The News

Investors further weakened their connections with

Vonage Holdings

In the fourth quarter, Holmdel, N.J.-based Vonage lost 42 cents a share, in line with Wall Street estimates. There was no comparable per-share figure for the company, which went public in late May. The company said the quarterly loss was less than the same period last year, narrowing to $65 million from $72 million. Revenue rose to $181 million from $95 million a year ago, slightly above the average analyst estimate of $180 million.

The full-year loss hit $286 million, or $3.04 a share, an increase from $261 million in 2005. Through Wednesday's close Vonage stock had tumbled 61% from its IPO price of $14.85.

Disappointing new-subscriber additions and stiffening competition spooked investors. Vonage added 166,000 net subscribers to its voice over Internet protocol, or VoIP, phone service in the last three months of the year, bringing its total customer base to 2.2 million. However, it was the weakest quarter for new subscribers since the first three months of 2005, says Stephane Beckert, research director of Telegeography, a Washington, D.C., telecommunications consulting firm. For the full year the company signed up a total of 955,000 net new subscribers, a 75% improvement from 2005.

Mike Snyder, Vonage's chief executive, said the company is still concentrating on increasing its subscribers. National cable companies including Comcast and Time Warner compete directly against Vonage and have the added advantage of being able to offer the so-called triple play of TV, data and voice services via cable.

"In 2006, the build-out of the business was clearly seen through the growth of our customer base and the resulting impact of scale benefits," CEO Snyder said during a conference call Thursday. "We more than doubled our revenue to $607 million and added nearly one million net subscriber lines while expanding margins and improving our overall operating position." The company projected revenue of $850 million to $900 million this year, shy of analysts' forecasts.

Vonage is funding its investment in expanding the business with its current cash flow, the CEO said, and seeks to become profitable by the first quarter of 2008. Analysts on average expect a loss of $2.69 a share in 2007.

The Analysis

An old saying warns not to pick fights with folks who buy ink by the barrel. Fans of both Vonage and

Tivo

Vonage looked like a promising competitor when it was trying to use its technology to upend conventional phone companies such as Verizon Communications and AT&T. Like Tivo, it had a great idea but little defense once its technology became coin of the realm, and cable companies realized they had a new service to market to a huge and established customer base.

"It's hard for them to lock in any clear advantage relative to other companies that are doing the same thing," says Telegeography's Beckert.

Because it can't bundle services in the same way as the cable heavy hitters, it's at a fundamental disadvantage among convenience-oriented consumers, says Munjal Shah, an analyst at Piper Jaffray.

"In the last year, the cable companies have become more competitive on VoIP," he says. "Vonage thought it would take away lines from Verizon and AT&T and offer more competitive pricing, and initially it did work. That's how the business got started."

Vonage gets an average of $28.25 a month per customer, an increase of $1.03 from $27.22 in the year-ago quarter. The cable companies pull in anywhere from $99 to $120 for their lowest priced triple-play service packages.

But in the fourth quarter alone, Comcast matched Vonage's subscriber additions for VoIP users, and Time Warner had 211,000 new customers for the service.

Shah says Vonage's projections of 700,000 to 900,000 new subscribers in 2007 will bring them up to 3.1 million at the outside. Comcast, which has about 1.8 million voice customers, figures on adding 2.6 million more customers this year, and they'll probably get them.

"It's working for cable because consumers like the triple-play service," Shah says. "The cable companies have leverage, and they're able to charge a little premium in the other services to subsidize the VoIP a little."

Beckert says the impact of cable is somewhat overstated, and that Vonage may be after more of a niche market of price-conscious, tech-savvy customers who could form a base of between 10 million and 20 million subscribers.

"The cable companies are pitching to heavy cable TV users I've got two small kids and I don't have time to watch TV but they're aimed at pretty much average Americans who have cable and are a bit afraid of technology. They're afraid of setting up a wireless router and plugging in their phone. You need to be wiling to take that step it's a leap of faith."

The Bottom Line

But if too few people take that leap, Vonage will be on the same slippery slope as Tivo, which was pummeled when cable operators added digital video recording technology to their set-top boxes and made the original innovator more of a niche offering to people who liked its interface.

Getting new customers costs money, and Shah points out that subscriber additions and marketing spending move in lockstep at Vonage. The company plans to spend between $400 million and $425 million this year, vs. $365 million in 2006. That means the cost per new customer will actually be going up, since Vonage expects to add fewer customers than it did last year.

"It's going to be tough for them going forward," Shah says. "To attain profitability, you're not going to have as much spending on subscriber additions."

Given the limits of the business model and Wall Street's deep skepticism Vonage's market cap has dwindled to $850 million from about $2.3 billion just after the IPO this may be a cautionary telecom tale for the Internet age. Investors should probably avoid the stock, at least until Vonage can better define its market and make more inroads.

"I've rarely seen a company that's been so universally scorned by the investment community," Beckert says. "But somebody bought the stock at the IPO, though nobody seems to admit it."