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VSNL: Call waiting! - Views on News from Equitymaster

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VSNL: Call waiting!

Jul 31, 2006

Performance summary
International long-distance telephony and bandwidth major, VSNL, announced poor standalone results for the first quarter of FY07 late last Saturday. While revenues have grown at a marginal rate of 1% YoY, net profits have witnessed a decline, mainly due to the sharp contraction in operating margins and lower other income. Pressure on margins was on the back of higher network and staff costs. The company has not released its consolidated numbers for the quarter.

Standalone financial performance: A snapshot…
(Rs m) 1QFY06 1QFY07 Change
Sales 9,150 9,240 1.0%
Expenditure 6,670 7,110 6.6%
Operating profit (EBDIT) 2,480 2,130 -14.1%
Operating profit margin (%) 27.1% 23.1%  
Other income 290 270 -6.9%
Interest - 10  
Depreciation 800 1,050 31.3%
Profit before tax 1,970 1,340 -32.0%
Extraordinary income/(expense) - (30)  
Tax 700 430 -38.6%
Profit after tax/(loss) 1,270 880 -30.7%
Net profit margin (%) 13.9% 9.5%  
No. of shares 285.0 285.0  
Diluted Earnings per share (Rs)*   15.5  
P/E ratio (x)*   23.5  
*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, telegraph and Internet services. The company also operates DLD (domestic long distance) and broadband services in the country.

What has driven performance in 1QFY07?
Other businesses save topline: VSNL’s other businesses, which include the national long distance (NLD) and Internet, saved the blushes for the company during 1QFY07, by showing a revenue growth of 28% YoY. However, since these businesses’ contribution to total revenues was still low at 11%, the impact on the overall topline was marginal. The company’s wholesale voice (international long distance, or ILD) business grew revenues by 5% YoY and contributed to around 58% of the company’s total sales during the quarter. While the company has not detailed out the performance of the ILD segment in terms of volumes and realisations, we believe it was more a result of growth in the former (paid minutes). This is because, in line with the overall market, realisations for companies like VSNL are on a decline due to excess capacity and competitive reasons.

Segment-wise performance
  1QFY06 1QFY07 Change
Wholesale Voice (ILD)
Revenue 5,140 5,380 4.7%
% of total revenues 56.2% 58.2%  
EBIT margin 19.8% 23.6%  
Enterprise & Carrier Data      
Revenue 3,210 2,840 -11.5%
% of total revenues 35.1% 30.7%  
EBIT margin 84.1% 74.6%  
Revenue 800 1,020 27.5%
% of total revenues 8.7% 11.0%  
EBIT margin 25.0% 19.6%  
Revenue 9,150 9,240  
EBIT margin 42.8% 38.9%  

The biggest ‘thorn in the bush’ for VSNL during 1QFY07 was, however, the Enterprise & Carrier Data (ECD) business, which reported revenue decline of 4% YoY. This business includes revenues from Internet leased lines and international and national private leased circuits. While the increasing need for faster and uninterrupted communication and consequently demand of bandwidth from companies across sectors has led to growth of this segment in the past, the poor performance during the quarter seems a blip. However, the fact that the ECD segment contributes to over 30% of VSNL’s total sales, any pressure on the same is bound to affect the overall performance of the company.

ECD dent to margins: Apart from inflicting much pressure on the topline, significantly lower PBIT margins for the ECD division also affected VSNL on the profitability front. This is because, against 30% share in revenues, the ECD business contributes to a much larger 59% of the company’s total PBIT. Pressure on the company’s NLD and Internet businesses has also dented the overall profitability during the quarter. The ILD business, though, provided some respite with margins expanding by 380 basis points (3.8%) to 23.6% during 1QFY07. Based on cost heads, higher network and staff costs dented operating margins during the quarter.

Cost details
(Rs m) 1QFY06 % of sales 1QFY07 % of sales
Network Cost 5,010 54.8% 5,360 58.0%
Operating and other expenses 1,200 13.1% 1,160 12.6%
Staff costs 460 5.0% 590 6.4%

All falls to the bottomline: Lacklustre topline performance and contraction in operating margins has led to VSNL reporting a 31% YoY decline in its net profits during 1QFY07. Lower other income has also played its part in suppressing the bottomline.

What to expect?
At the current price of Rs 364, the stock is trading at a price to earnings multiple of 23.5 times its trailing 12-months standalone earnings. This quarter seems a blip in VSNL’s path to improved performance by way of business restructuring and inorganic growth. Also, considering integration issues that have arisen so often in following an inorganic growth strategy, we shall look at the company’s growth with utmost caution. As far as the ILD business is concerned, volumes shall continue to drive growth in the future.

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