5. FINANCIAL STATEMENT ANALYSIS
5.2 Profitability Analysis
The period of analysis is four years, since a longer period was unfeasible. Since financial ratios are best calculated using average (primo/ultimo) numbers from the balance sheet, this unfortunately leaves only 3 periods. I have chosen to calculate numbers on FY2007 in despite of this, simply by using ultimo numbers only. Clearly, this is not opti‐
mal, however, the little information value, that it may add could turn out important. A grey font marks the ratios affected by this.
5.2.1 Return on Equity
Return on Equity (from here on ROE) reflects the stockholders return on equity from a fully comprehensive viewpoint, i.e. including both operational and financial effects. ROE on group level is calculated as shown in appendix III, equation A III‐II.
In prior fiscal years, there have been minority interests, which means that not all profit has been attributable to the parent company. For formula and example calculation on ROE on parent level see appendix III (Equation A III‐I and II).
86 SKAT. (2011). Selskabsskattesatser i EU landene. Retrived November 2011 from http://www.skm.dk/tal_statistik/skatter_og_afgifter/4607.html
ROE on both group and parent level is depicted in Table 5‐2 along with the underlying components, namely Return on Invested Capital (ROIC from here on), NFE expressed as a percentage (labeled Net Financial Costs), and Financial Leverage.
2007 2008 2009 2010
ROE Group 7,10% 0,03% 6,67% 7,53%
ROE Parent 6,26% -0,45% 6,54% 7,53%
ROIC 5,94% 2,18% 5,39% 5,52%
NFC 5,04% 3,95% 4,33% 3,86%
Leverage 1,28 x 1,22 x 1,22 x 1,21 x
Table 5‐2 Return on Equity and components87
ROE is positive around 6‐7 percent in the period except from FY2008, where it was close to zero on group level and slightly negative after minority interests. From 2009 to 2010 there was an increase of 0,86 percent‐points. In 2010 the minority interests are no longer present, which is why ROE on group and parent level is identical.
Examining the underlying components of ROE will help determining the cause of both level and trend. ROE is also calculated as ROIC plus/minus the spread (difference be‐
tween ROIC and NFC) multiplied by leverage. This basically implies, that ROE, besides depending directly on ROIC, also depends on whether the company generates more re‐
turn on its total invested capital than the cost of debt financing combined with the por‐
tion of invested capital, that is financed by debt. Moreover, when the difference between ROIC and NFC is positive, equity owners benefit from the company financing a portion of its activities through debt.
It appears from the table, that fluctuations in ROIC is the root cause of the dramatic drop. The level of the financial leverage is very stable, while NFC has gone up and down – reaching a level as low as 3,86 percent in 2010. In FY2008 the level of ROIC is below the level of NFC – despite NFC actually being quite low also – and hence, financial lever‐
age has a negative influence on ROE. Minority interests share has a negative effect on ROE for the parent, pushing it below zero. In the following two years, i.e. 2009 and 2010, ROIC has returned to a level above NFC, resulting in a positive spread, and hence, a ROE greater than ROIC.
87 Source: Own contribution, based on reformulated statements. See formulas and example calculations in appendix III.
Since TDC’s debt is based on floating rate loans, changes in interest rate represent a risk factor, especially seeing that the level now certainly is very low. By the end of 2010, 76%
of TDC’s gross debt was covered in terms of this risk, limiting the risk substantially.88 Furthermore, exchange rate changes also represent a risk; not a large one, though, since 97% of all gross debt in 2010 is in euro.
To understand matters further, the next section will be focused on analyzing ROIC by decomposing it into sub ratios and analyzing the underlying drivers through index and common‐size analysis.
5.2.2 Return on Invested Capital
ROIC is calculated as the turnover rate of Invested Capital multiplied by the Profit Mar‐
gin. The turnover rate reflects revenue generation per e.g. 1 DKK Invested Capital in op‐
erations, also corresponding to Net Operating Assets. The profit margin reflects the per‐
centage of revenue remaining after all operation related posts have been included, i.e.
NOPAT as a percentage of revenue. Since revenue is a stand‐alone driver, included in both measures, first step will be to analyze it as thoroughly as possible.
Revenue
TDC’s revenue has as already discovered not been subject to positive growth during the analyzed period, except for the most recent fiscal year, 2010 where there was a slight increase in total revenue of 0,34%.
Figure 5‐1 depicts the annual growth in total revenue along with its underlying elements in total numbers, i.e. revenue in DKK millions, split by business division.
