, viz. domestic long-distance, broadband and other integrated telecom services for corporates have helped the company report a 7% YoY growth in topline in 3QFY05. This is when the company's chief revenue generator, the ILD and related services business (73% of revenues) has witnessed a fall in revenues on a YoY basis. These performances are indicative of the restructuring exercise that VSNL has undertaken in order to reduce its dependence on the ILD segment where the company had a monopoly till the government opened the segment to private competition in the year 2002. The segment has, since then, contributed lower to VSNL's total revenues (see adjoining chart). VSNL provides most of its other services like broadband, Internet services and net telephony under the ‘Tata Indicom' brand, which has held the company in high stead in its initiatives of growing the subscriber base.

Segment-wise details
  3QFY04 % of total 3QFY05 % of total Change
International telephony and related services
Revenue 6,691 86.5% 6,035 73.0% -9.8%
PBIT 1,485 67.9% 1,604 52.8% 8.0%
PBIT margin 22.2%   26.6%    
Other services
Revenue 1,044 13.5% 2,236 27.0% 114.2%
PBIT 701 32.1% 1,436 47.2% 104.9%
PBIT margin 67.1%   64.2%    

In its initiatives to grow strongly in the end-to-end telecommunications space, VSNL acquired Tyco's global network of submarine cables for a consideration of US$ 130 m. This is one of the world's most advanced and extensive submarine cable systems and would give VSNL control over a network that covers 3 continents and spans about 60,000 kilometers (kms). This acquisition of Tyco, along with the 3,175 kms submarine cable that VSNL has launched connecting India with Singapore, is likely to help it take a step further in its initiatives of becoming an integrated telecom services provider.

Lower network costs aid margin expansion:  Apart from effecting a growth in revenue in 3QFY05, the strong growth in the other services segment has also helped the company in reporting improved operating margins for 3QFY05. This is because this segment has a better profitability profile than ILD where the company has witnessed tough competition from other private players. The table above clearly indicates that the other services segment earns PBIT margins almost three times that of the ILD segment. On an overall basis, a sharp decline in network costs (as a percentage of sales) has helped in the expansion of margins in 3QFY05.

Cost details
  3QFY04 % of sales 3QFY05 % of sales
Network Cost 5,766 74.5% 5,359 64.8%
Operating and other expenses 462 6.0% 908 11.0%
Staff costs 233 3.0% 413 5.0%

Lower other income mar profit growth:  Despite a decent YoY topline growth in 3QFY05, profits have declined owing to a fall in other income and higher depreciation expenses. For the nine-month period, a robust improvement in profitability at the operating stage has led to a much stronger growth in net profits in relation to the flat topline growth.

What to expect?
At the current price of Rs 218, the stock is trading at a price to earnings multiple of 13.0 times annualised 9mFY05 earnings. VSNL has shown a marked improvement in its financial performance over the past few quarters, riding the success of its broadband and enterprise service businesses. As far as the company's ILD business is concerned, we believe that the worst regarding tariffs may be over. From here on, we believe that volumes are likely to drive the company's topline, as tariffs remain stable. However, the risk profile of the stock remains high considering the fact that the company's business model is still in the (re)evolution stage. Investors should, thus practice caution.

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