Spirent Communications Plc - Essay Example

Table of Contents Introduction 2 Financial trend 3 Liquidity 3 Profitability 4 Efficiency 5 Investment 6 Corporate and financial actions 7 Risk management 7 Exchange rate risk 8 Country and political risk 10 Conclusion and recommendations 11 Reference List 13 Bibliography 15 Introduction Spirent Communications Plc is one of the global leaders in the technology industry that provide a variety of services to more than 1200 commercial consumers in approximately 15 countries worldwide. The company is headquartered at Sussex, London and presently listed at the London Stock Exchange. The company primarily operates in communication testing and measurement sector but is significantly involved in development of various software and hardware solutions such as transmitter, cable management system and so on, for the global communication industry. Despite various ups and downs in the global telecommunication industry, the company continues to invest in product development and innovation. (Spirent, 2012; 2014) The Spirent Group is considerably involved in acquisition and merger which further helps the company to grow its market share, offerings and consumer base. The company has current market capitalization of $427.61 million and about 30.9 percent of market share in the industry. Frost & Sullivan recognized that the company is market leader in segments such as 1GbE, 40/100GbE and 10GbE and appended that the company is way ahead of its nearest competitors. The company observed a turnover of $413.5 million in 2013 and witnessed 17% growth in the second half of the year with respect to the first half (Spirent, 2012a; 2012b). The current market condition can be considered as a reason of concern for the company as despite mild market growth, the revenue of the company is consistently declining while its competitors, Halma Plc and Agilent Technologies Inc are making effort towards building strong consumer base by diversifying their offerings (Spirent, 2013). The paper discusses financial trends of the company using past five year data and its corporate and financial activities during this period. Spirent is a global company and is susceptible to various risks and vulnerabilities such as foreign exchange risk and country and political risk that unfold from cross border trading. The paper highlights these risks and present recommendations in this regard. Financial trend Ratio analysis has been considered appropriate for assessing and comparing financial position of the company in past five years. Various ratios have been calculated to effectively evaluate liquidity, efficiency, profitability and return of the firm. In this regard, date has been sourced from the London Stock Exchange (2014). Liquidity The short term liquidity position of the firm and its long term solvency has been evaluated using current ratio and debt-equity ratio. Current ratio Figure 1 (Source: Author’s creation) The current ratio highlights relationship between the components of working capital, namely, current asset and current liability. It can be observed in figure 1 that Spirent had current ratio above 2 for past five years. Consequently, it can be determined that the company has sound short term liquid condition (Robinson, 2008; Subramanyam and Wild, 2009; Romic, 2011; Zack, 2013). Financial gearing ratios Debt-equity ratio Debt-equity ratio represents long term solvency position of a firm as the ratio establishes relationship between long term debt and equity capital of a firm. It can be ascertained from figure 2 that the firm has relatively low debt level ranging between 4% and 8%, which suggest that the company is significantly dependent on shareholder’s fund and therefore can be considered as a low geared firm (Robinson, 2008; Subramanyam and Wild, 2009; Romic, 2011; Zack, 2013). Figure 2 (Source: Author’s creation) Profitability Profitability of Spirent has been disclosed with the help of gross profit margin and net profit margin. Gross profit and net profit margin Figure 3 (Source: Author’s creation) Figure 4 (Source: Author’s creation) The gross profit and net profit margin reflect the level of profit a firm has earned over its revenue. It can be observed from the figures that gross profit and net profit of Spirent Communications has declined significantly in 2013. The reason can be attributed to structural changes and economic disruption in various geographical markets of the company (Robinson, 2008; Subramanyam and Wild, 2009). Efficiency The efficiency ratio reflects the effectiveness of a firm in terms of utilization of resources and conversion of the same in profit. The asset turnover ratio has been useful in evaluation of efficiency of Spirent. Asset turnover ratio Figure 5 (Source: Author’s creation) The asset turnover ratio denotes ability of a firm to make maximum utilization of its assets to earn more revenue. Spirent witnessed a decline in the ratio which suggests that due to external factors the company was unable to make maximum use of its assets to earn revenue (Romic, 2011). Investment Dividend cover ratio The investment return of the company to its shareholders has been depicted through dividend cover ratio. The dividend cover ratio of Spirent reflects that the company is retaining greater share of profit since 2008 in the business and as a result, dividend cover has declined significantly. The decline can also be attributed to revenue fluctuation as a result of financial crisis. However, declining dividend cover is a sign of poor dividend policy of the firm and may affect perception of shareholders pessimistically (Lease, et al., 1999). Figure 6 (Source: Author’s creation) Corporate and financial actions Recent decline in profit and revenue was considered as a consequence of structural changes in the industry and consumer preferences. Consumers in certain parts of Europe and China were affected by macroeconomic issues and thereby affected the