The accumulated negative growth in total revenue from 2006 to 2009 is substantial. It reflects the increased competition TDC is subject to.
Particularly TDC Consumer and TDC Business show very unfavorable development with decreasing revenue in all periods, they have suffered loss of 726 and 1.318 DKK millions respectively from 2007 to 2010. Operations & Wholesale has experienced a revenue de‐
crease over the period, i.e. from 2007 to 2010, of 1.051 DKK millions, however the big drop was from 2007 to 2008, and the trend has diminished substantially the following two years.
88 TDC A/S. TDC Annual Report 2010, p 115.
YouSee’s revenue contribution has developed basically in the exact opposite direction compared to TDC Consumer and TDC Business, i.e. steady and substantial growth throughout the period, with a total increase of 1.183 DKK millions from 2007 to 2010.
This alone, however, has not been sufficient to outweigh the negative developments in the remaining domestic activities. Hence, TDC the turning trend in TDC Nordic combined with the diminishing drops in Operations & Wholesale has been a decisive force in turn‐
ing the overall trend in 2010.
Figure 5‐1 Revenue Growth89
In the following subsections the development within each business unit will be analyzed more closely. Figures depicting the revenue of each unit split on product lines are found in appendix III (Figure A III‐I to V). Since revenue will be forecasted separately for each unit, this understanding of the underlying drivers of the revenue of each unit is crucial.
TDC Consumer
The decrease in TDC Consumers revenue over the entire period can be ascribed to losses on fixed line telephony, which is not surprising at this point.
Internet and network revenue has increased all years, except the latest. 90 A closer ex‐
amination, however, tells that the growth from 2008 to 2009 was inorganic, i.e. it was
89 See numbers in appendix III, Table A III‐VIII
90 Appendix III, Figure A III‐I -4,28%
-3,70% -3,11%
0,34%
-6,0%
-5,0%
-4,0%
-3,0%
-2,0%
-1,0%
0,0%
1,0%
2,0%
3,0%
4,0%
5,0%
0 2.000 4.000 6.000 8.000 10.000
2007 2008 2009 2010
Pct growth in total revenue
DKK millions
Revenue growth
Consumer
TDC Business TDC Nordic
Operations & Wholesale
YouSee
mainly the effect of acquiring Fullrate. ARPU has in fact decreased over the last two years.91
On the positive side, the mobile business has grown, in the last two years this is mainly because of an increase in the number of RGUs, which was only partially dragged down by decrease in ARPU (Average Revenue Per Unit). Being the largest business, a favorable development here is crucial.
TV activities have, also not surprisingly, grown by large factors in terms of revenue. The contribution is still minimal with total increase of 208 DKK millions in 2010 the revenue from TV activities still only represent a mere 4%92. The fact, that not only RGUs but also ARPU has increased, is very positive indeed.
With total revenues decreasing all of the past four years, the outlook is seemingly not very positive. TV is likely to continue to grow, as the market is far from mature in terms of triple‐play. Provided that mobility will continue its positive trend, and Internet and network services will remain stabile, the trend is likely to turn or at least “stop”, as the drop in fixed line telephony fades out.
TDC Business
Seen over the entire period, the revenue in generated from each product line in TDC Business has decreased.93 Again landline telephony, which does not drop as hard as in TDC Consumer, which probably is due to the different nature of needs for consumers versus companies.
Mobile services changes only marginally ‐ up and down ‐ over the period, leaving it at a level in 2010 that is just below that of 2007. Mobile broadband has been the positive story of the mobile services, which has grown over the period. However, decreases in ARPU on mobile telephony are observed in the last two years.94
Internet and network revenue has decreased in all of the periods. The drop is explained partially by a decrease in RGUs and ARPU on broadband. The decrease in revenue from other sources can mainly be explained by divestments, i.e. inorganic (growth).
91 TDC A/S. TDC Annual Report 2010, p 7980.
92 374/9.389 = 3,98
93 Appendix III, Figure A III‐II
94 TDC A/S. TDC Annual Report 2010, p 8283.
In terms of organic growth – i.e. keeping the effects of divestments out – the main source of the native trend is fixed line telephony and Internet and network services. The out‐
look is not positive and should the trend continue TDC Business is out of business. This is unlike to be the case, in my opinion. The decreases stemming from organic growth is certainly felt, however I do believe, that it reflects the economic downturn in the sense that business clients are dealing with their own economic limitations, forcing them to scrutinize the elements of their profit margin, perhaps even making quality of the net‐
work or quality of service less of a priority, when choosing supplier.
