VTL - Vital Telecommunications (formerly Team Talk)

[Snoopy]

The key line in the above cashflow statement is the 'Payments to Suppliers' line. My contention then, is that, during the Covid-19 lock down, and in the months of doubt that followed, the cashflow was saved by not installing new customer equipment for the equivalent of several months. The ceasing of this work had a big effect on 'cash out'. But capital previously spent meant that the existing capital installations(*) were cash cows that kept churning out revenue. Thus capital spending (*) at suppliers stopped, but revenue kept coming. This is my explanation for the dramatic positive change in cashflow at the operational level over FY2020!


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(*) The 'capital installations' and 'capital spending' I am referring to here is what I call 'micro capital spending' on equipment dedicated to one customer that would be recovered from that customer as part of the operational business model. I am not talking about the generally larger spending on networks that service many customers with an indeterminate payback date that I would be class as 'Investment cashflow'.
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If I am correct in reading this situation, then once the FY2021 results are released, the operational cashflow will drop back by at least $5m, confirming we are not in a bold new era of generating large excesses of operational cash.

Well it looks like I called this one wrongly! Updating the operating cashflows.

	FY2016	FY2017	FY2018	FY2019	FY2020	FY2021
Operating Free Cashflow	$8.241m	$7.121m	$7.680m	$7.102m	$13.698m	$13.351m

The Operating Free Cashflow over FY2021 continues to be strong. So let's have a look at the Cashflow Statements for the last three years to try and unpick this.

	FY2021	FY2020	FY2019
Cash flows from Operating Activities
Cash provided from:
Receipts from Customers	$33.094m	$37.197m	$35.865m
Net GST Receipts	($0.114m)	$0.212m	$0.087m
{A}	$32.980m	$37.409m	$35.952m
Cash applied to:
Payments to Suppliers & Employees	$17.798m
Payments to Suppliers		$11.061m	$15.968m
Wages & Salaries		$9.840m	$9.659m
Interest Expense net of Realised FX Gain/Loss	$1.771m	$1.652m	$1.133m
Income Tax Paid	$0.060m	$1.158m	$2.090m
{B}	$19.629m	$23.711m	$28.850m
Net Cashflows from Operating Activities {A}-{B}	$13.351m	$13.698m	$7.102m

When discussing last year's Operating cashflow result I wrote:

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To figure out what has happened we need to step back and think about how this company operates. A new bespoke job will typically involve a large payment up front for hardware, software and installation. This money, plus a profit margin, is recovered by Vital gradually over some years.

From p2 of AR2020 we learn
"Overall, we did see an impact to revenue, and we are experiencing a delay in forecasted orders, with some projects being postponed out to future years."

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I wonder if the reason for the good operating cashflow remains the same (set up costs for new contracts postponed)? Perhaps, when making that AR2020 commentary, they had assumed the RFP contract bid would have been sorted out by now?

Looking at other costs, the suppliers and employees gobbled up $3m less cash over the year (that's good). The income tax cash payment was down a million, although that seems a payment timing issue. The thing that most concerned me about the result was that, although the cashflow is good, the depreciation and amortization is large and real with the wireless assets (wireless assets are not long lived assets like fibre in the ground). Almost all of the welcome new wireless revenue looks to be offset by an equally large increment in depreciation. Meanwhile wired revenue dropped by a million, but the running costs of Vital's 'fixed fibre broadband' wired network barely moved.

Capex is tipped to be $5.3m for FY2022, despite the company announcing that it has completed its own major capital investments. Granted that $5.3m is not 'operating cashflow'. But that figure does show there is considerable demand on redirecting the surplus operating cashflow Vital does have into reinvestment. Does the $5.3m include future investment, assuming an RFP win? In the new 'work from home' era, is there a path back to recover some of that inner city fibre revenue from city offices scaling down or closing? I don't know the answers. I also don't feel the compelling urge to own the shares!

SNOOPY

discl; I am not and have never been a holder

[Snoopy]

I happened to notice that testing for impairment modelling of goodwill has changed (AR2020 p27). Both the discount rate of future earnings of 9.69% ‐ 9.84% (c.f. 2019: 7.37% ‐ 7.71%) and terminal growth rate 1.0% (c.f. 2019: 0.0%) has gone up. However the overall goodwill on the books for both the wired and wireless networks has not changed. This would suggest to me that Vital needed the sales growth into the future to increase above past expectations, in order justify the same amount of goodwill on the books. If this is not happening, we could be looking for a goodwill write-down once the FY2021 accounts are done and dusted. I wonder if the announcement on 15th June 2021 that the Head of Sales and Marketing is to leave, with no indication of what 'the next phase of his career' might be (contrary to the announcement of the Chief Technology Officer leaving in March) is tied in to this sobering profit outlook picture?

Something a little odd going on here to justify the valuation of goodwill on the books. I am looking at note 14 in the FY2021 accounts, and have tabulated the equivalent figures from the previous two years.

