The Revenue of Spirent Communications - Research Proposal Example

Finance and Accounting: Spirent communications Plc Contents Introduction 3 Business and Key Markets 3 Corporate and Financial Actions 5 Financial Trends 5 Profitability 5 Liquidity 6 Financial Gearing 6 Investment 7 Risk Management 9 Exchange Risk Management 9 Political Risk Management 11 Firm Based 11 Country Based 11 Global Risk Management 12 Conclusions and Recommendations 12 Reference List 14 Bibliography 16 Introduction Spirent Communications plc, telecommunication testing company has become one of the major players in both sides of the Atlantic. The business of the company is organized into two different segments namely, service assurance and performance analysis. The company provides services to multinational companies that are involved in the communications business by providing them with a strong and reliable network. The performance analysis business segment of the company focuses on testing of communications technologies which is used by third party service providers. Similarly, the service assurance segment of the company ensures effective field test solutions so that the service providers can detect problems and create strategic troubleshoot solutions (Reuters, 2014). The revenue of the company had increased by 2 million dollars in 2012. In 2011 the value was $470.5 million. The profit before tax of the company has also shown an increase of 3%. However, profit after tax for the company has went down from 87.9% in 2011 to 81.7% in 2012. The net income of the company has gone up by 33% (Spirent Communications Plc, 2012). The company operates both in the U.K. and the U.S.A. The purpose of this report is to analyze the key financial trends and the corporate strategies undertaken by the company to mitigate these problems. Most importantly, the focus of the report is to deal with the political and exchange rate risks that are faced by the company in operating in different political and economic environments. Business and Key Markets The following graph shows the revenue that has been earned by the company in the last four years. Figure 1: Revenue Earned (Source: Spirent Communications Plc, 2012) It can be clearly seen from the above graph that the revenues have increased consistently in the last four years. However, in 2013 the revenue of the company had suffered a fall and was estimated to be around 413.5 million dollars. Till 2012 the growth of the company was hugely driven by increase in demand that arose from cloud computing and broadband services. Ethernet technologies had also made significant progress in terms of technology and faster services were needed by the mobile service providers. Additionally, the increasing cases of cyber crimes had raised the demand for security concerns and Spirent Communications Plc became a trusted choice for the clients. As of 2012, maximum revenue was generated from Networks & Applications accounting for 213.4million dollars followed by wireless and service experience department scoring $167.7 million and finally service assurance department earning $32.4 million dollars (Morning Star, 2014). In 2013 the profits had dwindled because of certain changes taking place in the industry. Multiple forces had led to the crisis namely the fall in the launch of new service technologies, huge competition in the data centre market and unsatisfactory investment made in some of the business segments. On account of these changes, the business had suffered adversely. As a result, the profit before tax of the company had fallen drastically to $39.1 million in 2013 from $108.4 million in 2012 (Spirent Communications Plc, 2013). Corporate and Financial Actions In the recent past the company had grown considerably mainly by acquiring other businesses. For instance, Mu was acquired based on the expertise it had in the provision of cyber security. The value of this investment was $39.8 million. The company had also acquired Metrico in 2012. The price paid for this deal was $52.2 million (Spirent Communications Plc, 2013). This was a move taken by the company to integrate the live network of Metrico with the mobile device test technique of Spirent which is mainly lab based. These two acquisitions have allowed Spirent to increase its expertise in the market. Few other notable expansion strategies of the company were the deal that it had signed a contract with China Telecommunications Technology Labs to access the Chinese market. Similarly, the deal with IneoQuest Technologies has proved to be beneficial to improve video quality. In summary the corporate actions are largely guided by an effort to increase the satisfaction of the clients by improving the quality of the service. At present, the changing market trend is shifting from network and transport to applications and services. Financial Trends The key financial trends of the company are studied under four broad headings namely profitability, liquidity, financial gearing and investment. Profitability Figure 2: Net Profit Margin (Source: Global Data, 2014) The above graph shows that the net profit margin of the company has fallen till 2010 before showing signs of recovery in 2011. The strong demand conditions in the market were the primary factor causing this growth. There was very high expansion of wireless test capabilities as 4G and LTE networks became very popular. Liquidity Figure 3: Quick Ratio (Source: Global Data, 2014) It can be seen from the above graph that an improvement of the quick ratio has been observed for Spirent Communications plc. This is mainly because the conditions in the market were largely favourable and providing high speed ethernet and internet data became priority of major mobile service providers. A rising value of quick ratio indicates that the company is ready to meet its contingencies in the short run and is also a sign that the debt repaying capacity is good. Financial Gearing Net debt to equity ratio is employed in order to study financial gearing. Figure 4: Long-term Debt/Equity Ratio (Source: Global Data, 2014) The debt to equity ratio of the company is excessively high indicating that the company has a good financial leverage. Though there are inherent risks of high debt to equity