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Vocus Communications 2014 Results: What James Spenceley had to say...

2014-08-28T04:17:06+00:00

Less than 2 hours ago, I was lucky enough to be able to tune in to the Vocus Communications Limited (ASX:VOC) results presentation while waiting for a flight in Los Angeles. A basic perusal of the press release would tell you that underlying NPAT was up by 53% to $13.6 million revenue was up 38% to $92.3 million.

CEO James Spenceley provided analysts with a little more detail when he presented the annual results this morning.

Importantly, on of the biggest changes is that Mr Spenceley now predicts that capex will remain roughly flat in the coming year. This is because the company sees "lots of opportunities," and as a result, Mr Spenceley believes that "artificially constraining capex would be a mistake."

Indeed, Mre Spenceley was "excited" to report that the company produced free cash flow of $9.2 million in 2014, even after the impact of growth capex. If the company stopped spending on growth, free cash flow would skyrocket to well over $25 million. I think Mr Spenceley said that "maintenance capex" was $3 million - $4 million per year, although I couldn't hear him clearly (the connection was a bit funny).

Vocus has four business segments, and an analysis of the company requires at least a glance at each of them:

Internet

Revenues were up a whopping 38% to $37.5 million, but the really good news was that the steadily reducing margins are beginning to stabilise. Interestingly, the company has begun to compete with its wholesale clients, albeit in only around 50 buildings. According to Mr Spenceley, "we’ll allow the wholesale client to compete and compete effectively."

Voice

Voice revenues declined by 16%. Vocus mainly offers voice as part of a product bundle and this is the least important segment.

Fibre and Ethernet

This division is the most important one because it provides the sustainable competitive advantage. Pleasingly, the revenue was up over 87% to $28.2 million. This division is to be bolstered by the acquisition of FX Networks in New Zealand. It is important understand that FX Networks has relatively low yield because the network has not been properly leveraged. A company like Vocus leverages a network by making it as dense as possible - think about the number of buildings connected in a given street, and the number of offices connected in a given building. Many value investors might otherwise think the price paid for FX was too high.

The company connected 407 new buildings to the fibre network, and is expanding outside of CBDs where economical to do so - for example they now have fibre running to Parramatta. Many of the 1048 buildings now connected have tenants who are not using Vocus fibre - and it is hoped that targeted marketing spend will result in many of these tenants joining the network at relatively low incremental cost to Vocus.

Data Centre

Data Centre revenue was up 19% to $18.6 million. Mr Spenceley noted that they expect further revenue growth from the Auckland and Melbourne data centres, and I was chuffed to hear that they are expanding one of the centres by removing the reception area. After all, data centres don't need a reception and that shows the company is serious about making the most of every dollar spent. Generally speaking, data centre purchases make sense because they allow Vocus to cross-sell other products. At least, that has been the experience in the past.

Finally,

The company is changing its marketing strategy. It aims to build its brand and "become a household name in corporate Australia." Ideally, this will reduce the cost of sales and improve the yield from existing assets.

The author owns shares in Vocus. The purpose of this blog is to document my thoughts on different companies in an easily accessible way and to make connections with likeminded investors. Subscribers to the Free Newsletter get sent research first, and have access to the Hidden Research.

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Vocus Communications Added to Hypothetical Ethical Share Portfolio (ASX: VOC)

2014-02-26T23:20:57+00:00

Vocus Communications Limited (ASX: VOC) has pulled the annoying stunt of releasing its results 15 minutes before the market opened. I've had a quick look at the report, and decided to add the company to the Hypothetical Ethical Share Portfolio at the last traded price of $3.52 (at the time of writing). [Edit: buy price will be $3.70 or closing price today... see comments below]. [2nd Edit: whoops I added it at $3.77 instead]

I regret not adding Vocus to the Hypothetical Portfolio at $3.10, where it traded just weeks ago. This is especially true because I bought shares in my own portfolio at those prices. That's life I guess.

I don't have time to write up the report (indeed, I've only scanned the numbers myself). However, the thesis expressed in this stock research on Vocus Communications holds. In fact, due to the growth in fibre revenues, I'd say that the moat is widening.