TDC Nordic
The decrease in TDC Nordic’s revenue from 2008 to 2009 can mainly be attributed to unfavorable exchange rate movements95, which also explains why the decrease is re‐
flected in all the product lines96. Likewise, the increase from 2009 to 2010 was much affected by exchange rate movements; only it was in a positive manner. Additionally, however, there was organic growth to discover in all three countries.
Seeing as TDC Nordic has been kept out in the strategic analysis, making sound judg‐
ments here is very difficult. What can be said, however, is that the overall trend is posi‐
tive and with organic growth in all countries the last year, the outlook is seemingly somewhat positive.
YouSee
The very positive development in the revenue of YouSee over the entire period can in fact be attributed to growth within all product lines.97 As with TDC TV, it is a mixture of higher ARPU and increases in the number of RGUs.98 A part of the positive development is in fact also attributable to the success of TDC TV.
The outlook on YouSee’s revenue is certainly positive. There is always some natural limitation to high growth, but increasing ARPU tells that it is far from reached in this case. Value is being added by offering still more options such as video on demand etc.
95 TDC A/S. TDC Annual Report 2010, p 8586.
96 Appendix III, Figure A III‐III
97 Appendix III, Figure A III‐IIII
98 TDC A/S. TDC Annual Report 2010, p 9192.
Operations & Wholesale
The decrease in Operation & Wholesales revenue over the period is basically only at‐
tributable to the drop in fixed line telephony.99 Wholesale alone presented a revenue growth of 1,2% mainly due to the acquisition of DONG’s fiber net.
The acquisition of Fullrate had a negative effect, because the company as a stand‐a‐lone MVNO was a wholesale customer of TDC.100 Onfone, on the contrary, was a wholesale customer of Telenor; and hence the acquisition will not have a similar effect.
It is important to note here, that the negative trend has gradually declined and from 2009 to 2010 there was only a slight decrease. It seems that the drops in fixed line te‐
lephony is reaching its limits. Hence, this implies a stabile outlook on operations &
wholesale. However, seeing that MVNO competition may be eroded, the outlook is more of a steady negative one, as competitors increasingly rely on their own network, and traffic is shifting from fixed to mobile.
Turnover rate of Invested Capital
All else equal, declining revenue implies challenges in terms of turnover rate on invested capital. It is important to note however, that invested capital – at least from a theoretical point – also is a driver of revenue to some extend and vice versa, especially in the case of Telco’s. This is because infrastructure quality, which is highly dependable upon the amount of Invested Capital, is expected to have impact on customer satisfaction, which is a driver of customer retention, and thus affects the net revenue more or less. How‐
ever, there is also the fact, that revenue growth in terms of won market shares drives the investment in tangible assets, when an access line to the customer has not already been established.
Table 5‐3 shows the turnover rate of Invested capital along with a number of selected sub turnover rates based on items from Net Operating Assets, appendix III, Table III‐IV.
2007 2008 2009 2010 Turnover rate – Invested Capital 0,38 x 0,38 x 0,40 x 0,49 x Turnover rate - Intangible assets 0,50 x 0,50 x 0,51 x 0,62 x Turnover rate - Property, plant and equipment 1,32 x 1,23 x 1,23 x 1,47 x Turnover rate - Recivables 3,67 x 3,35 x 3,39 x 4,50 x Turnover rate - Trade and other payables -3,46 x -3,21 x -3,12 x -3,70 x Table 5‐3 Selected Turnover Rates101
99 Appendix III, Figure A III‐V
100 TDC A/S. TDC Annual Report 2010, p 8889.
It appears from the table, that the overall turnover rate in fact has improved during the period, despite the negative trend in revenue. The increase from 2009 to 2010 certainly helps to explain the positive change in ROIC in that same period.
It is especially the development in the turn over rates on Intangible and Tangible assets, which have contributed to the overall improvement. From 2009 to 2010 there has been substantial the company generated 0,11 and 0,24 DKK more per 1 invested DKK in In‐
tangible and Tangible assets respectively, mainly as a result of divesting Sunrise. Receiv‐
ables have improved as well; implying that TDC is has become better at collecting them.
The same apparently goes for TDC’s suppliers, i.e. the turnover rate on payables has in‐
creased as well. Nevertheless, the net effect is still positive.
