Vocus Communications – Focused and growing at optic fibre speeds

Vocus Communications Limited (ASX: VOC) announced on 2nd February 2012, its expected results for the first half of FY2012. Expected…

Vocus Communications Limited (ASX: VOC) announced on 2nd February 2012, its expected results for the first half of FY2012. Expected revenues are $21.9m up 57% from previous corresponding period, EBITDA (excluding foreign exchange differences) expected to be between $7.5m and $7.6m, up 63%.

The company also reported that it had no bank debt and cash in the bank of close to $5m.

The company

Vocus is a wholesale telecommunications provider of internet connectivity, data centres and dark fibre to telecommunications companies and ISPs across Australia, New Zealand, Singapore and the US. Its main asset is leased capacity on the Southern Cross cable network between Australia, New Zealand and the USA. This network currently provides the fastest, most direct and most secure international bandwidth from Australasia to the US.

The company has diversified into complementary services such as dark fibre services and data centres. Dark Fibre refers to unused optical fibres. For companies seeking super-fast internet & communication speeds, it makes sense to lease your own fibre.  Vocus Fibre now connects 14 major data centres and is within easy reach of every CBD building in Sydney and Melbourne.

Data Centres

Source: Data Centres 2011 Vocus presentation

Data Centres are sites designed and equipped to handle large amounts of computing hardware and throughput with backup power supplies and a high degree of security. Demand has increased so much, Vocus’s primary Melbourne Data Centre is full, Sydney is 69% full and Perth is 80% full. Vocus is in the process of securing more sites to provide as data centres in all three cities. Vocus’s services are particularly well suited to major ISPs, Web hosting companies and mobile phone providers including companies such as M2 Telecommuncations (ASX: MTU), iiNet Limited (ASX: IIN), TPG Telecom Limited (ASX: TPM), BigAir Group Limited (ASX: BGL)  and the Australian and New Zealand based arms of Vodafone (LON: VOD), Primus Telecommunications (NYSE: PTGI) and Yahoo! Inc. (NASDAQ: YHOO).

Why Invest?
Vocus is one of the largest providers of wholesale internet in Australia and New Zealand. It’s currently overlooked and not covered by any of the major broker analysts. It’s also cheap, trading on a forward PE of 10 (according to my forecasts), based on a conservative forecast. This is a growth company that’s going through a rapid expansion phase. Earnings per share is not likely to be much higher in 2012, mainly due to an increase in the number of shares issued, but don’t let that put you off.

In the last 12 months, Vocus’s share price has risen 29% versus the S&P/ASX200 index fall of 12%. Its 52 week high was $3.10.

Source: Vocus Presentation 2011

Internet traffic is growing. Vocus experienced 128% growth in traffic in FY2011. As you can see from the chart right, demand is forecast to skyrocket.

More and more activity is done “in the cloud”, and Vocus is perfectly positioned for it with integrated data centres, dark fibre and internet connectivity. Hardly any of its competitors offer the same integrated services.

The NBN will be positive for Vocus, thanks to an expected increase in demand for internet content (high definition video, games, streaming music & podcasts etc.), the majority of which comes from the US.

Most of its contracts are 36-60 months long, giving it annuity style revenues.

Management have a decent stake in the company, with CEO, James Spenceley holding 7m shares (12%) of the company alone.

Financials and Valuation

Source: Company Reports

The company only listed in Jul 2010, so financials are not comprehensive. However, net profit growth in its first 2 years has averaged more than 100%, earnings per share grew 93% from FY2010 to FY2011, operating cash flow increased 96% and revenues increased by 77%.

Return on Equity for 2011 was 37%, which is impressive, and net profit margin in 2011 was also impressive at 23.6%,. The company has no debt as at 31 December 2011.

FY2012 financials certainly won’t be as impressive, thanks to the current number of shares on issue now (approximately 60m), and the increased spend on acquisitions in the last year or so. However, the company expects dark fibre to contribute positive earnings in the 2nd half of FY2012. My conservative forecast is for FY 2012 Net Profit to be around $10m (excluding FX gains or losses), resulting in earning per share of around 16 cents. This would place the company on an undemanding PE of 10. Given the potential growth of this company, that appears to be cheap. The company doesn’t yet pay dividends, although that is likely to change in future. My worst case valuation is $2.00, so there’s a fairly large margin of safety on offer.

Risks and when we’d Sell

Competing Cable link to the US: Pacific Fibre announced in July 2011 that a contract had been awarded to build a new sub-sea cable linking Australasia with mainland US, and running at much higher current capacity than the Southern Cross cable currently used by Vocus. The new cable system is expected to be launched in early 2014. Vocus may need to lease capacity on the new Pacific Fibre Cable system to provide the level of services demanded by clients.

Vocus has recorded $22.3m as future liabilities due to rights associated with its contract with Southern Cross Cable, payable over the next five years. Southern Cross Cable has estimated that its cable network has 12 years remaining of its useful life, however continuous upgrades may mean it will extend its competitiveness & longevity.

The other risk Vocus faces is that in FY2011, 15% of its revenues came from one customer (most likely culprit is Vodaphone NZ). If Vocus lost that customer, that’s a significant loss of revenues. Although Vocus has more than 300 customers, we’d like to see the revenues more evenly split to negate that risk.

I would sell when the price increased way above our valuation and if we couldn’t justify the current price.

The Foolish bottom line
Vocus certainly deserves a closer look, as I expect the 2nd half of FY2012 financial performance to be much better than the first half. Having a handhold on the internet data pipe from Australia to the US is definitely worth a fair bit now and likely a lot in future, especially with the increasing demand for internet content likely to continue for years to come.

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More reading

Motley Fool contributor Mike King owns shares in Vocus. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Click here to be enlightened by The Motley Fool’s disclosure policy.

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