GigaOM readers in a poll earlier this month have spoken – Vonage stock is a sucker’s bet and is headed down. The stock market seems to agree. The odds are against the company. Daniel Berninger, senior analyst with Tier 1 Research thinks otherwise, and believes that like MCI that put the squeeze on old AT&T, Vonage can put the squeeze on its bigger, more well funded rivals including the Bells and Cable Companies.
Berninger, who was involved with Vonage in the early days, but does not own any stock in the company told The New York Times, that the stock is going up, and Jeffrey Citron could be the new Bill McGowan, the maverick who started MCI and took on the old Ma Bell. He might be in a minority (only 15% of 663 who voted in our informal poll thought that the stock will go higher than the IPO offering price of $17 a share.) Andy Kessler wasn’t too impressed by Vonage’s business model. Neither was I. Still, Berninger paints a pretty compelling case. He has been around in the telecom industry to see the parallels. Read for yourself … after the turn.
In the tradition of no good deed going unpunished, Jeffrey Citron’s attempt to break 130 years of telephone monopoly means he deserves a broken IPO. Rather than cheering Vonage’s 30% valuation decline in the first week of trading, we might consider the larger implications of Citron’s success or failure. With communication like energy an input for the entire economy, the prospect of a failure to reduce communication costs hardly seems like cause for celebration. Citron’s effort to give customers an alternative to AT&T and Verizon arises after a complete reversal of MCI CEO Bill McGowan’s achievements with the Bells back in control of long distance.
The demise of the long distance industry traces directly to McGowan’s death in 1992, because defeating monopoly requires a unique set of talents. Fortunately for the communicating public, Jeffrey Citron looks as much the antidote to monopoly as Bill McGowan. As with MCI’s IPO in 1972, the Vonage IPO represents only the beginning of a story. Citron uses the Internet where McGowan’s took advantage of advances in microwave technology, but both invent and dominate categories avoided by most rational entrepreneurs. The description of MCI as a law firm with an antenna on the roof was more true than not, because regulatory and antitrust considerations shaped the landscape. The success of Vonage owes to full throttle marketing even while navigating the regulatory pitfalls.
Anyone that thinks competition represents the main challenge for Vonage has not been paying attention. Vonage faces anti-competition from the new AT&T, Verizon, and the voice dreams of Comcast et al. The Bells and cableco’s have no intention of competing with Vonage in the sense of delivering better value for a better price. Both set their price points at almost double Vonage’s. The feature lists of Verizon VoiceWing and Comcast Digital Voice fall short without the virtual numbers and mobility offered by Vonage.
Skype and the voice offers of Google, Yahoo, and Microsoft do not represent competition as they do not offer a substitutable service. Their existence provides a net benefit in contributing to customer awareness. The competitive challenge from other independents already played out with Vonage building a customer base 10 times the #2 player. There does not even exist a Sprint as in the case of MCI.
The various tactics for defeating Vonage come from the monopolist handbook. The Bells and cablecos target only customers where they can leverage existing billing relationships and tie voice to other offers (aka bundle.) The Bells focus their resources toward manipulating the regulatory process and very little to make service offers more compelling. The Bells and like minded cableco’s still control last mile facilities. They will scheme to raise Vonage’s costs and disrupt the company’s relationships with customers. They will not compete for customers on the merits.
Vonage’s telecom costs remain at 30% of revenues even as economies of scale have cut other costs in half. The fact DSL and cable modem offers include limited upstream bandwidth serves to reduce the number of people that can use Vonage’s service. The Bells continue to tie their DSL offers to traditional telephone service. Customers trying to move their telephone numbers to Vonage wait weeks as an error prone manual process grinds away at the same time wireless numbers get ported in a few hours. The fact AT&T CEO, Ed Whitacre, mentions Vonage by name in his famous “my pipes” BusinessWeek quote vowing to unwind net neutrality does not represent an accident.
The tricks of the monopolist trade proved sufficient to defeat the post McGowan MCI, the wannabe’s created by the Telecom Act of 1996, and even bested AT&T itself with SBC acquiring Ma Bell for 50 cents per revenue dollar. The track record might rightly make CEO’s Whitacre and Seidenberg confident in the outcome unless they notice Jeffrey Citron shares many of the same characteristics that allowed Bill McGowan to make MCI under his leadership an exception to the rule.
The ugly landscape suits Jeffrey Citron as well as it did Bill McGowan. The inability of less hardy competitors to keep pace ended price competition in 2004 as well as any need to split the eventual treasure. SBC saved Vonage the trouble of dealing with a serious challenge by the old AT&T. Survival represents no small matter, but Vonage need only peel off a small percentage of the $200bn in annual Bell company revenues to generate a substantial business not to mention win the right to pursue a piece of the larger $1 trillion global voice business.
Jeffrey Citron’s Vonage has already pushed Bill McGowan’s cause further than any of the companies funded in the cycle of monopoly bashing launched by the Telecom Act of 1996. Vonage will hit the $600mn annual revenue milestone by the end of 2006 at the same pace as $100bn market cap Google. Even the so called failed IPO serves to build customer awareness not to mention provides $531mn in funding allows Vonage to grow into its marketing budget.
Consider a quote from AT&T CEO Robert Allen at Bill McGowan’s funeral: “Bill McGowan will go down in business history as one of America’s foremost entrepreneurs. Probably more than any other single person, he helped to reshape the long-distance business from the monopoly that it had been for so long to the highly competitive industry that we know today.” We may all reach a different conclusions about the prospects of Vonage’s long term success and, hence, the proper value of Vonage’s stock, but no matter the outcome Jeffrey Citron deserves the appreciation of everyone that receives a telephone bill (i.e. everyone).
Daniel Berninger is a senior analyst at at Tier1 Research.