business. Considering the market uncertainty, the company has underinvested in test system development along with restricted expansion of products in new markets; these factors also affected Spirent’s revenue. However, the company is making best efforts to meet consumer needs in the changing competitive environment and making sufficient investment thereof. The company recently acquired business of DAX Technologies Corporation paying consideration of $37 million. The company was acquired for their leadership in delivering solution in customer experience management. Spirent also acquired 58percent stake in Testing Technologies IST GmbH for enlarging their business in development and marketing of customer specific software (Spirent, 2012a; 2013). Risk management Spirent Communication is a global leader in the communication test business and is omnipresent in almost every continent. The economic condition of different countries has significant impact on the business of the company giving rise to a number of systematic and unsystematic risks such as foreign exchange risk, country risk and political risk. These risks have significant negative impact on future viability of the company (Busse and Hefeker, 2007; Clare and Gang, 2010). The paper discusses these risks and evaluates Spirent’s strategies towards risk mitigation and management. Exchange rate risk The exchange rate risk mainly comprises two major types of risks that a multinational company is vulnerable to, namely, transactional risk and translational risk. Transactional risk exposure denotes possibility of financial loss from a business transaction that has been pursued in a foreign currency. Such kind of transactions include contracts related to purchasing and selling of products on credit and lending and borrowing functions where settlement is to be conducted in foreign currency. Translational risk in foreign exchange arises as companies invest in assets in foreign countries or record the same in their balance sheet. An increase in translational risk occurs as companies purchase large proportion of assets or equity in foreign denominations. Most multinational firms make effort to risk mitigation by means of purchase of currency swaps and investment hedging using future contracts (Kelley, 2001; Erb, Harvey and Viskanta, 1996). Spirent Group operates in approximately 15 countries in continents such as Asia Pacific, Europe, Middle East and Africa and the United States; therefore, the primary currency exposures of the group include US Dollar, Yuan, Euro and other currencies. Majority of the company’s business occurs in the US dollar and Euro therefore significant exposure to exchange fluctuation thereof can be estimated. The group makes use of derivative transactions and forward contracts related to foreign currency exchange for managing and hedging risk exposure that arises from payments and receipts in foreign denominations with respect to the company’s commitments (Spirent, 2013). Each of the hedging instruments are very specific in terms of its function therefore are deployed wherever considered appropriate (Spirent, 2013). The company ensures that all derivative instruments are valued at a fair price. For illustration, when the company undertakes forward foreign currency exchange contracts, the contracts are initially realized at fair value as of the date of contracting and are afterward re-measured at specific fair value on a date as and when reported in financial statement such as balance sheet (Spirent, 2013). The company exclaimed that the fair values of the derivatives are calculated with reference to present foreign exchange rates for various contracts having same maturity profiles. Spirent group does not follow accounting rules related to hedging and consequently, total gain or loss (transactional differences) associated thereof are reported in the consolidated income statement of the firm (Spirent, 2013). It was also gathered that derivatives that are associated with various other financial instruments or host contracts are processed as separate derivatives if risk associated and characteristics of the derivative is considerably different from that of the host contracts (Spirent, 2013). The main objective of the treasury department of Spirent Communication is to guarantee mitigation of financial risks of the multinational and to ensure sufficient liquidity in the business (Kelley, 2001). Spirent Communications has implemented a formal control structure within which all activities related to treasure are conducted. All the policies and guidelines related to treasury activities are strictly monitored and approved by the Spirent’s corporate board. Alongside, the treasury policies are also reviewed periodically so as to have updated information. In this regard, one of the company policies explicitly forbids the firm from getting involved in speculative transactions related to the treasury (Spirent, 2013). One of the important aspects of currency risk is interest rate risk. Interest rate risk arises when a firm borrows in foreign denominations instead of home currency (Busse and Hefeker, 2007). Spirent Communications hardly has external debt; therefore, its exposure to this kind of risk is negligible. It has been reported by the company that their surplus fund are essentially held in various banks in the US and the UK and are invested in on-demand and short term bank deposits. Despite lack of foreign debt, the company fund is vulnerable to interest rate as interest on deposits in the US and the UK is affected by fluctuations in the value of sterling, Euro and US dollar. It was observed that forward foreign currency exchange contracts, cash equivalents and long term cash on deposit are susceptible to interest rate risk exposure (Spirent, 2013). Transactional risk exposure is faced by Spirent group due to their trading with various international customers in foreign currencies, while the translational risk exposure is