ratio, still it is an indicator that the company is taking advantage of the market scenario and constantly seeking for expansion. The recent acquisition of Mu and Metrico shows that the company is aggressively seeking for expansion (Spirent Communications Plc, 2013). According to the Annual report of the company Spirent have a smooth access of cash flows and it did not incur any debt. $120.3 million dollars of cash was earned from the operating activities. Investment Dividend Payout Ratio Figure 5: Dividend/ Payout Ratio (Source: Global Data, 2014) The dividend payout ratio of the company has risen consistently in the years 2010, 2011 and 2012. The expectations of the shareholders are the key ones to understand about the course of action. This is because some investors expect high value of debt to equity ratio while others want the company to reinvest the money so that it can earn higher returns. If the dividend payout ratio is low then it must be compensated with a high return on equity (Goldstein, 1993). Spirent Communications Plc has been able to maintain a high value of return on equity. However, the peak value was reached in 2009 after which there has been a fall. Figure 6: Return on Equity (Source: Global Data, 2014) Overall, it can be commented that the overall strengh of investment of the company is high. Risk Management A multinational company have to operate across diverse geographies exposing it to certain risks and difficulties. This report deals only with the political and exchange risk management. Exchange Risk Management Spirent Communications Plc mainly operates in two continents namely the Europe and North America. Precisely it operates in Crawley (United Kingdom) and Crawley and Sunnyvale (United States) (Global Data, 2014). This implies that fluctuations in the dollar value have an adverse impact on the profitability of the company. According to the research conducted by Jorion (1990) had shown that fluctuations in exchange rates can cause changes in the price of the inputs, raw materials and altering demand conditions. Spirent Communications plc has subsidiaries in the U.S. and Asia Pacific region which means that the money invested by investors is subjected to fluctuations. According to researchers changes in the real exchange rate of a country are particularly bad for companies because they impact future cash flows. Inevitably the investment planning of the company is hampered. On account of this, it is extremely important for companies to mitigate the risks arising out of fluctuations of exchange rate (Boyabatli and Toktay, 2004). The research of Hakkarainen, et al. (1998) had shown that companies either use internal or external mechanisms to manage their foreign exchange rate risk. Internal options refer to the prudent internal management and external management refers to contractual agreements like currency swaps and currency futures. The research conducted by Tufano (1996) had revealed that a company can resort to a number of measures to reduce their risks. These processes are considering alternative positions in the derivates market, maintaining adequate cash balances or maintaining debts in foreign currency. Researchers like Géczy, Minton and Schrand (1997) had pointed out that the use of customized contracts is also used by companies to transfer risks to third parties. The research of Mello, Parsons and Triantis (1995) had also confirmed that operational hedging is also becoming increasingly popular among firms to manage foreign exchange risks. In case of Spirent Communications plc, the management mainly relies on the prudency of internal management. Exchange rate risk is one of the predominant market rate risks of Spirent. The company undertakes a number of trading transactions in the U.S.A. and also has to convert net profit margin back to home currency before calculating final profit. Spirent Communications have operations in the U.S., Asia and other parts of Europe apart from the U.K. External foreign exchange rate risk management processes like hedging and futures contract are not used by Spirent Communications plc for managing accounting exposures. Calculation of operating risks and net assets are considered to be a part of the overall accounting exposures (Spirent Communications Plc, 2013). It has been found that Spring Communications plc is not subjected to major transactional foreign currency risks. The primary reason being majority of the business of the company is not related to non‑functional currency transactions. Therefore, avoiding such transactions is a part of the exchange risk mitigation policies followed by Spirent Communications plc. In cases when the company cannot avoid such transactions, a separate strategy is employed. There are exchange contracts signed by the company to reduce such risks (Spirent Communications Plc, 2012). Hedging is also another option that is being used by the company as a part of exchange contracts to minimize the risks. Non-functional currencies trading are largely conducted through hedging of financial assets and liabilities. On 31st December 2013 the company had cash balances on non-functional currencies amounting to $1.1 million. This implies that if pound sterling appreciates against U.S. dollar then it would increase profit of the company by 0.1 million dollars (Spirent, 2014). Political Risk Management Researchers have defined political risk as a key way in which political decisions taken by firms affects business enterprises. Political risks arise from a number of options like war, expropriation and domestication (Graham, 1996). The research conducted by Erb, Harvey and Viskanta (1996) had shown that there are five types of risks that are faced by multinational companies like financial risk, political risk, economic risk, composite risk and credit rating of countries. Firm Based Researchers like Bekaert, Harvey and Lundblad (2005) had pointed out that forecasting of political risks is an important part for managing the financial reserves. At the firm level avoiding violation of legislation is one of the primary techniques to prevent political risks. Researchers have found that companies are subjected to a number of political risks like regulatory measures imposed by the