[DesertCat]

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Not necessarily so. Their losses stem mostly from high marketing expenses. This is not uncommon for a new "high tech" company trying to penetrate the market. As time passes, revenue should still be able to grow while marketing costs are either maintained or decreased. It's a new technology and is still limited by the broadband subscriber base (as this is what the technology is based on).

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Great tech startups do grow revenues much faster than expenses and eventually become profitable. We of course heard this a lot during the internet era, and in the end few actually did it. In this specific case I'd be very skeptical if Vonage can.

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WSJ - 5/18

While Vonage doesn't release statistics on customer complaints, the company has been reporting an increase in customer defections. Some 77,000 subscribers quit the service in the first quarter, or about 2.1% per month. That compares with a loss of 1.9% per month in the fourth quarter of last year.

In a recent SEC filing, the company attributed the rise to "our rapid growth and inability to hire enough qualified customer care employees which led to less than satisfactory customer care during the quarter, which we are working to address." Vonage acknowledged many customers encountered long waits to speak to company representatives and said it has made hiring and training more representatives a top priority.

New customers vastly outnumber defections. Vonage added a record 328,000 subscribers in the first quarter and customer numbers have skyrocketed from 86,000 at the end of 2003, the year the company launched service, to 1.6 million. Vonage, based in Holmdel, N.J., owes its fast growth largely to its low price of $24.99 a month, which includes free features like voice mail. Recently it added free calls to much of Western Europe as part of its $24.99 unlimited-calling plan.


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WSJ 4/29

Vonage's rapid growth, however, has been expensive, and the company projects continued losses. In 2005 and the first quarter of 2006, Vonage said it spent $332 million on marketing, while posting revenue of $388 million and racking up a loss of $334 million.


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Marketing expenses can only decline in relation to revenues if you are able to hold on to your customers. Vonage is losing almost 25% of their users each year. In the first quarter they added 322k subscribers at a marketing cost of $88M minus an equipment sales of $7M, but plus COGs of $17M, or about $307 per subscriber. If the average subscriber is lasting 2 years, that's $600 in total revenues before expenses.

Q1 service revenues were $111M. Minus G&A($53M) & cost of the service ($38M), they are only netting 18% of revenues, or about $4.50 per month per customer at $25 per month. To cover customer acquistion costs alone (no profit), they need that customer to stay more than 68 months (5 years and 8 months).

Where is the scale in this? The only way it works is if they can substantially lower costs, increase revenues per customer, and lower customer turnover. Growing more with their current customer acquisition costs is just a way to die faster.

And there is a reason Vonage was forced to go public. They couldn't sell themselves. No one would buy them and the founder was desperate to cash out, probably because he was afraid Vonage would crash and burn. They aren't Skype, Vonage has a very costly infrastructure. Skype's business model is about 100x better.

And finally I wonder if the expense category summaries in their prospectus are accurate, and whether customer acquisition costs might be even higher than I estimated. It's pretty easy to hide customer acquisition costs in other categories, but only a company with unethical leadership would even think of doing that. Hmmmm.....

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The past background of our founder, Chairman and Chief Strategist, Jeffrey A. Citron, may adversely affect our ability to enter into business relationships and may have other adverse effects on our business.

Prior to joining Vonage, Mr. Citron was associated with Datek Securities Corporation and Datek Online Holdings Corp., including as an employee of, and consultant for, Datek Securities and, later, as one of the principal executive officers and largest stockholders of Datek Online. Datek Online, which was formed in early 1998 following a reorganization of the Datek business, was a large online brokerage firm. Datek Securities was a registered broker-dealer that engaged in a number of businesses, including proprietary trading and order execution services. During a portion of the time Mr. Citron was associated with Datek Securities, the SEC alleged that Datek Securities, Mr. Citron and other individuals participated in an extensive fraudulent scheme involving improper use of the Nasdaq Stock Market's Small Order Execution System, or SOES. Datek Securities (through its successor iCapital Markets LLC), Mr. Citron and other individuals entered into settlements with the SEC in 2002 and 2003, which resulted in extensive fines, bans from future association with securities brokers or dealers and enjoinments against future violations of certain U.S. securities laws. The NASD previously had imposed disciplinary action against Datek Securities, Mr. Citron and other individuals in connection with alleged violations of the rules and regulations regarding the SOES. These and other matters are discussed under "Information Concerning our Founder, Chairman and Chief Strategist."

There is a risk that some third parties will not do business with us, that some prospective investors will not purchase our securities or that some customers may be wary of signing up for service with us as a result of allegations against Mr. Citron and his past SEC and NASD settlements. We believe that some financial institutions and accounting firms have declined to enter into business relationships with us in the past, at least in part because of these matters.


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