Is Vonage Worthless?

Posted by John Carney, Sep 11, 2006, 11:37am

screwedcrackcharttoast.JPGWe’re ending our moratorium on Vonage—there were only so many times we could say Vonage was screwed/on crack/toast—to bring to your attention Nickel Capital’s Mark Langner analysis arguing that “there is no value to VG equity as a stand alone entity and little value as a takeover target.”

The problem with Vonage is that its marginal customer creates negative value for the firm – i.e., the cost of customers acquired today is never recouped by the EBITDA that those customers generate before they churn off the network. This is exacerbated by the fact that this negative contribution is incrementally increasing with each new customer as the cost of reaching the marginal customer becomes more expensive over time (the easiest customers are found first). Finally, since VOIP has moved through the early adopter (meaning the easy customers have been found), there is no evidence that the trend that is driving the negative NPV will reverse itself at all, let alone move into positive territory before the company runs out of cash.

Of course, Langner’s short Vonage but if you think you need to be conflicted or self-serving to see that Vonage is screwed, consider this—whatever fancy tech name you give the service Vonage supplies—Voice-Over-IP—it is still basically delivering telephone landlines to customers. Do you really believe the future of telephony is in landlines?

The Short Case on Vonage: Why No Price is Cheap Enough [Seeking Alpha]

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Posted by Chris, Sep 12, 2006 9:24AM

Sorry but I'm not really going to give any value to what a short seller is saying. Also, your comment on landlines is off base. Vonage works via the Internet and hence is available anywhere the Internet is available. Now I suspect you've heard of WiFi. I would even go so far as to think that you might agree that WiFi is becoming ubiquitous. Right now it's no surprise to see people in Starbuck's or an airport or anywhere in Google's home town using Vonage via their computer or one of the WiFi phones that Vonage sells. I've been assigned to work in Paris by my company (hey, it ain't easy) and certain parts of the city are now WiFi enabled (and free). My Vonage works great. I'm a very very happy Vonage customer with a U.S. number for my U.S. colleagues and friends to call as well as a local "virtual" number here in France for my French colleagues and friends to call. Calls to most of Europe are free. So, Vonage is really an ideal solution for me and for under $30 per month that ain't bad. It's amazing the damn thing works no matter where I go and my phone number stays the same and I have NO ROAMING CHARGES. Should I say that last part again or was the all caps shouting sufficient? 'nuff said.

Posted by John Carney, Sep 12, 2006 10:19AM

Vonage is primarily marketed as a replacement for landlines, home phones, etc. Our point was that its not a mobile business and to a lot of people it looks like mobile is the future of phone usage.

I agree with you about the transportability of the phone numbers being attractive. When my brother lived in Europe, he took a NYC phone number with him and we always called him on his Vonage line.

As for not listening to short sellers, well, to each his own. That's why we disclosed the position of the analyst in our brief item. You trust who you trust, although I don't understand why you would regard someone who is short a stock is less trust worthy than someone who is long. Are shorts just bad guys in your mind?

Posted by Chris, Sep 13, 2006 8:37AM

Thanks for your response. It reminds me that I forgot to point out that I don't own any VG and I never have. With that said, I'm certainly not a totally objective observer because I like my Vonage VoIP service and I don't want to lose it if VG folds.

With regard to your question on short sellers, I have nothing against the practice. In fact, I think it's a valuable and honorable tool, especially when used based on a company's (crappy) fundamentals. I don't, however, think it's worth listening to anyone who has a financial interest in what you take away from them.

I mean, just hypothetically, say a short seller had lost faith in their position, would you really expect them to say that? 99.9% if the time I'd expect that they'd just keep saying what they used to think and hope to drive the stock down enough to unravel the position without taking more losses. Or maybe hope to drive it down just a little bit more to improve their gains. In my book, a short seller shouldn't have to say anything about their position to make money. Sooner or later the market always unearths the truth. But, unfortunately, I think short sellers are much more aggressive in trying to generate stock moves by using the media or other methods than investors who are long a stock. Which is why I singled shorts out so aggressively in my previous comment.

I mean does this guy who wrote the VG analysis really believe that a company with 2 million paying customers can't find a way to become cash flow positive? I just don't buy that. Sure, VG is being aggressive with their marketing. There's a land grab going on for VoIP customers. It's perfectly logical that they pay to acquire as many new customers as possible. It's early days in a high stakes game and VG must bet aggressively if they're going to achieve their goals...at least that's my point of view. Personally, I hope they make it because I think their service is better, cheaper and more flexible than anything being offered by any of the ISPs. Skype is an interesting alternative - especially now that they have a phone that doesn't require your computer to be on. There are a few other players popping up as well. But the market can certainly afford - and benefit from - multiple players, including your vision for cell phone providers.

Posted by Rex Racer, Dec 28, 2006 5:25PM

Here is the problem with Vonage. It's simple. Forget about all the technology the company promises to deliver, and focus on one thing...cash burn. I spun the same sexy theories back in the late 1990's with a dot.bomb company that I ran (i.e., the idea of a business has more value than its ability to pay its "light bill"). How is Vonage going to get the cash needed to survive once all the IPO money is gone? No colorful Powerpoint presentation is going to convince anyone that the ideas of selling internet phone service with expensive television commercials is a good business.

Posted by pac, Dec 28, 2006 11:35PM

Everyone's right....They have a great products per chris, but at the same time advertising will eat up all the IPO $$(free money).
One important point...atthis time only vonage has the ability to offer mobility with their VOIP service, which means you can take it anywhere, which other VOIP providers like comcast or cablevision do not have.
I guess I am ordering one right now, since I am heading to georgetown...lol figure out which one....

Posted by mlangner, Feb 23, 2007 3:17PM

To Chris: "I mean does this guy who wrote the VG analysis really believe that a company with 2 million paying customers can't find a way to become cash flow positive?"

Since I wrote the analysis, I feel qualified to answer your question. Yes, I don't believe they can find a way to become cash flow positive - the numbers just don't add up. I understand the value that you find in the VG service, and I am not arguing tht it isn't a fine service, I am arguing its a bad investment. As an example, my wife and I loved WebVan, it was an unbelievable valuable service, we were loyal customers - but they couldn't make money so they shut down. I see the same potential for VG becuase they cannot generate enough profit from the customer's that they sign up to offset the cost of acquiring those customers in the first place. Bulls will point to cutting marketing costs as a way to profitablity - e.g., all they have to do is stop spending on new customers and everythign will be hunky dory - the problem is 1.) they can't, customers churn and need to be replaced, 2.) the costs of being a nationwide consumer branded product aren't very scalable and 3.) if they did stop marketing they would stop growing - which would mean the value of the company would be less than today anyway...

As for why should you listen to me or a short seller - or anyone else with a computer and an opinion - you shouldn't. You should make your own qualified decision. That is why I disclose my position up front in the piece - I don't want any confusion about my motivation in sharing my opinion. Your role is to read the piece and decide if my argument holds water, have I backed up my argument with facts? Not to accept it whole cloth. I would hope that my value in that analysis would be that I can provide some points of consideration that bulls would likely not bring up... again you have to check the work though - the data is there. Is it unethical to put that opinion into the market as a short seller? No way. Why should the company be allowed to discuss their earnings without critical assesment? VG spins the hell out of their numbers - using made up terms like "adjusted operating profit" - which ignores a key point of why VG will fail - the cost of customer acquisition. iBanks are conflicted but put their position out there as well. Again - it comes down to weighing the quality of the argument made rather than trusting the opinion in an uncritical fashion...

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