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In the third quarter Vonage (NYSE: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

Source: Why Vonage Is Doomed