	Discount rate of Future Earnings	Terminal Growth Rate	Goodwill on Books EOFY
FY2019	7.37%-7.71%	0%	$17.038m
FY2020	9.69%-9.84%	1%	$17.038m
FY2021	10.23%-10.28%	1%	$17.038m

The actual goodwill on the books hasn't changed. But to justify the goodwill valuation, the discount rate keeps going up! That could mean a couple of things (?).

1/ The modelled earnings power of the assets that contain the goodwill have not changed. But the modelled time needed to achieve the implied earnings power of those assets has been pushed further out into the future - hence the rise in the discount rate.
2/ The modelled earnings power of the assets that contain the goodwill have not changed and neither has the modelled time needed to achieve the implied earnings power of those assets. But in the interim profits are down more than expected. So this means from an 'annual growth ' perspective, the business will have to grow faster than last year to meet the book valuation goal. And because the business will have to grow faster, that introduces more uncertainty into the business model. Hence the increase in discount rate.

Is there any other way to interpret the changes in these figures? Is this confirmation of a 'hope the business improves' strategy? Is hope even a strategy?

SNOOPY

[Snoopy]

A claim from the Chairman and Chief Executive (AR2020 p4) is that of the $9m of capex spent over FY2020, around 80% of that is for new infrastructure (0.8 x$9 + or - $0.5m = $6.8m to $7.6m). This correlates well with the 'Assets under Construction' figure declared in the 'Property Plant & Equipment' note (AR2020 page 25 of $7.578m). So I think I can use this 'Assets Under Construction' figure over the years to get a pretty good idea of how much the 'transformation' of 'Vital', FROM 'analogue radio system' and 'overhead fibre' TO 'digital radio system' and 'underground fibre' has cost.

	FY2016	FY2017	FY2018	FY2019	FY2020	FY2021f	Σ(FY2017 to FY2021)	Average
Assets Under Construction	$5.267m	$3.589m	$5.110m	$8.856m	$7.578m	$3.750m	$28.883m
Sustaining Capex	$0.527m	$1.955m	$0.436m	$0.598m	$1.461m	$3.750m		$1.640m
Total Capex	$5.794m	$5.544m	$5.546m	$9.454m	$9.039m	$7.500m	$37.083m

Note

1/ I have not added the figure for FY2016 to the total. I believe the FY2016 'Assets Under Construction' relate principally to the construction of the 'RT Max' entry level radio network. As such, it does not represent part of the 'big two' ('undergrounding CityLink' and 'National Tier 3 Digital Radio') system upgrades. The undergrounding of Citylink had definitely not started in FY2016. Furthermore there was little investment in the now legacy 'ActionNet' two way radio arm, because it was not clear what technology would replace it. By elimination, the main infrastructure spend over FY2016 must have been on 'RT Max'.
2/ Capex for FY2021 is an estimate (refer AR2020 p4). The expectation is that after FY2021, the major transforming system upgrades will be finished.

Outside of the 'once in a system generation' upgrades, Capex normally relates to individual customer contracts. As such, it is normally recovered from those customers over the length of each supply contract. Such Capex is also 'lumpy', dependent on when new contracts are signed. Why does this matter? Because if the cashflow from any such 'initial investment' will not match the cashflow from the customer that is paying for it, then this means that once the hardware is in place cashflow should be greater than profits. And that offers the potential for paying out 'more than your earnings' as dividends on a sustainable basis. This is the basis for rival wholesale broadband provider Chorus indicating they will look to be paying dividends out of cashflow rather than profits. Nevertheless the publicly stated dividend policy at 'Vital' is to pay out no more that 50-70% of NPAT as dividends (AR2019 p2).

Whenever I read or make forecasts, I usually find it enlightening to go back over the forecast when the actual figures are released. A well known investor on this forum gives merit to companies that "do what they say they will do." So how did Vital square up against this 'dwtstwd' (wow a palindrome, I like it) test?

Here is the full text of what was forecast for FY2021 (from AR2020 p4)

"For the year ending 30 June 2021 Vital is forecasting Capital Expenditure to be around $7.5m with just over 50% of this going towards infrastructure and new services. This year a significant component of capital expenditure is for the St John Ambulance network following on from the contract we signed earlier this year."

"As we move forward into the future financial years, we will see capital expenditure go back to normal levels, with the majority being customer funded."

	FY2016	FY2017	FY2018	FY2019	FY2020	FY2021	Σ(FY2017 to FY2021)	Average
Assets Under Construction	$5.267m	$3.589m	$5.110m	$8.856m	$7.578m	$7.725m	$32.858m
Sustaining Capex	$0.527m	$1.955m	$0.436m	$0.598m	$1.461m	$0.550m		$1.000m
Total Capex	$5.794m	$5.544m	$5.546m	$9.454m	$9.039m	$8.275m	$37.858m

Compared to the forecast (quoted post) Capex for FY2021 is $8.275m/$7.5m = +10.3% over budget

Back in AR2019, the current dividend policy was articulated:
"The policy is that we will pay in the range of 50 – 70% of net profit after tax ensuring the business remains
sustainable and able to make future investments to keep our infrastructure up to date."

