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Vonage IPO: Lots of Style, Little Substance

Voice over IP (VoIP) start-up Vonage Holdings Corp. filed a prospectus for an initial public offering (IPO) with the U.S. Securities and Exchange Commission yesterday. While not specified in the document, Vonage is reportedly seeking to raise $250 million through the stock sale. The filing forces Vonage to let the financial and analyst community take a look under the hood of its VoIP-mobile. The verdict: Vonage has the sleek body of a Ferrari, a shell it has paid handsomely for, covering the engine and suspension of a 1986 Yugo. After launching its VoIP service in 2002, Vonage racked up $310 million in cumulative losses through September 30, 2005. Vonage lost $189.6 million during the nine months of 2005 alone thanks to an unbelievable $176.3 million in marketing expenses, compared to only $174 million in revenue. During this same period, Vonage reported $25.60 in average telephony service revenue per line with a marketing cost per gross subscriber line addition of $213.77. One has to wonder: Is Vonage building a real company or just buying itself a brand name? In its prospectus, Vonage is careful not to reveal how many customers it actually serves. Instead, Vonage reports "lines," an odd metric for a VoIP provider that offers a line-less service. Vonage said it counted 1.4 million lines as of February 8, 2006. The kicker is that Vonage defines lines as: "All subscriber lines from which a customer can make an outbound telephone call ... Our subscriber lines include fax lines, SoftPhones and WiFi phones." In other words, a customer with a VoIP adapter at home, softphone client on their PC and a WiFi phone counts as three lines, even though they may be using these as part of a single subscription. Vonage touts its "satisfied, loyal customer base" in the prospectus and presents a 2.11% customer churn rate as evidence. However, in the fine print, Vonage notes "terminations, as used in the calculation of churn statistics, do not include customers terminated during the period if termination occurred within the first 30 days after activation." In other words, someone that tries the service for a few weeks, decides it stinks and cancels, never really was a customer. And, Vonage notes it calculates churn based on customers, rather than lines. So which are they counting and reporting, lines or customers? Now, let's get to the quality of the Vonage VoIP service. The company notes for the record that "certain aspects of our service are not the same as traditional telephone service." For example: "Our customers may experience lower call quality than they are used to from traditional wireline telephone companies, including static, echoes and delays in transmissions." And, Vonage "customers may experience higher dropped-call rates than they are used to from traditional wireline telephone companies." Not to mention, "Our basic emergency and new E-911 calling services are more limited than those offered by traditional wireline telephone companies and may expose us to significant liability ... In each case, those differences may cause significant delays, or even failures, in callers' receipt of the emergency assistance they need." It seems Vonage has no qualms about spending millions trying to convince consumers to drop their primary line phone service, leaving them with questionable emergency services access. Perhaps as part of some sort of cosmic boomerang, Vonage is having difficulty with local number portability provisioning. The company notes: 'Transferring numbers is a manual process that in the past could have taken us 20 business days or longer É A new Vonage customer must maintain both Vonage service and the customer's existing telephone service during the transferring process.' Not exactly a smooth transition. Investors are also warned about the background of Vonage Founder, Chairman and Chief Strategist, Jeffrey A. Citron. The prospectus notes: 'Prior to joining Vonage, Mr. Citron was associated with Datek Securities Corporation.' While he was there, 'the SEC alleged that Datek Securities, Mr. Citron and other individuals participated in an extensive fraudulent scheme involving improper use of the Nasdaq Stock Market's Small Order Execution System É Mr. Citron and other individuals entered into settlements with the SEC in 2002 and 2003, which resulted in extensive fines, bans from future association with securities brokers or dealers and enjoinments against future violations of certain U.S. securities laws.' It will be interesting to see how investors respond to this offering when Vonage stock hits the street.
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