Vonage future looks troubled

The VoIP service provider has a tough road ahead as it tries to recover from a disappointing opening on the stock market.

Marguerite Reardon Former senior reporter
Marguerite Reardon started as a CNET News reporter in 2004, covering cellphone services, broadband, citywide Wi-Fi, the Net neutrality debate and the consolidation of the phone companies.
Marguerite Reardon
5 min read
After a difficult two days as a publicly traded company, Internet telephony provider Vonage Holdings has a tough road ahead as it faces mounting losses, increased competition and potential shareholder lawsuits.

On its first day of trading on the New York Stock Exchange, shares in the company slid to $14.85, almost 13 percent below the initial offering price of $17. Losses continued on Thursday as shares closed at $13. Many on Wall Street have predicted the stock could finish the week in single digits.

Signs of a troubled debut were apparent before the deal even went out the door. For one, Vonage was already in a precarious situation. It had reportedly filed for its initial public offering only after failing to find a buyer. According to reports, Vonage wanted roughly $2.6 billion for the company, the same price eBay paid for Skype last year--a deal critics said at the time was too expensive.

The second problem is that Vonage's debut also came at a bad time. The market has been in a sharp decline for the past month. In fact, the Nasdaq hit a high on April 19 and dropped about 9 percent in the five weeks that followed.

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"The wind was in their face going into the deal," said John Gibbons, founder of IPO research firm IPOdesktop.com. "My guess is the bankers decided to go ahead anyway since they risked hurting the deal even more if they waited."

It's clear now looking at the market's response, the price was likely set too high. Investors say they are skeptical about the company's long-term viability, despite its strong brand recognition and rapid revenue growth. As a result, Vonage will have to navigate through some rough waters in the next few months as it struggles to compete against bigger and stronger competitors with a wider range of service offerings.

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Vonage is the best known and fastest-growing voice over Internet Protocol (VoIP) provider on the market. In the first quarter of 2006 it nearly tripled its revenue to $118.9 million, and it now boasts 1.6 million subscribers. But the rapid growth has come at a price.

In 2005 alone, it lost about $210.3 million, nearly quadrupling losses from the previous year. It currently has a deficit of about $467.4 million. Most of the loss stems from an aggressive marketing program that plasters the orange-and-blue Vonage logo in national TV advertisements, on Web pages and throughout print magazines.

High-speed spending
According to its filings with the Securities and Exchange Commission, the company has no plans to slow down spending. The 31.3 million shares of stock sold in the IPO raised about $531 million for the company, which it has said it plans to use to continue funding the aggressive marketing campaign. Vonage did not respond to requests for comment.

But the fact that Vonage was losing money was not necessarily enough to scare off investors. From 2001 to 2005, about 47 percent of the companies that went public had negative earnings, according to Jay Ritter, a professor of finance at the University of Florida.

"It's not that unprecedented for a company to go public when it hasn't been profitable," he said. "What is different about Vonage is the scope of the losses, and the fact that they don't intend to slow down that spending."

All of this is happening as Vonage faces its most intense competition since it first started offering service in 2002. Phone-service giant Verizon Communications has all but declared war on Vonage by more aggressively marketing its often-forgotten IP telephony service, called VoiceWing.

Earlier this month, VoiceWing matched Vonage in pricing, dropping its monthly fee $5 to $24.99 for unlimited U.S. local and long-distance calling. Verizon also dropped the price of its traditional phone service, offering its basic unlimited local and long-distance U.S. calling plan for $29.95 a month.

Cable companies also have begun aggressively marketing their phone services as part of a total package that includes high-speed Internet access, cable TV and phone service. The strategy seems to be working as they rack up more customers. Time Warner added 270,000 digital phone subscribers in the first quarter of 2006, its biggest gain ever. And Comcast, the largest cable provider in the U.S., added 211,000 new phone customers during the quarter, more than it had signed up during all of 2005.

eBay's Skype, which has never marketed itself as a phone replacement, is starting to compete more directly with Vonage too. As part of a promotion to get more people to use its service, users can now make free "SkypeOut" calls to traditional landline and mobile phones in the U.S. and Canada until the end of the year.

"The bad thing is that Vonage really needs to pull the brakes on its marketing campaign at a time when they need that marketing the most to acquire new customers," said Patrick Comack, an analyst at Zachary Investment Research.

But some analysts fear competition is only one of the many worries that Vonage faces. The decline in the company's stock price over the last couple of days could spur lawsuits.

"There is always a risk of a lawsuit whenever you put together a public offering," said Jocelyn Arel, a partner at Goodwin Procter, a law firm based in Boston. "Nine times out of 10 when you see a company come out and take a nose dive like Vonage did, you see plaintiffs circling to file lawsuits."

Vonage also may have damaged its relationship with some of its customers. About 13.5 percent of the shares offered during the IPO were sold to customers. Demand was strong for the shares before the IPO, as some customers may have had flashbacks of the IPO heydays of the late 1990s. But now that the stock has fallen so fast and so quickly, some of those customers could be displeased.

"If customers got hung out to dry, they're not going to stick around with the service," said Comack of Zachary Investment Research. "And I'm sure they'll be wanting to get their money back some way."