Here are my notes on the half yearly. The numbers are approximate, and the comparisons are with the immediately prior period (2H 2013). I don't believe the company is notably cyclical, so I don't care for prior corresponding period comparisons.

Vocus 1H 2014

Fibre and Ethernet Revenue growth of over 40% from $9.5 million to $13.2 million - slightly exceeds expectation

Data Centre from $8 million to $9.2 million growth of about 15% - meets expectations

Voice from $4.5 million to $3.8 million: contraction of 15% - under performs expectations

Internet from $14.5 million to $17.8 million growth of 22% - really exceeds expectations

Other observations: Capital Expenditure higher than expected. Depreciation and Administration were significant($9 million together) - capable of explaining the deficit between profit and cashflow. Cashflow up strongly for the half, to $13 million.

While depreciation and amortisation is real, I believe that much of the network equipment will outlast its depreciation period of 5 -30 years. Also, the Voice segment is the least important segment, so if any area can under-perform without breaking the thesis, then that's it.

The Author owns shares in Vocus Communications. Nothing on this website is advice, ever. The purpose of this blog is to keep track of my decisions and invite feedback

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Vocus Communications is a good long term investment (ASX: VOC)

2013-11-13T04:42:12+00:00

Introduction to Vocus Communications (ASX: VOC)

Vocus Communications is one of the more attractive companies trading on the ASX, and it’s the company that I have held longest in my portfolio. Earlier this year, the shares were trading under $1.70, at an apparent discount compared to Amcom Telecommunications, which also owns a fibre network and data centres. Surprisingly, even after the company released their preliminary results, I was able to double my holding at about $2.30. At the current price of $3, I still think Vocus offers good value for long-term shareholders, and I have no intention of selling at this price.

The CEO, James Spenceley previously build Comindico, which is now part of TPG Telecom (ASX: TPM). Asides from not hurting anybody, Vocus does demonstrate a 'coporate conscience,' having matched donations to the Red Cross Bushfire appeal in January 2013. Vocus is also a member of the charitable Telco Together Foundation.

Vocus Revenue Streams

The Internet revenue stream ($27 million in FY 2013) basically involves the re-selling of capacity on an undersea cable connecting Singapore, Hong Kong, Australia, NZ and the US. Vocus is an attractive wholesaler, because it is not Telstra, and does not compete for retail customers. It therefore makes sense to for providers such as M2 Telecommunications (ASX: MTU) to consider using Vocus’s capacity. It's worth noting that TPG Telecom owns Pipe Networks, which is the main competing cable.

Vocus has an Indefeasible Right of Use, and has recently increased its capacity. While revenues are growing, there is increasing competition in this business, and it seems likely new cables will be built within the next 5 years. This was the founding revenue stream of the company, but it is likely to become less profitable over time. The liability is in $US, so Vocus suffers from a falling $A.

The Voice revenue steam ($8.7 million in FY 2013) is the smallest revenue stream and is actually shrinking. Strategically it may not make the most sense to be in this business, as margins are falling and the company may be competing with some of its wholesale clients. However, it is important Vocus has a voice offering for its enterprise clients.

The Fibre and Ethernet revenue stream ($15 million in FY 2013), is by far the most important, because this is where Vocus has a competitive edge. Vocus can offer “dark fibre” to clients. This gives their internet connection maximum speed and maximum security. In the latest Annual Report, the company said “we have signed up substantial clients across the media, finance, mining and insurance sectors; and have important sales momentum heading into FY 2014.”

Importantly, the Vocus Network encompasses all the major metro areas in Australia, so it is able to serve big enterprise effectively. It can connect different offices directly with the data centre. Vocus had 651 buildings connected when they last reported. A possible competitor in this business is TPG Telecom, which has 1600 buildings connected to its fibre network, and also offers dark fibre. However, TPG seems to be focussed on the residential market, and Vocus appears to have the most compelling offering for big business.

