23 Comments

Summary:

The remarkably uniform pessimism regarding Vonage’s prospects, reflected in the share price, would lead you to believe that Vonage is on the death bed, gasping its last breath. The $58 million potential payout to Verizon has the gravediggers out in full force. The B-word is being […]

The remarkably uniform pessimism regarding Vonage’s prospects, reflected in the share price, would lead you to believe that Vonage is on the death bed, gasping its last breath. The $58 million potential payout to Verizon has the gravediggers out in full force. The B-word is being thrown around. However, Vonage’s reported results and financials do not support a conclusion of imminent demise.

The supply and demand mechanism of the stock market reflects investor sentiment, not company performance. Vonage fan club meetings have become increasingly lonely affairs, as investors discount for the fact Verizon wants Vonage to die. That is ironic, because Vonage is less than 1 percent the size of Verizon.

Anyway, the loss of this patent case is not as desperate a situation as most think. In the most recent quarter, Vonage used only $28 million of its $500 million cash reserve; so paying Verizon $58 million (if the companies don’t settle for less) does not threaten bankruptcy.

Secondly, Vonage gets $16 per month of incremental margin from each subscriber addition, so an injunction requiring payment of 5% or $1 per month per line does not destroy the prospects for profitability.

In a quick-to-judge reaction, many have forgotten that the successful imposition of E911 requirements on VoIP companies in 2005 cost Vonage more than the worst-case scenario outcome of the patent dispute. And the application of Universal Service obligations in 2006 added another $1.25 per line to Vonage’s costs.

Somehow, Vonage has survived, and posted impressive growth over past five years, if not profits, mostly because it adopted the flat-rate-plan that is typical of Internet companies. With that move it has forced a radical change in the incumbent business model of charging per minute, thus forcing new pressures on incumbents’ revenue streams. To compete, incumbents have to deal with the flat-rate voice plans. And maybe that is why the Bells want to see Vonage die.

Here is a little historical perspective. The breakup of AT&T in 1984 did not eliminate monopoly control over local telephone service. The Telecom Act of 1996 removed restrictions on long distance and consolidation setting up Verizon and AT&T with $200 billion in revenue.

The Bells defeated the wannabe competitive local exchange carriers created by Telecom Act (and $500 billion of investment capital). They now own the long distance carriers they once dueled with – MCI and AT&T. CLECs are all but gone, though a handful are hanging around.

So what makes Jeffrey Citron hope for a different outcome? The Internet! MCI used microwave transmission to overcome barriers to entry associated with the wired networks. Vonage leverages the Internet to similar ends.

The pristine anti-competitive track record of Verizon et al suffered its first blemish with the defeat (for now) of efforts to unwind net neutrality. Vonage’s national reach makes it difficult for the regional Bells to apply a price squeeze (raise costs and reduce revenues) that worked so well against the CLECs and LD companies. The cost side of the strategy is working, but the relatively high price umbrella allows Vonage to pass through the cost of the E911 and USF to customers.

Vonage can take a similar approach with any patent royalties or just go with a generic line item called anti-competitive pass-through fee.

A low stock market valuation does not directly impact prospects until Vonage needs to raise additional capital. Funds obtained through the IPO leave Vonage flush through 2010. Status as Jim Cramer’s most hated stock does not help morale, but Citron needs the endorsement of customers more than investors. As long as they keep voting with their subscriptions, reports of Vonage’s demise are still an exaggeration.

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  1. Vonage needs to mature. VoIP remains in its infancy, not yet publicly accepted as a real substitute for standard land lines, and Vonage’s technology deployment methods simply do not inspire confidence in the consumer. The industry will mature, there will be new methodologies for deploying VoIP solutions as alternatives to traditional broadband services come to market and the consumer will eventually start taking these guys seriously.
    I believe the real question will be no so much what ma Bell is doing so much as what Skype and other parties emerging in the VoIP space are doing. What really is the best methodology? Time will tell, as the technologies and market evolve.
    Vonage is a pioneer in this wild new frontier. Perhaps Vonage is just too ahead of the curve?

  2. Coverage of this company has been wrapped in sensationalistic reporting since the company’s IPO faltered. Thanks for taking the high road and providing an honest analysis into all that is Vonage.

