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VSNL: Shifting guards? - Views on News from Equitymaster
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VSNL: Shifting guards?
May 28, 2007

Performance summary
International long-distance telephony and bandwidth major, VSNL, has announced mixed results for the fourth quarter and full year ended March 2007. On a standalone basis, the company has reported 7% YoY growth in topline during FY07. However, on the back of lower other income, higher interest expenses and higher effective tax rate, the bottomline has recorded a 2% YoY decline (adjusting for extraordinary items). For 4QFY07, the topline and bottomline have grown by 13% YoY and 18% YoY respectively. On a consolidated basis, the company has recorded an 89% YoY growth in net sales, while higher interest and tax expenses, as also higher one-time costs, have impacted its net profits (down 78% YoY). The board has recommended a dividend of Rs 4.5 per share (dividend yield of 0.9%).

Standalone financial performance: A snapshot
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Sales 9,595 10,842 13.0% 37,810 40,418 6.9%
Expenditure 7,277 8,444 16.0% 28,942 31,112 7.5%
Operating profit (EBDIT) 2,318 2,399 3.5% 8,868 9,306 4.9%
Operating profit margin (%) 24.2% 22.1%   23.5% 23.0%  
Other income 697 880 26.2% 2,288 2,122 -7.3%
Interest 16 32 99.4% 18 69 283.9%
Depreciation 1,023 1,048 2.4% 3,594 3,913 8.9%
Profit before tax 1,976 2,199 11.3% 7,544 7,445 -1.3%
Extraordinary income/(expense) (676) (117)   (676) (319)  
Tax 186 770 314.4% 2,072 2,441 17.8%
Profit after tax/(loss) 1,114 1,313 17.8% 4,795 4,686 -2.3%
Net profit margin (%) 11.6% 12.1%   12.7% 11.6%  
No. of shares         284.9  
Diluted earnings per share (Rs)         16.4  
Price to earnings ratio (x)         28.0  

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, telegraph and Internet services. The company also operates DLD (domestic long distance) and broadband services in the country.

What has driven performance in FY07?
Volumes drive topline: VSNL’s topline growth during FY07 has largely been a result of volume growth while the company has reduced tariffs on the back of regulatory pressures. As a matter of fact, on a consolidated basis, VSNL’s ILD (international long distance) volumes increased by 8% YoY during the fiscal while the NLD (national long distance) volumes recorded a growth of a whopping 83% YoY. As for the enterprise and carrier data business, a segment where the company plans to increase its focus in the future, standalone sales witnessed a growth of 9% YoY. The ‘Other’ business segment, which includes broadband and Internet services, recorded sales growth of 25% YoY during FY07.

Segment-wise performance (Standalone)
  4QFY06 4QFY07 Change FY06 FY07 Change
Wholesale Voice (ILD)
Revenue 5,409 5,742 6.2% 21,627 22,169 2.5%
% of total revenues 56.4% 53.0%   57.2% 54.8%  
EBIT margin 32.1% 23.1%   21.3% 19.1%  
Enterprise & Carrier Data
Revenue 3,109 3,915 25.9% 12,618 13,807 9.4%
% of total revenues 32.4% 36.1%   33.4% 34.2%  
EBIT margin 78.4% 82.5%   81.3% 82.1%  
Revenue 1,077 1,185 10.0% 3,565 4,443 24.6%
% of total revenues 11.2% 10.9%   9.4% 11.0%  
EBIT margin 20.4% 25.0%   24.2% 33.0%  
Revenue 9,595 10,842 13.0% 37,810 40,418 6.9%
EBIT margin* 20.6% 20.3%   20.0% 18.4%  
* After adjusting for unallocable expenses

Margins (almost) maintained: Lower network costs helped VSNL almost maintain its margins during FY07. However, marginal increases in operating and staff costs led to a small contraction of the same. As for segments, while ILD business margins declined, seemingly on the back of pressure on realisations, those for the enterprise and Internet businesses expanded, led by strong growth in volumes and operating leverage.

Lower other income mar bottomline: VSNL’s other income declined by 7% YoY during FY07, leading to an adverse impact on the company profits, which also bore the brunt of a 284% YoY rise in interest expenses. But for a lower extraordinary expense, the bottomline decline would have been larger during the fiscal.

What to expect?
At the current price of Rs 460, the stock is trading at a multiple of 28 times its FY07 standalone earnings. The management has outlined an aggressive growth plan in its bid to increase share of high margin retail revenues (broadband and enterprise & data business) while further reducing the contribution from low-margin wholesale (ILD & NLD) businesses. The company has planned for a capex of US$ 500 m in FY08, a large portion of which will go towards network expansion.

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