Vonage Holdings (VG)

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Vonage Holdings (NYSE: VG) is a leading provider of voice over Internet protocol (VoIP) telephone services in the U.S., with over 2.4 million subscribers.^[1] Through monthly service plans, customers can utilize many features that are not available on traditional telephone lines at little or no additional charge. Vonage competes with traditional phone companies as well as cable companies, who are becoming more prevalent in the telephone industry.

One example of Vonage's phone plans is the World Plan, which offers free unlimited calling to landline phones in all cities and locations in more than 60 countries with popular features like call waiting, call forwarding and voicemail for one low, flat monthly rate.^[1] Vonage's service is sold on the web and through national retailers including Best Buy (BBY) and Wal-Mart (WMT) and is available to customers in the U.S., Canada and the United Kingdom.

Company Overview

Vonage is a leading provider of broadband telephone service. Their Voice over Internet Protocol (VoIP) technology allows for inexpensive communications similar to traditional telephone service. Vonage offers a number of service plans to subscribers, each with features similar to (and in some cases beyond) those available through traditional phone line services.

Business and Financial Metrics

First Quarter 2010 Results (ended March 31, 2010)

During the first quarter, Vonage generated net income of $14 million or $0.07 per share. This was an improvement from $5 million or $0.03 per share in the first quarter of 2009 and $4 million or $0.02 per share, sequentially. Vonage reported record adjusted EBITDA of $40 million, up from $21 million in the year ago quarter and $34 million sequentially. Revenue of $228 million increased from $224 million year-over-year and sequentially. Income from operations increased to $25 million, up from $5 million in the year ago quarter and $19 million sequentially.^[2]

VoIP Technology

Using VoIP technology, voice signals are converted into digital packets and transferred over the Internet. There are three steps that take place when a Vonage subscriber makes a call:

1. The sound travels from the customer's handset to their Vonage-enabled device, which converts the analog audio signals into digital data packets.
2. These packets are sent through the customer's existing broadband connection to a call processing center.
3. The digital packets are then routed in one of two ways, depending on the recipient of the call. If the recipient is also a Vonage customer the packets are routed directly over the Internet to their location and converted back to analog signals. Otherwise, the packets are routed through one of Vonage's regional data connection points, where they are converted to analog signals and sent to the public switched telephone network.

Services

Vonage provides subscribers with some features that are not available on standard telephone lines. Many of these features come at no cost, while some require additional fees. All the Vonage calling plans include call waiting, caller ID, and call forwarding.

Basic and Enhanced Features (no charge)

• Area Code Selection: Customers can choose the area code for their phone line. This allows subscribers to avoid long distance charges regardless of their physical location.
• Service and Number Portability: Vonage customers can use their Vonage phone number to make and receive calls anywhere that has a broadband Internet connection.
• Online Account Management: Vonage offers online options such as real-time feature management, call forwarding options and a lifetime call activity log.
• Personalized Web-Enabled Voicemail: Customers can access their voicemail messages through an audio file sent to their email account. Vonage customers are also able to check their voicemail online or from a touchtone phone.

Premium Features (additional charge)

• Virtual Phone Number: Customers can pay an additional fee to have a second number ring on their primary line. These different numbers can have different area codes, which allows customers to receive calls from people in different areas of the country without those callers incurring long distance charges. In addition to U.S. area codes, Vonage also offers virtual phone numbers from Canada, France, Italy, Ireland, Mexico, Spain, and the UK.
• Toll Free Plus: For an additional fee, Vonage customers can hold a toll free number on an existing subscriber line.
• Vonage SoftPhone: SoftPhone is a computer application that can be downloaded and installed onto a customer's computer, enabling them to make calls without a telephone. SoftPhone essentially turns the customer's computer into a fully functional telephone.

Operating Metrics

• Churn: The percentage of customers lost during a given period. It can be seen as an indicator of customer satisfaction as it measures the percentage of customers retained. Vonage has recently seen higher churn rates.

• Customer Acquisition Cost (CAC): The amount of money spent per customer gained. For Vonage, the majority of this cost stems from marketing expenses. Average monthly marketing cost per additional line is a similar metric that Vonage uses.

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Trends and Forces

Demand for VoIP service

Many consumers are skeptical of switching their phone service over to an Internet-based system. Traditional phone service is very well established and reliable, and, in many cases, the savings margins of Vonage's service are relatively small. VoIP service has been criticized for inconsistent call quality and is still a developing service.

Decreasing costs of alternative providers

In recent years, cable providers (who happen to provide the broadband Internet that Vonage customers use for VoIP) have been bundling multiple services into a single package. Most of these package deals include Internet service, cable television, and telephone service. By doing so, these companies have been able to cut service prices significantly. These package deals are also very convenient for consumers as they combine three services into one bill with one provider. If the competition amongst cable companies builds and the price wars continue, the implied price of the phone service they provide could become significantly cheaper than what Vonage offers.

Increasing churn & the marginal cost of customers

tVonage has seen increases in both its churn rates and the cost of acquiring new customers. These two trends coupled together are especially negative for Vonage. The cost of acquiring new customers is rising because the target market is shifting away from "early adopters", who often need little convincing to switch providers, to a increasing mainstream market. As a result, Vonage is forced to spend more money on marketing to gain these mainstream customers. At the same time, Vonage's increasing churn rate means that it needs to gain a steadily rising number of new customers to maintain its customer base. This is a particularly toxic situation; Vonage needs more and more new customers, and each new customer costs Vonage more to win over than the previous ones.

Competition

Other VoIP Providers

Companies like 8x8 (EGHT) provide very similar services as Vonage. Barriers to entry are not very high.

Incumbent Telephone Companies

Vonage's primary competition comes from traditional phone companies that have (in most cases) been in business for many years. These companies include: AT&T (NYSE: T), Qwest Communications (NYSE: Q) and Verizon Communications (NYSE: VZ). These companies are all much larger than Vonage and include many customers who don't have broadband internet access (and are thus unable to use Vonage) or are satisfied with their current provider. Furthermore, when Vonage customers make a call, the connection travels over these incumbent companies' "last mile" connections to reach the recipient of the call. For this service, Vonage pays their competitors directly. However, when a customer of one of these competitors calls a Vonage subscriber the incumbent phone companies pay nothing to Vonage. Below are some metrics that compare Vonage to major incumbent telephone companies.

Cable Companies

These companies include Cablevision Systems (CVC), Comcast (CMCSK), Cox Communications, and Time Warner Cable. These companies are investing increasingly in last-mile broadband connections and, as a result, positioning themselves to use these connections to increase their share of the telephone service market. Cable companies are marketing many of their products as package deals. In many cases, cable companies are now offering fixed monthly prices for a bundle of cable television, Internet access, and phone service. This bundling allows for often substantial cost savings, which can make the implied cost of cable phone service lower than the prices for Vonage's VoIP services. To remain competitive with these providers, Vonage relies on its unique features such as area code choice and portability.

Wireless Telephone Companies

Wireless service providers like AT&T, Sprint Nextel Corporation, T-Mobile USA, Inc., and Verizon Communications (VZ) have customers that utilize wireless phones as a replacement for a traditional phone line. These companies also provide wireless broadband Internet access and could potentially offer VoIP services in the future.

References

1. ↑ ^{1.0 1.1} About Vonage
2. ↑ Vonage Investor Relations: "Vonage Holdings Corp. Reports First Quarter 2010 Results" May 5, 2010
3. ↑ Vonage: Factsheet