• OCTOBER 26, 2004

VSNL: Extraordinary effect

VSNL has reported improved performance in the second quarter of FY05. While the growth in topline has been only marginal, the operating margins have shown a marked improvement. Expansion in margins seems to indicate an improvement in the company's core business. We would also like to point out that though the topline growth has been negligible, it is indeed better than the performance that the company reported during the past two years, when topline had declined on a consistent basis.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Net sales 7,755 7,785 0.4% 16,119 15,729 -2.4%
Expenditure 6,582 6,072 -7.7% 14,040 11,767 -16.2%
Operating profit (EBDITA) 1,173 1,713 46.0% 2,079 3,962 90.6%
Operating profit margin (%) 15.1% 22.0%   12.9% 25.2%  
Other income 463 294 -36.5% 1,362 542 -60.2%
Interest - -   - -  
Depreciation 406 568 39.9% 793 1,115 40.6%
Profit before tax 1,230 1,439 17.0% 2,648 3,389 28.0%
Extraordinary items (578) 2   (965) 4  
Tax 165 560 239.4% 538 1,244 131.2%
Profit after tax/(loss) 487 881 80.9% 1,145 2,149 87.7%
Net profit margin (%) 6.3% 11.3%   7.1% 13.7%  
No. of shares (m) 285.0 285.0   285.0 285.0  
Diluted earnings per share (Rs)* 6.8 12.4   8.0 15.1  
P/E ratio (x)         11.3  
(* annualised)            

India's largest long distance telephony services provider
VSNL was incorporated on April 1, 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 (87% of revenues), telex and telegraph services. The company has also started its DLD (domestic long distance) and brodband services in the country.

What has driven the performance in 2QFY05?
Restructuring paying off: VSNL has embarked on a restructuring exercise which includes the company to increase focus on the DLD, broadband and other integrated services to corporates. This restructuring has been initiated in order to move away from its core international long distance (ILD) services, which have suffered over the last 2-3 years due to the opening up of the sector to competition. In 2QFY05 also, the topline contribution from its international telephony services have taken a beating and revenues have dropped by 17% in this segment. Its other services segment has, however, reported a 107% rise in revenues in the September quarter. This is likely to bode well for the company as the EBIT margins of the latter are much better than its core ILD services revenues. Going forward, we are likely to see further improvement in the company's profitability on account of higher contribution from services like DLD, broadband and other intergated telecom services for corporates. The table below indicates the EBIT margins of the various segments of the company.

Segment-wise performance
  1HFY04 1HFY05 Change
International telephony &
related services
14,094 11,936 -15.3%
EBIT margin* 21.9% 29.1%  
Other services 2,025 3,793 87.3%
EBIT margin* 68.6% 69.2%  
Total 16,119 15,729 -2.4%
EBIT margin* 27.7% 38.7%  
* Before extraordinary income and expenses

Operating margins: The company has been able to significantly improve its operating margins. As the company continues to witness contribution from high margin services, we may see further improvement in its operating margins and consequently its profitability. There has been a significant drop in the company's network costs, while operating and other expenses have shown a jump.

Bottomline performance disappointing, but for extraordinary expenses: Despite just a marginal growth in the topline, the bottomline has surged significantly. However, this is not strictly comparable to the corresponding quarter of FY04 as the company had then borne an extraordinary expense of Rs 568 m on account of its VRS scheme. If one were to discount the extraordinary expense (for VRS) in 2QFY04, the bottomline actually shows a decline of nearly 17%. There are several other factors that have also contributed in limiting the bottomline growth - lower other income, higher depreciation and higher tax outgo.

What to expect?
At the current market price of Rs 170, the stock is trading at a P/E multiple of 13.7 times annualised 2QFY05 earnings. VSNL seems to be making the right moves in order to derisk its revenues and on this account, it seems to be witnessing early success. As far as its core ILD business is concerned, we believe that the worst regarding tarriffs (both settlement and accountaing rates) may be over. From here on, we believe, while the tarriffs may not rise, higher volumes in the segment will help VSNL. The company is also betting big on the broadband market in the country, regarding which the goverment has recently announced its policy. However, we would still like to reiterate that the company's business model is still evolving and to that extent the risk profile of the stock is remains relatively higher.

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