Since we know, that revenue has decreased from 2007 to 2009 and only grown slightly from 2009 to 2010, we now have some more explanation on the trend of the turnover rate on invested capital. Intangible and tangible assets have been reduced in equivalence to total revenue in the period from 2007 to 2009. From 2009 to 2010, however, the turned trend, presenting a close‐to‐zero growth in revenue was not matched by a steady state of intangible or intangible assets, and thus neither in invested capital.
Profit Margin
Declining revenue similarly implies pressure on the profit margin. Adjustments in the organization as to fit with the level of activity are rarely made on a day‐to‐day basis.
Rather, these adjustments, such as staff size, size and place of office buildings, number of physical stores, etc. take time, implying that profit margin in deed is at risk when facing declining revenue, since these adjustments drive changes in costs such as wages and rent, and depreciations (which, despite not having cash effect, reflects investments). It can be referred to the important distinction between variable and fixed costs.
Figure 5‐2 depicts the profit margin along with special items as a percentage of revenue (measured on the right side axis) and indexes of selected items of the reformulated in‐
come statement, i.e. revenue, TC and COGS, other external expenses, wages and salaries, and depreciations. For full tables see of both common‐size and index on income state‐
ment and balance sheet see appendix III, Table A III‐VI and VII.
101 Own contribution based on TDC A/S. TDC Annual Report 2010.
TC and COGS are variable, while the remaining cost items are variable. The revenue is included to hold the other items up against, as it is the relationship between revenue and those items that determines the profit margin.
Figure 5‐2 Return on Invested Capital, and selected driving components102
The development in the profit margin over the period is unfavorable – besides hitting a low point of 5,74%, which is nearly 10 percent‐points lower than in 2007; there is an overall declining trend.
The variable costs basically follow the revenue trend, albeit by a factor stronger than 1, showing a decrease of 18,9% from 2007 to 2009, and a decrease over the entire period of 15,08%, which is a lot compared to the revenues total decrease of 6,38%. Seeing as this item is the largest cost‐item, amounting to 25,8% of revenue in 2010, this is in deed a very favorable improvement.
Wages and salaries are decreasing steadily over the period, reflecting the headcount reductions identified and discussed earlier, even throughout 2010, presenting a total
102 All are based on index‐numbers on reformulated income statement, except special items which is based on common‐size (i.e. calculated as a percentage of revenue) and ROIC which is based on previous calculations. See appendix III for both index and common size tables.
15,59%
5,74%
13,46%
11,18%
4,0%
-7,3%
-0,5% -0,7%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
70 80 90 100 110 120 130
2007 2008 2009 2010
Percentage, Special Items and Profit Margin
Index (FY2007=100)
PM Special items in percentage of revenue
Revenue TC and COGS
Other external expenses Wages and salaries Depr., amort. and imp. losses
decrease of 23,54 %. Other external expenses follow the same pattern, only less dra‐
matic, i.e. a decrease of 13,9%. Both items are large, taking up 16,5% and 17,3% respec‐
tively of revenue in 2010.
Depreciations are the last big stabile recurring item (except tax) included in NOPAT, representing 20,5% of the revenue in 2010, which is almost identical to the level of 2007. The level should be expected to lie around here – all else equal – since the change can be traced to 1) a higher amortization rate of customer relations (immaterial asset) due to a methodological change in calculations and 2) a number of acquisitions made during the year, i.e. DONG’s fiber net, A+, M1, and Fullrate103. There was however a large decrease from 2007 to 2008. It could therefore seem strange, that the profit margin dropped so hard in the exact same period, as all items presented till now have decreased more than revenue – all else equal implying a positive change in profit margin.
The answer lies in special items, which changed by 11,3% percent‐points in the period, and thus, went from adding extra 4% of revenue to being a negative post taking up 7,3%.
In the following two years, special items amounts to only ‐0,5% and ‐0,7% of revenue.
In addition, restructuring costs were low in 2007 compared to the remaining fiscal years, i.e. 1,6% compared to 4,6%, 3,8%, and 4,5% respectively.
From the above analysis, it has now become evident, that movements in several underly‐
ing drivers are to “blame” for the course of event in relation to profit margin.
First, TDC has managed to present cost decreases in larger scale than that of revenue.
There are a number of exceptions, however, working against these positive trends. With repeated large restructuring costs since 2008, the overall level has been pushed down 2‐
3 percent‐points. Furthermore, in 2010 depreciations, amortizations and impairment losses return to a level corresponding to that of 2007 ‐ that is measured as a portion of revenue. Lastly, special items are to blame for the dramatic drop in 2008.
103 TDC A/S. TDC Annual Report 2010, p 69.