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VSNL: On a higher bandwidth! - Views on News from Equitymaster

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VSNL: On a higher bandwidth!
Jun 27, 2006

Performance summary
International long-distance telephony and bandwidth major, VSNL, has announced strong standalone results for the fourth quarter and fiscal ended March 2006. At first glance, while the net profit performance seems gloomy, it must be noted that, excluding the impact of one-time income from sale of assets in FY05, net profits for 4QFY06 and FY06 have actually grown by 406% YoY and 60% YoY respectively. The company has done good to maintain operating margins during the fiscal. For the fourth quarter, operating margins have expanded due to lower network costs. On a consolidated basis, the topline has grown by 38% YoY during FY06.

Standalone financial performance: A snapshot
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Sales 8,786 9,595 9.2% 33,030 37,810 14.5%
Expenditure 6,766 7,267 7.4% 25,339 29,052 14.7%
Operating profit (EBDITA) 2,020 2,328 15.2% 7,691 8,758 13.9%
Operating profit margin (%) 23.0% 24.3%   23.3% 23.2%  
Other income 324 698 115.4% 1,075 2,288 112.8%
Interest 1 16   1 18  
Depreciation 741 1,023 38.1% 2,439 3,594 47.4%
Profit before tax 1,602 1,987 24.0% 6,326 7,434 17.5%
Extraordinary income/(expense) 3,636 (687)   4,214 (567)  
Tax 1,246 185 -85.2% 2,976 2,071 -30.4%
Profit after tax/(loss) 3,992 1,115 -72.1% 7,564 4,796 -36.6%
Net profit margin (%) 45.4% 11.6%   22.9% 12.7%  
No. of shares 285.0 285.0   285.0 285.0  
Diluted earnings per share (Rs)         16.8  
P/E ratio (x)         22.3  
P/E ratio (excluding extraordinary items)         20.0  

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 has also started its DLD (domestic long distance) and broadband services in the country.

What has driven performance in FY06?
Wholesale business leads topline: VSNL’s international long distance (ILD) business has led the topline growth for the company during FY06. In growing revenues at 15.2% YoY during the fiscal, the segment has seen its contribution to total revenues increase marginally. While the company has not detailed out the performance of the segment in terms of volumes and realisations, we believe it is more a result of growth in the former (paid minutes), while the latter witnesses competitive pressure in terms of pricing of voice data.

Segment-wise performance
  4QFY05 4QFY06 Change FY05 FY06 Change
Wholesale Voice (ILD)
Revenue 4,863 5,409 11.2% 18,765 21,626 15.2%
% of total revenues 55.3% 56.4%   56.8% 57.2%  
EBIT margin 20.5% 32.1%   16.5% 21.3%  
Enterprise & Carrier Data
Revenue 3,076 3,108 1.0% 11,170 12,617 13.0%
% of total revenues 35.0% 32.4%   33.8% 33.4%  
EBIT margin 82.4% 78.4%   78.2% 81.3%  
Others
Revenue 847 1,078 27.3% 3,095 3,567 15.3%
% of total revenues 9.6% 11.2%   9.4% 9.4%  
EBIT margin -1.1% 20.4%   20.6% 24.1%  
Total
Revenue 8,786 9,595   33,030 37,810 14.5%
EBIT margin 40.1% 45.8%   37.8% 41.6%  

The second bigger business segment for the company, i.e., Enterprise & Carrier Data (ECD), witnessed 13% YoY growth in revenues during the fiscal. This business includes revenues from Internet leased lines (27% of FY05 ECD revenues) and international and national private leased circuits (61% of FY05 ECD revenues). Growing need for faster and uninterrupted communication and consequently demand of bandwidth from companies across sectors has led to growth of this segment. The company’s other businesses viz., national long distance (NLD) and Internet grew revenues by 15.3% YoY during FY06.

ECD propels EBIT margins: If one were to look at the second table above, there emerges a stark difference between the contribution to VSNL’s ECD business to its topline and profits. While the segment has contributed to just over 33% of the company’s FY06 turnover, its contribution to total EBIT is a whopping 65%. Also, an improvement in its margins from 78.2% in FY05 to 81.3% in FY06 has propelled the overall margins for VSNL. ILD, NLD and Internet businesses have all witnessed margin expansion during FY06. On an overall basis, operating (EBIDTA) margins have almost remained unchanged during the fiscal. While the company has reported increase in its operating and staff expenses, lower network costs (as % of sales) have pared these increases.

Cost details
(Rs m) FY05 % of sales FY06 % of sales
Network Cost 20,031 60.6% 20,959 55.4%
Operating and other expenses 3,895 11.8% 6,002 15.9%
Staff costs 1,413 4.3% 2,091 5.5%

Extraordinary impact on bottomline: During 4QFY05, VSNL had recorded profit of Rs 4.7 bn on sale of its investments in New Skies Satellite N.V. and Intelsat, which had artificially increased the bottomline during that quarter. Now, during 4QFY06, the company has charged a sum of Rs 612 m to its profit and loss account in lieu of write down of certain network assets. This is reflected in a large extraordinary outgo during the quarter, as shown in the first table above. Excluding the extraordinary impact for both FY05 and FY06, the net profit growth for these periods has been 406% YoY and 60% YoY respectively. The company has also gained from higher other income by way of income tax refunds.

Consolidated picture: VSNL completed the acquisition of Teleglobe during February 2006, and as such, two months’ performance of the latter is also included in the consolidated results of VSNL. The consolidated results also include performances of Tyco Global Network (effective July 2005) and VSNL Broadband (formerly Tata Power Broadband; effective November 2005). The fact that Teleglobe, with almost US$ 1 bn in revenues, is in the red has seemingly impacted VSNL’s consolidated performance as well, with its bottomline declining by 56% YoY, even when one excludes the extraordinary impact.

Consolidated performance
(Rs m) FY05 FY06 Change
Sales 33,083 45,624 37.9%
Expenditure 25,743 39,395 53.0%
Operating profit (EBDITA) 7,340 6,229 -15.1%
Operating profit margin (%) 22.2% 13.7%  
Other income 1,051 2,370 125.5%
Interest 12 398  
Depreciation 2,531 4,856 91.9%
Profit before tax 5,848 3,345 -42.8%
Extraordinary income/(expense) 4,214 (567)  
Tax 2,976 2,080 -30.1%
Profit after tax/(loss) 7,086 698 -90.1%
Net profit margin (%) 21.4% 1.5%  
No. of shares 285.0 285.0  
Diluted earnings per share (Rs)   2.4  
P/E ratio (x)   153.5  
P/E ratio (excluding extraordinary items)   84.7  

What to expect?
At the current price of Rs 376, VSNL is trading at a price to earnings multiple of 20.0 times its trailing 12-months standalone earnings (excluding the impact of extraordinary items). The board has recommended a final dividend of Rs 4.5 per share (dividend yield of 1.2%).

VSNL continues on its path of improved performance by way of business restructuring and inorganic growth. After Teleglobe, Tyco and Tata Power Broadband, the company has now acquired Direct Internet Limited (for a consideration of Rs 942 m) and the Internet business of Seven Star Dot Com (for Rs 179 m). Considering integration issues that have arisen so often in acquisitions, we shall look at the latest moves by VSNL with caution. As far as the ILD business is concerned, volumes shall continue to drive growth in the future. Improved profitability of the ECD business, and its consequent impact on the overall profitability of VSNL is a major positive.

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