government, taxation on cash flows, social barriers to operation and completion fostered by state policies (Kesternich and Schnitzer, 2010). In order to mitigate firm based risks, Spirent Communications plc follows the compliance code of London Stock Exchange, government policies and other jurisdictional requirements. Fair and accurate information are provided by the management of the company to avoid any type of legal issues. The company ensures that there is no misappropriation or fraud in the calculation of ratios or any fabrication of data. Country Based Political risks of Spirent Communications mainly arise out of the uncertainty faced by the governments in different geographies in which it operates. One of the pressing problems at present is the crisis of the Euro zone regarding the fate of Euro. 11% of the revenue earned by the company comes from Euro zone, so splitting of the Euro will affect Spirent. Political risks faced by telecommunications companies also impacts Spirent’s Communications plc. Falling growth of China and political instability in Middle East have caused a number of telecommunications companies face losses and exit market thereby harming Spirent (Spirent Communications Plc, 2012). The conditions in the U.S. are also quite turbulent and the policies taken by the government regarding tax policies and debt ceiling are likely to cause problems for Spirent Communications plc. The debates in the U.S. regarding key policies of taxation create an uncertain future for the company (Accenture, 2014). In order to mitigate legal risks and comply with the regulatory framework in the U.S., Spirent Communications plc has refrained from any type of bribery and any other unethical business practice. Spirent has not been involved in any type of infringement of copyrights, patents and trademarks. (Spirent Communications, 2011). Global Risk Management It is quite common for companies to face different political conditions in developing and developed countries. For instance, developed countries have high regard for environmental preservation which is not present in the developing countries. Additionally, management of political risks is also important for influencing the public perceptions about companies (McGowan Jr and Moeller, 2009). Researchers have found that multinational firms often resort to management of regulatory framework, overall legal structure and relationship it shares with the government (Jensen, 2003). Spirent Communications plc is no stranger to this rule and has adapted itself according to the legislations of the countries. For instance, the company has committed itself to environment safeguard policies as a part of its overall gesture to support the commitment of the government of the European Union to supplement its effort in reduction of carbon emissions (Spirent Communications Plc, 2012). Relationships with external stakeholders are extremely important for the company and integrity is strongly followed in all its operations. The company has devised strong control procedures to ensure that the declarations made to the government are accurately backed by local data. Conclusions and Recommendations Spirent Communications plc has established itself as a major player in the test communications department of telecommunications sector. The foreign exchange risk of management of the company can be considered as a mix of both internal and external mechanisms to ensure business profitability. In case of managing the political risk, the company mainly resorts to sound business practices and transparent disclosure. However, political and exchange risk uncertainties looms large as hints of drastic policy changes are present in the U.K. and the U.S. The following recommendations can be suggested to handle uncertainties in a better manner: Firstly, to take measures regarding corporate donations so that political decisions can be moulded in favour of the company. The general elections of the U.K. can bring certain problems for Spirent if the new government alters monetary and fiscal policies. Under these circumstances, it is imperative for the company to form better relations with the government. Secondly, as has been observed the current financial profits of Spirent Communications plc are declining and understanding that the market trends and changes will be very important to stay in the business. Therefore, it is recommended that the company takes proper market research to decipher the changes in the trends in the market. Finally, changes in the Euro Zone particularly the fate of Euro will be a crucial factor in determining profitability standards of the company. In order to maintain a favourable position it will be important for the company to tailor its exchange contracts so that non‑functional currency transactions can be protected in a better manner against currency fluctuations. Reference List Accenture, 2014. Managing political risk controlling loss, finding opportunity. [pdf] Accenture. Available at: < http://www.accenture.com/sitecollectiondocuments/pdf/accenture-managing-political-risk-controlling-loss-finding-opportunity.pdf> [Accessed 26 November 2014]. 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Parsons, J.E. and Triantis, A.J., 1995. An integrated model of multinational flexibility and financial hedging. Journal of International Economics, 39(1), pp.27-51. Morning Star, 2014. Spirent communications PLC ADR [online] Available at: [Accessed 26 November 2014]. Reuters, 2014. Spirent Communications plc [online] Available at: [Accessed 26 November 2014]. Spirent Communications Plc, 2012. Annual Report 2012 [pdf] Spirent Communications Plc. Available at: [Accessed 26 November 2014]. Spirent Communications Plc, 2013. 2014. About us [online] Available at: [Accessed 26 November 2014]. Spirent Communications Plc, 2013. Annual Report 2013 [pdf] Spirent Communications Plc. Available at: [Accessed 26 November 2014]. Spirent Communications, 2011. Ethics policy. [pdf] Spirent Communications. Available at: [Accessed 26 November 2014]. Spirent, 2014. Spirent Communications Plc: Preliminary results for the year ended 31 December 2013. [pdf] Spirent. Available at: [Accessed 26 November 2014]. 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