You don't have to pay for your Vonage shares

[DesertCat]

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Vonage Will Pay Underwriters
For Shares Its Users Don't Want
By DIONNE SEARCEY and IAN MCDONALD
May 31, 2006; Page C3 Wall Street Journal

Vonage Holdings Corp., which just conducted one of the most unsuccessful initial public offerings in nearly two years, has offered an unusual contingency to its underwriters: If the Internet phone company's customers balk at agreements they have made to buy shares, Vonage will cover the cost.

The plan was spelled out in Vonage's registration documents filed with Securities and Exchange Commission before the IPO and before customers started having second thoughts about their agreements to buy shares.

Generally underwriters are on the hook if investors who commit to buying IPO shares change their minds after the stock tumbles. But Vonage, one of the largest Internet phone companies, indemnified its underwriters -- led by Deutsche Bank AG, Citigroup Inc. and UBS AG -- for the portion of its issue its customers agreed to buy, according to the prospectus.

Setting stock aside for customers is an unusual move. Typically IPO shares are bought by deep-pocketed institutional investors and often surge in their first days of trading, making them coveted by Main Street investors.

But Vonage set aside up to 13.5% of its $531 million IPO for its customers, selling to them via email and messages left on voice mail. The idea was to build tighter ties with clients and to create a buzz for the IPO.

That plan backfired when Vonage shares sank after they were initially offered at $17 last week. In 4 p.m. composite trading on the New York Stock Exchange yesterday they were at $12.50, down 52 cents, or 4%, for the day and 26% since their debut.

"Maybe on paper this sounded like a good idea," says Tom Taulli, author of "Investing in IPOs" and an adjunct business professor at the University of Southern California's Marshall School of Business. The move to give customers access to IPO shares isn't common and given Vonage's experience, "it may go from rare to extinct," Mr. Taulli says.

One online forum, vonage-forum.com, had many Vonage customers unhappy with their investments. Greg Foulks was allocated 500 shares of Vonage but now is trying to decide whether he should stop payment on his $8,500 check. He worries the tumult surrounding the IPO could prompt Vonage to scrap the whole deal.

"It's a big mess and we need Vonage to provide some answers," Mr. Foulks, of Columbus, Ohio, wrote in an email. "Meanwhile I'm stuck with a dog of a stock that will likely see $6 in the coming months."

The question now is what happens if investors like Mr. Foulks refuse to execute their trades. In SEC filings, Vonage stated that it "agreed to indemnify the underwriters" in case the customers turned investors fail to pay for and accept delivery of the stock.

If the underwriters seek indemnification, Vonage would likely have no legal standing to sue the investors, according to experts. But the underwriters do have that recourse and could decide to pursue it instead of seeking indemnification.

Vonage declined to comment, citing a legally imposed quiet period following the IPO.

But CNBC yesterday reported Vonage issued the network a statement on Sunday stating that it wanted to avoid "alienating" its customers. If "certain" customers who refused to buy the shares didn't pay, Vonage expects "to repurchase shares from the underwriters if necessary," CNBC reported.


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[kyleb]

Wow. What a [censored] mess.

[PassiveCaller]

Vonage is a total disaster.............

[hawk59]

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Vonage is a total disaster.............

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I know next to nothing about the VOIP industry, but I do figure it will grow and VG grew their revs by 230% last yr. And it doesn't take many years of 200% growth to make silly valuations look not so silly. You just need to keep an open mind is what I am saying.

[PassiveCaller]

Very true. Keeping an open mind is very important.

I should have said "vonage ipo was a disaster..." I haven't done nearly enough homework to have a firm opinion on this industry although i do know the competition is already steep with Skype/Ebay and MS on its way in (and more Google/AOL/etc). My inclintion though is things are going to be tough with that competition and SkyPe being free.

Those companies can afford to keep up with that and be more creative with the revenue to build up a base but can Vonage?

[DesertCat]

I haven't looked at their prospectus, but from what I read, their losses have grown just as fast as their sales. If that's true, the faster you grow the more cash you burn, and it won't take long to burn all this new IPO money. IIRC they have a customer turnover problem.

[thing85]

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I haven't looked at their prospectus, but from what I read, their losses have grown just as fast as their sales. If that's true, the faster you grow the more cash you burn, and it won't take long to burn all this new IPO money. IIRC they have a customer turnover problem.

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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).

[DesertCat]

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The Associated Press/HOLMDEL, N.J.
JUN. 1 5:07 P.M. ET Ending speculation, Internet phone company Vonage Holdings Corp. said customers who agreed to buy into its initial public offering last week must follow through on their commitment to buy shares, even though they have fallen more than 29 percent in value.

Vonage had set aside up to 13.5 percent of its $531 million offering for customers, an unorthodox move aimed at increasing customer loyalty and creating publicity ahead of its IPO. That move backfired when the stock dropped almost as soon as it started trading.

IPO participants committed to buy the stock at $17 a share. On Thursday, the shares closed at $11.63, down 39 cents, or 3.2 percent, on the New York Stock Exchange.


Under the terms of the program allowing customers to participate in the IPO, "if a customer was allocated shares in the Customer Directed Share Program, that customer is obligated to purchase their share allocation from the underwriters," Vonage said in a statement late Wednesday. "To be clear, we have not offered and are not offering to repurchase any of the shares of common stock from our customers."

However, Vonage said in its prospectus that it has agreed to pay the banks that arranged its IPO for any losses arising from customers who refused to pay for their shares. That unusual provision helped fuel speculation, even though it may have been legally impossible for Vonage to buy back shares from one class of IPO investors to the exclusion of others.

Deutsche Bank, Citigroup and UBS were the lead underwriters of Holmdel-based Vonage's offering.


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If the prior articles are accurate, it doesn't matter what Vonage says. If a buyer doesn't pay their broker for IPO shares, Vonage will be on the hook to pay for them. And Vonage has no leverage over the buyer to get compensation.

[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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[pvn]

So what does this mean? If I had bought shares through the IPO, and still had them, I could just return them and owe nothing? If I had already sold them (at a loss, presumably, since I don't think VG ever traded above the IPO price), would I get my money back?

I did get offered IPO shares as a customer, but I declined to act on the offer.