Why Mixed Signal Phones are Bad News for Vonage

Lots of excitement recently about mixed signal phones - phones that operate both on a wireless network and a wi-fi network connected to an VOIP enabled router. Some have argued that this is a big deal for Vonage (VG) as it will drive more users to take on VOIP.

This may be true, but this development is not a good thing for Vonage - in fact its a bad thing as it has the potential to add to VG's competitive woes - even if it does drive more users to consider VOIP as a product for their home phone.

Note: We are short VG. See our rationale for why we are short here.

At the core of the problem are VG's Average Revenue Per User [ARPU] assumptions - which, according to the analysts' models from the banks covering the company, are pretty stable over the next 10 years. The reason they are stable is that if ARPUs drop much then the discounted cash flow [DCF] valuations that support the current $1B valuation move into negative territory - and VG never digs out of the funding hole it has been digging for itself since before its IPO.

We have already seen Comcast (CMCSA) pushing $19.95 service on a bundled basis in certain cases. This is already below the $24 ARPU where we believe Vonage gets into real trouble vis a vis reaching cash flow before running out of cash - assuming all the other VG assumptions, such as line growth and Customer Acquisition Cost [CAC] targets are met.

VG cannot compete with Comcast because they don't have an integrated product with which to compete. The beauty of IP telephony is that it's cheap to supply - e.g. you don't have to build an expensive network - but it's a double edged sword as there are NO barriers to entry.

Comcast will have the same economics as VG for the service - but much better CAC costs because 1) they have a captive customer base to market to, and 2) they can spread their marketing costs across a larger customer base and more products than VG.

Other considerations give Comcast more pricing flexibility than VG - e.g., VOIP can be a throw away to keep video customers (which drive everything from advertising rates, to programming expense/revenue, to network utilization rates). VG lacks that ability with its cheap phone-only offering.

Now, imagine the big cellular players getting into this market as well. VG has no way to "lock up" customers the way that cellular players can through service contracts. Like a Comcast, VOIP will be an add on to a cellular provider's core wireless service - something that they can make a small profit on or even lose money on and have it be beneficial to the overall bottom line - a luxury that VG just doesn't have. So while any VG customer who has a cell phone becomes a potential customer for the cellular provider, VG doesn't have the same ability to "poach" cellular customers.

In order for mixed signal phones to be an advantage for VG, those customers will have to decide to contract separately for the cell and VOIP services - something that we see as unlikely, especially if they are getting a big break/subsidy from the cellular provider for the equipment as part of the cellular contract. And who pays retail for cell phones? Even if a customer were to separately contract the only reason we can think of would be for cheaper service from VG over the cell provider - which puts us right back into the falling ARPU problem.

This is yet another reason to steer clear of VG on the long side - or short it if you are so inclined.

VG 6-month chart:

Disclosure: Author is short VG