developed from operations and assets that have been acquired by the firm’s overseas subsidiaries (Chowdhry and Howe, 1999; Spirent, 2013). It has already been highlighted that majority of business activities of Spirent are conducted in US dollar; however, it was determined that the firm’s functional currency continues to be Sterling and share capital of the company is reported in pound sterling. Additionally, Spirent has operations along with assets and liabilities in Asia and Europe which are affected in terms of translation due volatility in exchange rate with respect to US dollar. Since, overseas assets and liabilities are considered within the purview of accounting exposure instead of cash exposure, the company has not invested in hedging instruments thereof. The hedging strategies of the company further include purchase of forward contracts whenever the company undertakes non-functional currency transactions. The treasury of the company is responsible for conducting transaction hedging activities with relation to firm’s normal trading activities (Spirent, 2013). Country and political risk Allayannis and Ofek (2001) posited that country risk can be noted as a bundle of multiple kind of risk that a multinational firm comes across during its foreign operations and business activities. The kinds of risk include political risk and economic risk. Political risk originates from political instabilities and modification in regulations in a country which can have possible effect on return of a company’s investment. Spirent, like every other multinational company, is exposed to operational resistance and risk while operating in foreign nations. Country risk comprises market risk along with economic and political risk and when it is understated, situation may become impossible to control (Erb, Harvey and Viskanta, 1996). The business of Spirent has global exposure and consequently is vulnerable to present economic conditions worldwide, over which it has little or no control. Macro economic factors including spending priorities of government have significant impact on Spirent’s business in the US (Spirent, 2013). In this regard, Jensen (2008) voiced that political issues and economic adversities has significant impact on consumer behaviour while Wang, et al. (2000) emphasised that blurred geographical borders have resulted in direct impact on operational process, firm’s earnings and operational strategy. As it has been observed that majority of activities of Spirent Communications has operational base in the US and the Euro zone, therefore, economic downturn, structural changes and disruption in the government regulations will have significant impact on operations and profitability of the company (Spirent, 2014). The recent global financial has engulfed and affected the telecommunication sector as well and the outcome is significant decline in revenue growth of major firms. Bekaert, Harvey and Lundblad (2005) pointed out that modification in growth and infrastructural policies will also affect the business of Spirent significantly. Spirent can adopt mitigation actions in this regard in the form of close monitoring of the market, product and service diversification and geographical diversification of consumer base (Clare and Gang, 2010). According to Forbes (2012), the greatest dilemma that an organization comes across with respect to political risk is that the issues can be neither completely mitigated nor measured. The political risks that Spirent is susceptible to can be classified as micro risk and macro risk. The micro risks are generally limited to a specific industry (in this case, communication industry) and include risk such as intellectual property and patent loss, prejudicial actions, capital control and discriminatory practices against foreign firms. On the other hand, the macro risks include license cancellation, protest, insurrection, unacceptable regulatory practices and expropriation. These risks can be mitigated by means of negotiable contracts with legal system of the host country and by implementing enterprise risk management system (Accenture, 2012; Dewit, 2001). Management of political risk by means of local sourcing and stakeholder engagement can by proposed for Spirent communications. On this note, corporate citizenship may prove to be an ideal strategy for the company. As underlined by Bekaert, Harvey and Lundblad (2005), corporate citizenship or social responsibility helps a firm in developing growth avenues by means of social, economic and environmental development. Social development can be initiated by means of local sourcing which will provide the firm ample opportunity for cost minimisation through domestic supply and create employment opportunities (Jordaan, 2011). Conclusion and recommendations This paper is a critical assessment of Spirent Communications Plc from financial and non-financial perspective. As the company has global presence, it is normal for the firm to face a variety of complications such as exchange risk and country and political risk with respect to its host countries. From the context of foreign exchange management, it can be recommended that Spirent can adopt certain non-hedging techniques for currency risk exposure such as netting of exposure and exposure transfer. Transfer of exposure has often proved useful for firms yet netting is the most common technique that is adopted by multinational firms who frequently pursue large scale foreign transactions. Additionally, it can be recommended that Spirent can invest in risk hedging measures such as cross hedging currency swaps, options and future contracts. Country and political risk management is a complicated process and for this purpose it is recommended that Spirent should undertake initiatives such as global risk management so that managers are able to foresee potential risks and predict impact of the same of company’s performance. 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