One of the difficult things about the way Vocus Communications Limited (ASX: VOC) reports is that it often reports prior corresponding period numbers by way of comparison. This is unhelpful, because Vocus earns a great deal of recurring revenue, and its business is not cyclical in a traditional sense. While telecommunications companies often experience cyclical margin compression and expansion, I find it easier to gauge growth based on the immediately preceding half. So let's take a look at how the company's various segments are doing, compared to the second half of 2013.
Internet Revenue grew from $14.38 million to $17.8 million, a gain of 23.7%. I had not expected such a significant revenue gain in this segment. I expect margin compression due to competition in this segment, but it is pleasing to see that the company has been successful in growing both the amount of internet traffic and revenue in this segment.
Voice revenue went from $4.43 million to $3.9 million, a decline of 11.9%. This is greater than the decline from the prior corresponding period. Voice is the least important segment for Vocus, but it is important that the company can offer voice services as part of a product bundle.
Data Centre revenue grew from $8.1 million to $9.2 million from the second half of FY 2013, growth of 13.5%. This was about in line with expectations, as the company began to fill its new data centre in Melbourne. Data Centre revenue is very important to the company, and I am expecting growth of around 10% per half for a couple more halves, at least.
The most important segment for Vocus is the Fibre and Ethernet segment. Vocus does have a couple of competitors in this space, the main ones being Amcom Telecommunications Limited (ASX: AMM) and TPG Telecom Ltd (ASX: TPM). It doesn't (usually) make much sense for competitors to lay cables where the others already have cables, so there is somewhat of a land grab ensuing as the companies roll out their dark fibre offerings to different areas. The larger network Vocus can build (as long as it is to areas of high demand) the wider its business moat becomes.
Fibre and Ethernet revenue grew from $9.3 million to $13.2 million, an increase of over 41%, a splendiferous improvement on the preceding half, that exceeded my lofty expectations. This bodes particularly well for the long term, as fibre network utilisation still sits below 11%. One day, I think it is likely that this figure will be substantially higher, if demand for superfast, ultra secure fibre optic internet continues to grow. If you don't think that will happen, steer clear of Vocus.
Both Administration and Depreciation expenses were higher than I had expected. It's a pity to see admin expenses continue to rise, but the depreciation expense is far less of a worry. The Vocus network components are being depreciated over 5 – 30 years. However, I honestly believe that much of the network will have significant value for far more than 30 years.
One slightly negative piece of news was a reduction in customer numbers. In June 2013, the company reported that it had 1,157 customers. By the end of December, this number had shrunk to 1,126. Although this is not a substantial decline, this is one metric to keep an eye on. It seems possible that this may be linked to the decline in Voice revenue. I wonder if the company saw an increase or decline in fibre and data centre customers.
Perhaps the most pleasing aspect of the result was the strong growth in operating cashflow: over $13 million for the half. Surprisingly, capital expenditure was higher than the company had expected, at almost $16 million. It seems likely that this is partially a consequence of higher than expected demand for fibre optic connections forcing the company to upgrade those parts of the network that see the most traffic. While the average network utilisation is around 11%, some parts of the network are clearly more heavily utilised than others, at any given time.
Foolish takeaway
Given that various governments have proven hilariously incapable of implementing a coherent fibre optic broadband policy, it appears likely that demand for private fibre will remain strong in the coming years. In my view the chief beneficiaries of this trend will be Vocus, Amcom and TPG Telecom.
Of these companies, I find Vocus the most attractive option at current prices. This is because I believe demand (in the long term) will be strongest in the CBDs of Sydney and Melbourne, where Vocus appears to have a strong offering. I consider Vocus a reasonable long-term investment at the current price of $3.77.
