Vonage Stumbles on Disappointing 2007 Outlook

Feb.15.07 | About: Vonage Holdings (VG)

It was another rotten day for investors in Vonage (NYSE:VG). The voice over IP phone company reported revenue for the fourth quarter of $181 million, about in line with Street expectations of $180 million.

The company reported a net loss for the quarter of $65 million, with an “adjusted loss from operations,” adding back stock options expense, depreciation and amortization, of $53 million.

Other stats from Vonage were not encouraging. The company added 166,000 net subscriber lines in the quarter, down from 204,591 in the third quarter and 256,000 in the second quarter. Marketing costs per gross subscriber line addition jumped to $306, from $254 in the third quarter and $239 in the second quarter.

More telling, I think, is the marketing costs per net subscriber addition, which is a number you have to calculate, since Vonage doesn’t report it. In the second quarter, marketing per net add was $351.56; in the third quarter, $444.79; in the fourth quarter, $578.31.

For 2007, the company sees revenue of $850 million to $900 million; that is below the Street consensus of $924 million. The company expects marketing expenses this year of $400 million to $425 million, up from $365 million in 2006. Vonage sees an adjusted operating loss of $150 million to $170 million, with positive adjusted operating income “as early as the first quarter of 2008,” a prediction the company has made before. The company expects to end 2007 with 2.9 million to 3.1 million subscriber lines, up from 2,224,000 at the end of 2006.

If you crunch the numbers, you find the company does not see any big reversal in the increasing cost of gaining new subscribers. The company sees net adds of 676,000 to 876,000; based on their marketing forecast, those newcomers will cost between $456 and $629 in marketing dollars.

Daniel Berninger, an analyst with Tier 1 Research, contends Vonage could be profitable if the company would be content to grow the topline at 10%; trim the marketing budget to a third of the planned level, he says, and they could be profitable on a GAAP basis. But he says it makes sense for them to follow their current strategy and grow as fast as possible given the steady uptick in the cost of getting new customers. Berninger, who is one of the few people I know that has been consistently positive on the company’s prospects, contends Vonage has become too cheap: he notes that the stock now trades for under $400 a subscriber, compared with roughly $6,000 for a cable company like Cablevision. The gap, he thinks, is too wide.

I have been consistently bearish on Vonage; I actually wrote a negative story about them in Barron’s before they even filed to go public. In this week’s print edition, I take another swipe at them. (Subscription required for the magazine stories.) But I do wonder how low the stock can go: the market cap today is down to $855 million, and they have $500 million in cash. Now, I happen to think they are in a very bad competitive position, stuck in the no-man’s land between the cable companies on one side and the telcos on the other. But there may be a point at which someone will take a flier on Vonage, maybe as a way to cross sell other services to its customers. I’m not saying it would be a good idea. But as the price keeps sinking, someone might be willing to take the gamble.

Vonage today is down 32 cents at $5.52.

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