Virtutone Networks (V.VFX) rings up profits by buying, selling long distance minutes

It’s easy to believe there’s no money to be made in long distance calling when Skype and Google give it away for free. But the fact is that you can ring up profits from what we call the “minutes” game - buying and selling long-distance minutes as a middle man.

(Google Inc. (NYSE: GOOG, Stock Forum) and Skype may not charge you for a call but they do pay for the minutes you use. Their business model is to sell your eyeballs to advertisers.)

With that said, we are recommending the shares of Virtutone Networks Inc. (TSX: V.VFX, Stock Forum). We believe the company is at an inflection point where revenues are poised to grow dramatically. Given the highly scaleable nature of the business, this means we expect earnings to multiply.

Virtutone buys minutes from smaller local carriers (phone companies) for a set price and resells them to bigger, international carriers, at a higher price. Its customers range from obscure VOIP operators you’ve never heard of to big providers like British Telecom and Telus Corp. (TSX: T.T, Stock Forum)

The company specializes in exotic locations, primarily Africa and SouthAmerica, where margins are better. The reasonsVirtutone’s customers don’t do this themselves is that they don’t do enough business with, say Gambia, to connect to their networks. Security is also a concern for big, established telcos.

They don’t want to give network access to just anyone. So Virtutone does it and plays the role of middle man.

On average, Virtutone earns 5% gross margins (that is, the difference between price sold and price paid for minutes.) So this is a high-volume, low margin business. Barriers to entry are not particularly high, although the Virtutone story proves that skill, experience and relationships do matter a lot.

The other principal characteristic of Virtutone’s business is that it is essentially a financier. It buys the minutes cash (i.e. pays up front) then sells them for payment to be received later, typically 30 days. It therefore requires tremendous working capital to finance the purchase of minutes until it collects payment.

In other words, growth requires capital - not for physical assets so much but to allowfor cash recycling. If the company can acquire capital at a reasonable cost, Virtutone can grow its earnings in a very big way.

The current run rate of revenue is about $120 million annually. We think it could eventually reach $1 billion or more eventually.

Virtutone’s CEO is Jason Allen, an impressive entrepreneur who has built and sold a few companies, mainly in the telecom space. Virtutone started as a fax-over-satellite service provider to the oil patch (for faxing a remote well’s data log).

The company then added VOIP lines to complement its fax service, and Mr. Allen was introduced to that growing market. (VOIP stands for voice-over-internet-protocol. It differs from traditional copper based phone lines in that it uses the Internet to route voice traffic.)

The company then entered the business-to-consumer VOIP industry, but that proved a tough slog. Mr. Allen, however, learned about the opportunities in wholesaling VOIP minutes wholesale from one carrier to another, and last March acquired a Los Angeles based firm that was posting about $1 million a month of revenues.

Virtutone’s revenues climbed from about $1 million a month to about $9.2 million in January. They slipped a little in February because of a shorter month and a technical glitch, but are on pace to recover in March.

To get that kind of growth Virtutone invested $1 million in SONUS switching equipment, which is housed in Toronto, and allows the company to tie into big telecom companies’ networks. That equipment can handle about 10 times more volume than the company is currently producing. It also pretty much lasts for ever, unless specs change.

Today, Virtutone is growing revenues briskly. That, as you already know, requires money. The company completed two recent financings raising about $5 million. It also has a line of credit with the Royal Bank, of Canada (TSX: T.RY, Stock Forum) at about 7%. But it’s small, at $2 million. It is close to acquiring a new, $10 million line of credit from Tier 1 bank at an attractive 5.5% rate of interest.

Virtutone always has a lot of receivables by definition, and credit risk is always a concern. But the company’s customers are chiefly Tier 1 telecoms. Plus Virtutone uses an escrow account service called Akirix, which greatly reduces the risk of write-offs, if it doesn’t eliminate it.

This is an exciting time for the company. If it lands a bigger line of credit, which we fully expect, it will have enough capital to continue rapidly expanding its revenues. Plus, the company has two ambitious accelerants to lean on. The first is breaking into the long-distance SMS (text messaging) wholesale business.

Virtutone has hired a former senior Telus executive to spearhead this plan. Telus alone carries 10.5 million overseas texts per day.

Margins in SMS are closer to 20%, so once Virtutone gains traction here (which we expect it will because it already has relationships with the carriers and its equipment can handle SMS as well as voice) we should see accelerating top line growth and expanding profit margins.

The second is acquisitions, and there are plenty of targets. Most are private, and like the opportunity of being bought by a listed company to provide upside and liquidity.

This is our model of what earnings could look like without acquisitions (turnover is the rate at which the company can cycle its cash, from bank account to purchase of minutes to collection of receivables) and without SMS. We think this is conservative:


Clearly there is significant upside from todays’ price if things unfold conservatively. With SMS and acquisitions, the upside is potentially much bigger. One of the major dealers is about to initiate coverage on Virtutone. Retail investors have a chance to get in before the name gets institutional interest. There are risks, of course, but we think the rewards more than compensate for them.

About the Author

Fabrice Taylor is a Canadian financial journalist, publisher and investor best known for writing a stock-market column in The Globe and Mail newspaper and Report on Business Magazine. Since January, 2011, he has authored and published The President’s Club Investment Letter, a joint-venture with The Globe and Mail. He is a frequent guest on the BNN network. For more information on his investment newsletter visit www.thepresidentsclub.ca

He began his journalism career at The Globe and Mail in 1995 and later became the paper’s capital markets columnist. [1]He won a National Newspaper Award Citation of Merit in 2003 and that same year obtained his CFA designation.