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VSNL: It’s (not) ringing! - Views on News from Equitymaster
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VSNL: It’s (not) ringing!
Jun 10, 2005

Performance summary
International long-distance telephony major, VSNL, has announced mixed results for the fourth quarter and full-year ended March 2005. For 4QFY05, while revenues have grown by 16% YoY, profits are up a strong 386% YoY mainly due to a large extraordinary income of Rs 4.7 bn on account of profit on sale of its investment in New Skies Satellite N.V. and Intelsat Ltd. For FY05, while revenues have grown by 4% YoY, net profits have almost doubled. However, if one were to remove the effect of the one time extraordinary income, the profits have actually declined by 59% YoY and 13% YoY for 4QFY05 and FY05 respectively. On the operating front, lower network costs have helped the company to expand its margins for both the periods.

Financial performance: A snapshot…
(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Sales 7,783 9,017 15.9% 31,642 33,030 4.4%
Expenditure 6,116 6,994 14.4% 26,340 25,339 -3.8%
Operating profit (EBDITA) 1,667 2,023 21.4% 5,302 7,691 45.1%
Operating profit margin (%) 21.4% 22.4%   16.8% 23.3%  
Other income 349 323 -7.4% 2,069 1,074 -48.1%
Depreciation 503 742 47.5% 1,724 2,439 41.5%
Profit before tax 1,513 1,604 6.0% 5,647 6,326 12.0%
Extraordinary items (49) 3,633   (214) 4,214  
Tax 642 1,245 93.9% 1,656 2,976 79.7%
Profit after tax/(loss) 822 3,992 385.6% 3,777 7,564 100.3%
Net profit margin (%) 10.6% 44.3%   11.9% 22.9%  
No. of shares 285.0 285.0   285.0 285.0  
Diluted earnings per share* (Rs) 11.5 56.0   13.3 26.5  
P/E ratio (x)         8.6  
(* annualised)            

What is the company’s business?
VSNL is India’s largest international long-distance (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, 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 FY05?
Telephony and related services save the day:  The 5% YoY growth in VSNL’s telephony and related services business (98% of revenues), which includes international long distance, domestic long-distance, Internet, broadband and other integrated telecom services for corporates, has helped the company report a 4% YoY growth in topline in FY05. The performance of the ILD business, which had been under tremendous pressure in the past, is however not known. However, we think that VSNL would have further reduced 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. 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. The company’s other services segment also witnessed a 27% YoY decline in revenues during FY05.

Segment-wise details
  FY04 % of total FY05 % of total Change
Telephony and related services
Revenue 30,775 97.3% 32,400 98.1% 5.3%
PBIT 9,829 99.3% 13,099 99.7% 33.3%
PBIT margin 31.9%   40.4%    
Other services
Revenue 867 2.7% 630 1.9% -27.3%
PBIT 73 0.7% 39 0.3% -46.6%
PBIT margin 8.4%   6.2%    
Revenue 31,642   33,030   4.4%
PBIT 9,902   13,138   32.7%
PBIT margin 31.3%   39.8%    

Telephony aids margin expansion as well:  Lower network costs have aided the telephony segment shore up its margins during the fiscal. From the 32% level in FY05, telephony’s PBIT margins have expanded to over 40% in this fiscal. Margins for the other services segment have, however, contracted by 220 basis points to 6.2%. As a matter of fact, network costs have declined from 70% of sales in FY04 to 61% of sales in FY05, thus aiding the overall expansion in operating margins.

One-time income spruce up net profits:  The net profits have almost doubled in FY05. And this has been made possible by a one-time income of Rs 4.7 bn, which the company has recorded as profit on sale of its investment in New Skies Satellite N.V. and Intelsat Ltd. If one were to remove the effect of this extraordinary income and other small one-time items, the profits have actually declined by 59% YoY and 16% YoY respectively for 4QFY05 and FY05.

What to expect?
At the current price of Rs 228, the stock is trading at a price to earnings multiple of 8.6 times FY05 earnings. Excluding the extraordinary effect, the price to earnings valuation comes to around 19.4 times FY05 earnings, which is at the higher end of the valuation spectrum. The board of the company has recommended a dividend of Rs 6 per share (dividend yield of 2.6%). This includes Rs 1.5 as special dividend.

Despite the poor performance on the bottomline front (excluding the extraordinary income), we believe that VSNL has shown a marked improvement in its financial performance over the past few quarters. As far as the company’s ILD business is concerned, we would reiterate that the worst regarding tariffs may be over and that that volumes are likely to drive the company’s topline in the future, as tariffs remain stable.

During the fiscal, 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. 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 in the country.

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