What's lining iiNet's pockets

The bullish sharemarket reaction to the latest profit results from internet service provider iiNet appears warranted if the company's headline numbers are taken at face value.

But a deeper analysis of the figures released by the country's fastest growing provider of high-speed broadband would suggest things are not as rosy as they first appear and that the 7.5 per surge in the share price is a little overdone.

Respected analyst Mike Henshaw from Petra Capital says that instead of focusing on the 44 per cent rise in net profit to $25.6 million, shareholders ought to look at the underlying profit performance.

According to Henshaw's analysis, iiNet's underlying profit only rose 4.9 per cent to $27 million after stripping out various one-off items.

Henshaw is quick to say that he remains positive about the stock but he raises the perfectly valid question: Why did last year's $83 million purchase of Perth-based ISP Westnet fail to deliver any financial benefits in the first full year of ownership?

A secondary key question is: Are the Westnet synergy benefits being held back because of iiNet's concern that if it cuts costs it will have a repeat of call centre disaster that followed the Ozemail acquisition in 2004?

The board of iiNet, which includes founder Michael Malone and AAPT CEO Paul Broad, showed its confidence in the outlook by declaring a final dividend of 5 cents a share.

That makes a total payout for the 2009 year of 8 cents a share, up 1 cent on the previous year.

Those who hate technical analysis of financial accounts will allow their eyes to glaze over the next few paragraphs. But there is a bigger picture message – amortisation is a non-cash item that can distort financial results.

Henshaw's analysis of the iiNet profit result starts with a note to the 2008 annual report, which says that if Westnet had been included for the full year, the company would have delivered a net profit of $27.45 million in 2008.

The 2008 result was boosted by a $1.7 million (after tax) one-off benefit from a stamp duty ruling which should be stripped out. That takes the comparable result for 2008 to $25.75 million.

Henshaw says this year's result of $25.6 million needs to be normalised with the removal of foreign exchange gains and the adding back of $3.6 million in Westnet amortisation.

That gives a full year 2009 result of $27.36 million.

However, Henshaw says the Westnet deal was supposed to deliver $2.5 million in synergy benefits, offset by $2 million in one costs for establishing a new call centre. If these are adjusted for underlying profit for 2009 is $27.0 million.

The bottom line, according to Henshaw, is that the underlying profit at iiNet only rose 4.9 per cent in the year to June 2009.

But Henshaw remains positive about the company's prospects because of the savings it will make in bandwidth costs this year from shifting its international internet traffic to Pipe Networks which is opening a new link to the United States from October 1.

Henshaw says iiNet should be able to cut its bandwidth costs significantly, while the synergies from moving Westnet customers onto its network should lift profitability in fiscal 2010

Finally, the debate about the quality of the numbers released today should not diminish the company's achievement in adding 47,500 new DSL broadband subscribers to the iiNet subscriber base in the year to June.

That performance means iiNet beat Telstra's net adds in fixed line broadband of 20,000 and just pipped Optus which added 46,000 new subscribers in the year to June. The company now has 8 per cent of the broadband market and is targeting 15 per cent.

As highlighted in my comment, the Australian fixed line broadband market is extremely competitive and Telstra is not part of the current growth momentum.