Net profit after tax was $0.841m / 41.381m = $0.02cps

From AR2021
"Post 30 June 2021 the Group has declared a fully imputed dividend of $0.02 per share." (100% of NPAT)

I take it from this that the business is now unsustainable and the company lacks the capital for future investments to keep infrastructure up to date?

Meanwhile, Marilyn on the Chorus thread, highlights a press release today highlighting dramatically improved upstream and downstream data speeds for existing plan holders at no extra cost.

https://sp.chorus.co.nz/product-upda...firmed-changes

That sounds like very tough competition for Vital who have traditionally pitched their broadband offering at a slightly higher speed than the former plans from Chorus.

The share price of Vital fell 5.5% today to 69c. That is very close to the March-April 2020 Covid-19 low point.

Yet if it goes below 40c, this hound may yet be interested.

SNOOPY

[financewiz]

Any thoughts on if the Amazon facility being planned for Auckland will be a positive or negative?

[Onion]

The Annual Report is out.

I can't see anything particularly remarkable from a quick read.

Revenue is down but lower finance costs mean a growth in profit.

The next year or so will depend a lot on the outcome of their bid for the Public Safety Network. They say they are well equipped to win the competitive tender process. It is an opportunity for a bit of growth.

[Snoopy]

Vital 'Wired Networks'

Consists of two wholesale fibre communication networks, one around the CBD in Wellington (acquired) and the other around the CBD in Auckland (built in house). The electronics on the end of the fibre have concurrently been updated to produce a more flexible product package range that tops out for maximum speed at 10Gbps (slightly higher than the maximum 8Gbps offered by top line Chorus hyperfibre). 'Citylink' serves business (including Dimension Data and Datacom) and the telecommunications industry (including Spark, Vodaphone and 2 degrees). 'Citylink' also offer cloud based data storage capability to customers in Wellington and Auckland, and provide peering exchanges for ISPs to share data.

Any thoughts on if the Amazon facility being planned for Auckland will be a positive or negative?

I had forgotten that 'Citylink' did their own cloud storage, before looking back at my own post to confirm that they did.

Amazon proposes to spend $7.5billion on their NZ datacentres (although the fine print does say the $7.5 billion was calculated over 15 years, and included the cost of building at least three data centre zones and stocking them with hardware, plus operating costs including utilities and salaries). The total market value of Vital is $28.6m, and the Vital Data Centres would be worth just a fraction of that. This brings into sharp view what a niche player Vital is in 'cloud storage capability'[.

If you look at this Herald article:

https://www.nzherald.co.nz/business/...EB5YJXKIT6S5A/

the overall picture is that Amazon AWS has 50% of the world data storage market. You would think with this kind of market power, Amazon AWS would have the capability to see of the likes of Vital as you or I might slap down a sand-fly that has just landed on our leg. But would Amazon even notice a competitor as small as Vital?

I get the feeling that Vital would supply 'data storage' as part of an overall internet access and connectivity package. My gut feeling is that they won't be affected by the likes of Amazon and Microsoft building giant big data storage centres in Auckland. But I could be wrong.

I found more information on other niche data centre providers here:

https://www.datacentre.co.nz/testimonials/

Feenix Communications?, Quickweb?, Solarix?, Vpscity?, Techday?, Netscope? I can't say I have ever heard of any of them. Are they all scheduled to be executed with the arrival of the Amazon AWS sword? Even Spark is getting into this data storage game! I am a little worried that everyone seems to have decided this is a profitable space to get into. I guess the key to survival for the small guys will be picking just the right niche.

SNOOPY

[Onion]

I had forgotten that 'Citylink' did their own cloud storage, before looking back at my own post to confirm that they did.

I think they offer connectivity to cloud storage, not the storage.

[Snoopy]

The next year or so will depend a lot on the outcome of their bid for the Public Safety Network. They say they are well equipped to win the competitive tender process. It is an opportunity for a bit of growth.

The result of the bidding process is out and Vital were not the successful bidder! This looks to be a disaster unfolding for a highly leveraged company seemingly being outcompeted by others in their core business area of expertise. Share price is down by 19% today so far at 55c. But bidders are only starting to line up at 50c. So more carnage to come.

Vital are putting on a brave face:

"Vital remains open to partnering with the down selected parties to assist in the outcomes that PSN and emergency services require."

But surely Vital must now use whatever cashflows remain (the St John's contract has a few years to run) to urgently pay down debt. I wouldn't be surprised to see the need for a cash issue to shore up the company. Truly a nightmare day for Vital shareholders. Thankfully I am not one of them. But I don't rule out getting on board as a 'white knight' at the right price of course. Sympathy to current holders!

SNOOPY

[Onion]

The next year or so will depend a lot on the outcome of their bid for the Public Safety Network.

It certainly went the wrong way for VTL.

[Onion]

The result of the bidding process is out and Vital were not the successful bidder!

I’m surprised the announcement is not flagged as price sensitive.