Why Vonage Is Doomed

In the third quarter Vonage (VG) added 359,000 new subscribers vs. 377,000 in the second quarter. They gave as the reason for the decline increasing competition. They lost 154,000 subscribers due to cancellations for a net gain of 204,000.

Even if they continue to win the same customers in future quarters, their growth will slow dramatically, even if the churn rate goes down to 2.4%, because as their total subscribers increase, churn increases also as an absolute number.

I did a projection using the above assumptions (359,000 new subscribers per quarter, 2.4% churn) and come up with a total of 3.1 million subscribers in March 2008, an increase of 51% versus Sept. 2006.

Projected Income Statement under the assumption of flat CPE (customer equipment) expense of $29, half of SGA expense fixed, half variable, flat marketing expense, flat average revenue per user [ARPU]:

Telephone services revenue ..... $233 Mill.
Direct Costs ................................ (60)
Customer equipment (net).......... (11)
SGA................................................(90)
Marketing......................................(91)
Depreciation..................................(6)

Net loss......................................... (25) , that is over 10% of sales.

Their growth rate at that time will be down to 20% p.a., and profitability nowhere in sight.

Also, their customer acquisition costs are $254 plus $29 for the customer equipment subsidy for a total of $283. If half their SGA expense is variable, total variable costs per line are $13, for an initial gross margin of $13.33.

If you figure in the churn rate, it takes them 27 months after a new customer signs up just to get their money back, without making any profit. Only after that time do they make $13.33 per line, but only half the customers are left.

Moreover, it is likely that by then the ARPU is lower, making it even worse.

Some people have mentioned a buyout. Why would anybody spend money to buy such a huge cash incinerator? Cable and phone companies have much lower customer acquisition costs, and these penny pinching Vonage customers are not so desirable anyway.

Disclosure: Author is short VG

Related: The Short Case on Vonage: Why No Price is Cheap Enough

Comments

[David Neubert:]

If the cut their marketing budget in half they would be profitable by as much as they are losing. And I imagine the most expensive customers to obtain are exactly the same ones who leave so quickly. Amazon numbers didn't look so different for a long time. I remember thinking "back in the day" that Amazon would be profitable if they just cut their marketing.

2006 Nov 15 07:32 PM