Connected Consumer: Vringo

| About: FORM Holdings (FH)


Vringo (VRNG) is a microcap company that provides an innovative video ringtone service for consumers. Since completing an IPO with third-tier investment banks at $4.60 in June of 2010, the shares have languished. But, recently the company launched a more social and connected product that integrates user data from Facebook with their video ringtone technology. The result is a new, more interesting service that doesn’t rely on carrier efforts to grow. This business, while still very new and very small, is off to a fast start. This is a potential catalyst for renewed (or perhaps just new) investor interest in the company. It’s too early for us to consider this name for proper coverage, but the background below is meant to provide some groundwork. If management continues to execute the shares are likely to revisit their IPO level of $4.60 revisit their IPO level of $4.60 in the coming months.

Company Overview

We've known Vringo for two years and always appreciated their innovative "video ringtones" which provide a much richer experience around making phone calls.

The company managed to complete an IPO back in June 2011 and as can be seen in the chart it has not (yet) been a path to higher valuations for them. Although the company has made notable progress in developing their market, the carrier ecosystem makes for slow growth and limited profits. Just ask shareholders in RealNetworks [(NASDAQ:RNWK) - $8.45] or Motricity [(MOTR) - $1.88]!

VRNG Stock Chart

Unlike RNWK and MOTR, VRNG might have found a path to higher growth and better investor positioning. They have a new service called Facetones that combines their video ringtone technology with personal photos to create a much more interesting socially-aware smart phone add-on.

Facetones automatically creates a virtual slideshow mash-up of photos from your friends on Facebook. So when making a call to or receiving one from a person the screen shows a montage of these photos. It’s more personal and less effort than downloading and using a specific video ringtone to the phone.

It’s still early days but there were over 100,000 downloads of the application in the first month. The free version relies on a short post-call advertisement, and the service has reached 300,000 ad impressions/day after one month. User reviews have been favorable (4.3 out of 5 with 252 reviews so far) and although there are some glitches it’s clear many users like it. Installs are continuing although they appear to be declining slightly rather than shifting into exponential growth. It’s a solid first offering in a social/smart phone context for Vringo, and we will have to watch how it develops in the next few months.

Their core business is an important asset that continues to grow after years of building carrier relationships. These include many big ones [Verizon (NYSE:VZ), Orange, Telefonica (NYSE:TEF), Vodaphone (NASDAQ:VOD), NTT docomo (OTC:NTDMF)] with more are in process. Video ringtones represent a small but attractive $1-5/month add-on for carriers and their customers. Sending a video to your friend when you call is still a desirable and fun way to enjoy smart phones. The company has delivered consistent monthly growth in subscribers and grown them about 7x over the past year to 350,000.

4G is another important catalyst for video and VRNG stands to benefit from that. According statements by TMobile on Monday, September 26th, they have seen a huge increase in video use with 4G networks. 15% of TMobile smart phone customers are on 4G yet they account for 50% of the video traffic. These higher speed networks will pave the way for more video-based services.

There are some other related lines of business in video mixing and fan loyalty programs. These have upside with our guess that fan loyalty offerings might be more attractive. But, we will focus in more closely on the Facetones business for now.

The big question for investors and for the company is how the revenue model will develop. The company went to a paid-model in the core video ringtone product line and has both a paid and ad-supported model for Facetones. That still leaves open the question of what the average revenue per user (ARPU) will be for Vringo.

The company has an ARPU target for the core business of $12 to $60 per year. Unfortunately, their biggest success so far is in Malaysia where their ARPU is much lower. Vringo needs to demonstrate a combination of higher ARPU from the core business and validate their Facetones business and revenue model. Even if the ARPU in the core business doesn’t achieve the target ARPU a number much higher than the current $1.20 from Malaysia will be well received. This is an important trend to watch.

Vringo has aggressive goals for Facetones including 1m downloads and 500,000 active users by January. We know these numbers are likely to shift as they get more experience and build a bigger base of data. Our guess is that they will see the 30/10/10 rule start to be a factor in their business.[1] However, many active users they get their target revenue calls for $0.10 to $0.50/month in ad revenue share. A rough estimate would say that every 1m users translates into $1m of quarterly revenue.

Since IP and patents have been such a popular topic with investors lately it's worth noting that Vringo has taken steps to protect their position with 22 filed applications and 2 granted patents so far. There's no easy way to put a value on these but at a minimum they provide a degree of protection.

Vringo recently acquired Zlango which at least on the surface is a silly mobile application that automatically inserts little graphics into your SMS traffic. If you type "martini" you get a little picture of a martini in your text. It’s hard to get excited about the Zlango business. We will assume that the real reasons are the addition of carrier relationships, customers, and geographies. This is another area to watch for further developments.

The management team includes the founder/entrepreneur Jon Medved who is well-known in startup circles and some of our own contacts. He has added members to the operational management team like Andrew Perlman, the President who has a background in consumer entertainment, and Ellen Cohl who is the CFO was at Arthur Anderson. We can't say much about the board now although it wouldn't be surprising if Vringo updates it as they transition into a more commercial company.

Vringo is essentially a public venture-stage company that is now in revenue mode. They just completed a financing with Benchmark Capital and DAG Ventures to add operating capital and fund the Zlango acquisition. Their revenues for the first two quarters of 2011 were $147,000 and $227,000 respectively. Those are small numbers but at least they are growing fast on a sequential basis. Facetones grew from nothing in Q1 to 22% of revenue in Q2. The company lost $1.5m in Q2.

It’s early days for Vringo, and the company has lots of hard work ahead of it. At 1m users, the company will reach $4m in annual revenues. We'll use a price to revenue multiple range of 3-6x yielding a $12m to $24m market cap as a bottom. The scalability of the model is what makes it hard to pinpoint the right valuation. Although it comes with challenges and expenses, the company could reach 10m users and still only have a single digit percentage share of the total market opportunity. That realization would drive revenues to $40m+ and absorb all the additional shares that will be available if the company is successful.

Stated shares outstanding are only 5.8m but share count will expand rapidly with higher stock prices and profitability. For example, there are 8m warrants out at a strike price of $5.06 a share.

In the short to medium term, we'd expect the shares to move up on continued progress and maybe even revisit the IPO price of $4.60. At that level the shares will need some additional visibility on sustained revenue growth and margins to move higher. Still from the current $1.60 that is a substantial move.

If the company continues to develop their business, we will revisit the stock for ongoing coverage as part of our “connected consumer” practice.

[1] “The Rule of 30/10/10” Fred Wilson Blog Post.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.