  3. Vonage: Rocky Road, not Road Kill | The New Basement Tapes Friday, March 16, 2007

    [...] GigaOM » Vonage: Rocky Road, not Road Kill [...]

  4. Jesse Kopelman Friday, March 16, 2007

    Daniel, you make a good case for why the incumbents want to be rid of Vonage, but where is the case for their survival in a competitive market? It should be simple enough looking at the numbers. How long do they have to keep a subscriber to recover acquisition costs? Historically, how good have they been at protecting/growing margin? What is their churn? What is their customer acquisition forecast? From those 4, we can make a pretty good picture of future cash flows. Now compare that to current cash and ability to raise additional funding. What does the prognosis look like?

  5. Nice analysis, Daniel; but, even with the (for now) big cash cushion, the most important point of your post is this:

    “…if not profits…”

    The inherent structure of the current and near-term (next 1-3 years) VoIP/communication marketplace/s insures that they will never see profitability–no matter what they or their competitors do or don’t do.

    Their business model never had a chance.

    Vonage’s death bed was made and waiting for them…on the day they were born.

  6. Steve, put me in the morbid camp, but Dan does make a good point. one issue i think the company has its business operations and practices.

    it is leaking money and needs to streamline its business if it needs to survive against the giant. the competition is fierce, but Dan makes me rethink – maybe they aren’t going to go away that soon.

  7. Jim Ward-Nichols Friday, March 16, 2007

    Very well said! Of course Verizon wants Vonage to go away. ALL the ILECs (all 3 of them – ha!!!) want Vonage to go away. But with the best-in-class VoIP service Vonage provides, customers (just like me) will continue to remain loyal. I also don’t believe that the verdict will hold upon appeal. This is a complex technical issue. And in reality, as many have pointed out, it really is just like someone trying to “claim” the rights to a Christmas Tree. Verizon’s claim to the patents in question won’t hold up upon appeal. These kinds of details will emerge during said appeal where, one would also hope, Verizon’s true motives will be in the spotlight for all to see. KEEP THE FAITH, FOLKS!!! Vonage rules! Yup.

  8. Daniel Berninger Saturday, March 17, 2007

    The point remains to separate conclusions supported by the numbers and conclusions supported a qualitative assessment of the competitive (anti-competitive) landscape. The numbers bode well for Vonage. Vonage generates positive cash flow from each and every customer. The losses are discretionary not structural. Vonage made the strategic decision to front end load customer acquisition. In the last century, customer acquisition meant building a network. Customer acquisition presently means building a brand. Vonage’s net loss as a % of revenue declines every quarter (145% in 1Q05 to 35% in 4Q06.) Vonage projects spending $400mn to add 800k subs in FY07 for 40% Y/Y growth. They could have easily decided to spend $100mn for 10% growth and ended the year with positive net income. With regard to the the qualitative threat posed by Verizon et al, Vonage has already proven it can take the hits. The telco’s have successfully hurt Vonage’s costs, but they have not found a way to reduce Vonage’s revenues. The misdeeds of the telco’s against VoIP designed to slow Vonage ends up protecting Vonage against price competition. Vonage did reduce prices in response AT&T’s original VoIP offer, but SBC showed up to take CallVantage off the market. The regional nature of the Bells means they need an (illegal) cartel to price against Vonage. Ditto the cable co’s.

  9. Markus Goebel Saturday, March 17, 2007

    This story all reminds me of Amazon’s early years. I thought they never would be profitable and the billion dollars venture capital would be lost very soon. All the old school book vendors were saying that Amazon would dissapear because you need real life shops to sell books.

    Well, Amazon is still there and one of the biggest book vendors worldwide. It’s long ago that I heard those nasty comments about Amazon being only a cash burn machine.

    I think Vonage could be the same. Maybe one day all the negative comments, that are so easy to make from the actual situation, are forgotten like the anti Amazon comments are today.

  10. AT&T’s CallVantage isn’t off the market, they’re just not actively marketing it.

    See: http://www.usa.att.com/callvantage/index.jsp?

    This stuff is a commodity. Consolidation time looms. It’ll be Vonage by AT&T or Vonage by Verizon, or perhaps even Vonage by AOL, soon enough.

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