The Data Centre revenue ($15.6 million) is linked to the fibre revenue, because a company that has a dark fibre contract with Vocus is likely to also want a Vocus data centre. This is just practical so that the company doesn’t have to deal with multiple suppliers. Data centre space is a commoditised product, but Vocus can cross-sell data space due to its fibre offering, which provides a moat. Together the fibre and data centre revenue streams make up 46% of the company’s revenue. This figure is sure to grow.

Vocus has a high rate of return on investment

The flagship Data Centre at 530 Collins Street, Melbourne is expected to go live in Q2 2014. this state of the art facility is an important milestone for the company being the first Data Centre built by Vocus. The company reports strong pre-sale demand, as the quality of the facility makes it the logical choice to pair with other Melbourne Data Centres. Spenceley has said that "After carrying the operating costs of the facility during Fy2013," he is "particularly pleased to see it launch."

At this early stage, Vocus has generated $45 million on capital expenditure of $65 million. This represents about 70c back for every $1 spent. Taking Cashflow from 2010 as the start, Vocus has grown cashflow by $15 million on Capital Expenditure of $64 million (namely, at 23% of capital expenditure.) This is a 6 year snapshot reasonably early in Vocus’s development. Amcom Telecommunications (ASX: AMM) has a similar business model to Vocus, but has operated for a longer period of time. Vocus compares favourably to Amcom, in my view.

	Years	Operating Cashflow back per $1 Capex	Increase in Operating Cashflow as a % of Capex
VOC	2008-2013	70c	23.60%
AMM	2003-2008	49c	17.70%
AMM	2006-2011	72c	14.50%
AMM	2007-2012	85c	14.30%

Vocus Investment Thesis

The investment thesis for investing in Vocus relies particularly on the continued growth of Fibre revenue. This is at the core of the thesis because this is the high margin business. Importantly, this is also the competitive edge that assists Vocus in cross selling its other services, in particular, allowing it to fill its data centres at rates the competition must envy.

Vocus fibre is at 9% capacity on average. However, that does not mean it can increase its customers by a factor of 10 without substantial ongoing investment. Vocus uses single mode fibre of 312 strands. It is clear that single mode is the best choice (by far) for telecommunications. However, it does have its limitations compared to multimode: Only a single light wave can be transmitted at a given time.

Therefore, 9% utilisation would imply on average 28 of 312 strands are being used. While this allows plenty of growth, it is possible that certain runs of fibre have much higher utilisation, while others lag behind. For example, one connection may have only 10 strands used, while another connection could be utilizing 100 strands.

Vocus doesn’t currently face intense competition. If a competitor started replicating Vocus’s assets, that would be a major cause for concern. Further, if TPG Telecom started to aggressively market dark fibre connections to corporate customers, that would probably hurt Vocus. However, as long as Vocus keeps winning fibre customers, it is very likely earn excellent returns for shareholders. The key metrics to watch are the number of buildings connected, and the fibre and data revenues. The most important qualitative factor to monitor is competition (which would reduce margins).

Is Vocus worth $3 per share?

Based on a starting free cashflow of about $13 million, and assuming continued growth, I believe Vocus is a decent investment at the current prices of $2.90 - $3.10.

On average, over the next 10 years, I expect Vocus to grow profits at over 10% per annum. I expect profit growth of at least 15% in FY 2014. The Melbourne data-centre, which was a drag on the company in FY 2013, should be operational by now, and it will make its first contribution this year. If Vocus is able to continue to gain customers for its fibre business, I believe 15% profit growth is readily attainable, and the company may well exceed that figure.

Over the long term, I believe current buyers will make a good return. However, the market continued to offer Vocus shares at around $2.30 well after the most recent results had been released. This suggests to me that there may well be better opportunities to buy the shares in the future, as existing shareholders take profits. Personally, I will be looking at the company's results as soon as they are released, and will be ready to buy shares if, once again, value is on offer. With the market capitalisation approaching $250 million, I expect that Vocus is about to receive more attention from institutions and brokers. The bottom line: I'm not selling my Vocus shares, despite the fact that they have almost doubled since I first bought them. I'd be more likely to buy more.
The Author owns shares in Vocus Communications. Nothing on this website is advice, ever. This post is for entertainment (and for my own reference!)

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