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I am an Australian value investor. I have gone to full time investing this year (2012) at age 36 and am passionate about helping other Aussie investors succeed. My website is www.edgeseven.com.au
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Edge Seven Pty Ltd
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Edge Seven Value Investing
  • ASX: VOC - Vocus Communications Limited 0 comments
    Jul 9, 2012 12:15 AM

    Is Vocus experiencing growing pains?

    Vocus is a wholesale telecommunications provider of internet connectivity, data centers and dark fibre to telecommunications companies and Internet Service Providers (ISPs) across Australia, New Zealand, Singapore and the US. The heart of the Vocus business is its main asset which is leased capacity on the Southern Cross cable network between Australia, New Zealand and the USA. This network is currently the fastest and most secure international bandwidth from Australasia to the US.

    To explain further, Telstra and Optus have their own internet connectivity infrastructure in place. However, most other ISPs need to access cable network infrastructure via a company like Vocus. Vocus is the largest provider of wholesale connectivity to other ISPs. Vocus' customers are ISPs like Vodafone, iinet and Macquarie Telecom who compete with Telstra and Optus.

    Vocus has pursued an aggressive growth strategy in recent years by acquiring Data Centres and Dark Fibre services.

    The Dark Fibre services connect major data centers in Sydney, Melbourne and Brisbane CBD and metro areas. The dark fibre services essentially provide super-fast internet and voice communication to companies who lease dark fibre space from Vocus.

    Vocus' expansion into owning and operating data centers is as a result of seeing an increase in data storage and data security needs by corporate customers. Due to a trend towards storing data via cloud computing, demand for data centre space is growing at astronomical rates.

    Does this business have a sustainable competitive advantage?

    Vocus' sustainable competitive advantage comes from its leased capacity on the Southern Cross cable network between Australia, New Zealand and the USA. This lease is known as an Indefeasible Right of Use (IRU) on the Southern Cross Cable network.

    In September 2011, Vocus took on a lease to double its capacity to meet increased demand.

    The IRU means that Vocus receives an ongoing revenue stream from their ISP clients such as Vodafone, iinet and Macquarie Telecom. So, effectively, every time you use internet date by downloading something or accessing facebook or twitter, you pay your ISP based on your internet plan. Your ISP then pays Vocus for their capacity on the Southern Cross Cable.

    With internet usage and data levels growing at about 100% each year, the growth and future looks very bright for Vocus.

    Vocus' integrated services provide a point of difference with an integrated offering of internet connectivity, dark fibre services and data centre services. This suite of integrated service offerings to their clients is a source of competitive advantage.

    What are the risks facing this business?

    The biggest risk to Vocus comes from their growth and diversification strategy which is creating significant cash flow issues. Vocus has diversified their revenue streams away from being reliant largely on the international internet revenue. Vocus' revenue breakdown is now approximately:

    • International internet is 46% of revenue
    • Voice is 21% of revenue
    • Data centre and Cloud services is 19% of revenue
    • Dark fibre services is 14% of revenue

    The company's aggressive growth strategy is creating significant cash flow shortages causing the company to regularly come back to the market to raise capital.

    Last week, Vocus announced a capital raising of $22.4 million to "fund existing capital expenditure requirements and provide financial flexibility for future growth". The company went on to say "Vocus continues to consider potential acquisitions that would expand or complement its existing product set".

    It appears a pattern is set that closely correlates the company's negative cash flow with the amount of capital raised. Interestingly, Vocus' cashflow for the first half of FY2012 was negative $11 million.

    Is it likely that their full year result will show a cash shortfall of double the half year amount ie $22 million?

    So, as we know last week, the company went to the market to raise $22.4 million.

    In March 2011, the company announced a capital raising of $15 million to "fund the company's growth strategy and provide working capital"

    In June 2010, the capital raising equaled $12.5 million.

    And, the company had equity contributed of $6.2 million

    So, capital raised since inception totals $56.1 million.

    Interestingly, cash flow for the first half of FY2012 was negative $11 million. Let's assume the full year equals double the half year result ie negative cash flow of $22 million.

    Cash flow for FY2011 was negative $26.2 million.

    Cash flow for FY2010 equaled negative $8.6million.

    Negative cash flow since 2010 = $56.8 million.

    In summary, it appears a correlation exists between capital raised = $56.1 million vs negative cash flow = $56.8 million.

    The risk to the company is what would happen if next time, the market turned off the capital raising tap.

    Is it run by able and trustworthy management?

    Vocus's management have significant ISP/Telco industry experience with their CEO James Spenceley having more than 14 years experience. The company's Chairman David Spence has more than 20 years Telco experience.

    The growth strategy appears to be undertaken without much regard for the cash flow needs of the business. Management seem to be dangling a golden carrot that is fast growth and relying on the generosity of the market to fund their business operations and aspirations in the meantime.

    Vocus is run with a relatively high 68% net debt to equity ratio as of December 2011.

    Is it trading at a bargain price?

    While Vocus' revenue has grown significantly, the company's value has declined each year due to its capital raising diluting the value of each shareholders stake. The company's profitability has also declined in lock step since 2010.

    Rank2011 Actual ValuationToday's Share PriceMargin of Safety2012 Forecast Valuation2013 Forecast Valuation2014 Forecast Valuation
    Silver 3$2.60$1.775.85%$1.88$1.58$1.76

    *Please note that forecast estimates of intrinsic value are subject to change on a daily/weekly basis.

    Summary

    In summary, Vocus is a company in a fast growing segment on the IT/Telco market. It has experienced management who have used their main asset to grow and diversify the revenue of the business. The growing pains are causing the company to continually face cash flow problems. The negative cash flow is leading the company to regularly raise capital which reduces the value of the company for shareholders.

    This article is published by Dean Mico.

    The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person, nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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