Vonage--An IPO filing like it's 1999

Critics say profit-challenged Vonage is going to have a tough time convincing Wall Street it's a good investment.

Do executives at Vonage think it's 1999 again?

Like the founders of many an Internet company in the late 1990s, executives at the Holmdel, N.J., upstart--which has widely marketed its low-cost voice over Internet Protocol (VoIP) service--seem to believe that profits can wait.

"We are pursuing growth, rather than profitability, in the near term to capitalize on the current expansion of the broadband and VoIP markets and enhance the future value of our company," Vonage said in a filing Tuesday with the Securities and Exchange Commission that lays the groundwork for an initial public offering.

No one denies that Vonage is targeting a potentially hot market.

But now that the 5-year-old company has filed for an IPO that could raise $250 million, that "invest now to make money later" strategy is going to be harder and harder to justify.

In fact, Vonage's filing offers eye-popping insight into a company that's captured lots of attention among the technorati without turning that interest into profits. In the first nine months of 2005, Vonage lost $189.6 million against $170 million in sales. It cost the company $213 in marketing dollars to acquire every customer--up from $137 per subscriber the year before. That means, based on Vonage's most popular, $24.99 monthly residential subcription, it would take roughly nine months to break even on marketing costs for each new subscriber.

It gets worse. The average revenue from the company's various pricing packages has dropped to $26.63 per subscriber--from $30.99 a year ago. Vonage officials would not comment for this article.

While Vonage has increased sales at a respectable clip--from $18.7 million in 2003 to $174 million for the first nine months of 2005--its losses have also mounted. The company has lost about $310 million since it started selling its service to consumers back in 2003. Vonage readily acknowledges that its losses, largely due to marketing costs, have increased every quarter and will likely continue for the foreseeable future.

Of course, no one denies that Vonage is targeting a potentially hot market. Forrester Research expects 14 percent to 15 percent of all households in the United States to switch to a VoIP phone service as their primary phone service by 2010. Today, the firm estimates that 4 million of the 107 million households in the U.S. currently subscribe to VoIP.

Cable isn't the only competition for Vonage to worry about.

That's a big target for a small company like Vonage, which has rapidly been signing up new customers. The company more than tripled its subscribers in 2005, and as of Wednesday, it said, its VoIP service had more than 1.4 million subscribers.

But Vonage isn't the only company chasing the VoIP dream. Cable operators have aggressively pushed voice service as part of their service bundles, which also include television programming and high-speed Internet access. And they've already seen huge success. Time Warner Cable reported 1.1 million subscribers at the end of 2005. Cablevision brought its total to roughly 600,000 in the first nine months of last year.

And cable isn't the only competition for Vonage to worry about. EarthLink and AOL are also offering IP telephony services to replace traditional phone service with products that are very similar to Vonage's service. Wireless operators also plan to enter the VoIP market with dual-mode phones that support 3G and voice over Wi-Fi. Sprint Nextel has already joined forces with several cable companies to get this underway. In addition, companies such as Yahoo and Skype have entered the market with free PC-to-PC calling. For a fee, they also allow PC-to-regular phone calling. And Google is expected to launch its VoIP service, Google Talk.

Traditional telephony players such as Verizon, AT&T and BellSouth aren't sitting on their hands, either. They are slashing prices on existing phone services to stay competitive. BellSouth has even teamed up with 8x8 to offer VoIP calling to its customers.

"Vonage will be severely challenged and will need both low prices and more distribution partners to stay in the game," said Maribel Lopez, a vice president at market research firm Forrester Research.

Analysts say Vonage has done a good job marketing the VoIP concept and getting early adopters to sign on to its service. In its marketing materials, the company emphasizes that its customers can choose their own area code and take their phone numbers with them when they move out of the calling area, something phone companies and cable operators don't allow. But experts say that alone won't likely keep customers loyal to the service.

Vonage is also missing critical elements of phone service that consumers have come to rely on, such as always-on service even during an electrical outage and enhanced 911 support, which offers emergency operators the location and phone number of people calling for help. Vonage admitted in the SEC filing that in some cases its emergency system could cause delays or failures in getting needed help.

Even though it could be difficult for Vonage to sell its pitch to investors, Forrester's Lopez says the company has little choice but to go for the IPO.

"If they want to keep their momentum, where are they going to get the money to fund it?" she asked. "They can't take another round from the venture capital community. The VCs are looking to get their money back. So they have to get the capital from somewhere."

Some people point to the $2.6 billion that eBay paid for Skype, the small European company that offers free PC-to-PC Internet calling, as an indication of how hot the market is right now. Skype had 54 million customers (roughly 2 million of them paying, since Skype's service was also offered for free) when it was acquired. But others say Wall Street hasn't forgotten the lessons of the dot-com boom and subsequent bust. And they say they're unlikely to make the same mistakes twice.

Not surprisingly, some competitors say Vonage's IPO road show isn't going to be easy. They should know.

Bryan Martin, CEO of Vonage competitor 8x8, recently has been on the road trying to convince institutional investors of the value of his own VoIP company. 8x8 went public back in 1997 as a video conferencing company, and started selling its Packet8 consumer VoIP service in 2002. With about 113,000 subscribers, 8x8's the fourth quarter revenue was about $8.5 million with a $6.5 million loss.

"I think it's going to be a tough sell for Vonage to market those numbers to Wall Street," Martin said. "It's not 1999. Most of the investors I've talked to are still rolling their eyes over the Skype valuation, and they haven't forgotten what happened after the bubble."

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