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|
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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