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VSNL: In fourth gear! - Views on News from Equitymaster
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VSNL: In fourth gear!
Feb 1, 2006

Performance summary
International long-distance telephony and bandwidth major, VSNL, announced robust results for the third quarter and nine-month period ended December 2005. Apart from the strong growth in topline for both the periods, the company has reported an expansion in operating margins for 3QFY06. Also, while the bottomline growth seems depressed at first instance, if one were to remove the effect of extraordinary income in the corresponding period of FY05, the picture improves tremendously.

Financial performance: A snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Sales 8,405 9,775 16.3% 24,244 28,215 16.4%
Expenditure 6,708 7,724 15.1% 18,573 21,785 17.3%
Operating profit (EBDITA) 1,697 2,051 20.9% 5,671 6,430 13.4%
Operating profit margin (%) 20.2% 21.0%   23.4% 22.8%  
Other income 217 980 351.6% 751 1,588 111.5%
Depreciation 583 882 51.3% 1,698 2,571 51.4%
Profit before tax 1,331 2,149 61.5% 4,724 5,447 15.3%
Extraordinary items 578 81 -86.0% 578 120 -79.2%
Tax 486 729 50.0% 1,730 1,886 9.0%
Profit after tax/(loss) 1,423 1,501 5.5% 3,572 3,681 3.1%
Net profit margin (%) 16.9% 15.4%   14.7% 13.0%  
No. of shares 285.0 285.0   285.0 285.0  
Diluted earnings per share* (Rs)         26.9  
P/E ratio* (x)         14.4  
* On a trailing 12-months basis            

What is the company’s business?
VSNL is India’s largest international long-distance (ILD) services and bandwidth provider. 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, telex and telegraph and Internet services. The company has also started its DLD (domestic long distance) and broadband services in the country.

What has driven performance in 3QFY06?
Strong growth in the telephony segment: Sustained growth in volumes in all the business segments has seemingly aided VSNL’s topline growth during the quarter. Apart from robust growth in ILD and DLD volumes, those in the Enterprise Data business have also contributed to the overall growth, even as the company faced pressure on bandwidth tariffs. During December 2005, the company clocked over 600 m minutes in its voice services, which is the highest-ever monthly traffic in the company’s history.

The management had indicated in the past that the integration of Tyco and Teleglobe is in progress and the company expects to consolidate these by March 2006. The management has also estimated both these entities to achieve cash break-even by the end of FY07. We expect significant synergies to accrue to VSNL from these acquisitions.

Lower network costs aid margins: An almost 5% drop in network costs (as a % of sales) has helped VSNL improve upon its operating margins during 3QFY06. Other operating and staff costs have, however, witnessed increases, thus paring margins expansion.

Cost details
(Rs m) 3QFY05 % of sales 3QFY06 % of sales
Network Cost 5,257 62.5% 5,597 57.3%
Operating and other expenses 1,094 13.0% 1,600 16.4%
Staff costs 357 4.2% 527 5.4%

Extraordinary impact on bottomline: VSNL had recorded a profit on sale of investment of Rs 578 m during 3QFY05, which had artificially increased the bottomline during that quarter, thus paring the YoY gains for 3QFY06. If one were to remove this effect, the net profit growth for 3QFY06 and 9mFY06 has been 68% YoY and 19% YoY respectively. The bottomline is also aided by substantially higher other income, by way of interest on Income Tax refunds.

What to expect?
At the current price of Rs 388, the stock is trading at a price to earnings multiple of 14.4 times its trailing 12-months earnings. The company has shown a marked improvement in its financial performance over the past few quarters. As far as the ILD business is concerned, we would reiterate that the worst regarding tariffs may be over and that volumes are likely to drive the company’s topline in the future, as tariffs remain stable. Also, with global bandwidth prices under tremendous pressure on account of increased competition and an oversupply situation, the strategy of VSNL to play the volume game shall stand it in good stead going forward.

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