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Vonage's red ink: why all the woo-hoo in the world won't help

It's awful difficult to look at Vonage's second-quarter 2006 numbers and see anything more than a company starting to circle the drain as it chases its own tail.First, the basics: the company lost $74 million last quarter.
Written by Russell Shaw, Contributor
It's awful difficult to look at Vonage's second-quarter 2006 numbers and see anything more than a company starting to circle the drain as it chases its own tail.

First, the basics: the company lost $74 million last quarter. Yes, I know those losses were down from $85 million in 1Q, but at what cost? Let Vonage explain:

During the second quarter the Company continued to pursue its strategy of investing in marketing for customer acquisition, retention and brand building. Total marketing costs were $90 million in the second quarter 2006, 46% above the year-ago quarter amount of $62 million, and 2% above the prior quarter 2006 amount of $88 million.

I read numbers like this, and my first thought is that the company is spending so much on advertising and marketing, that no wonder there have been enough subscriber gains to narrow the loss. But just because the loss has been narrowing doesn't mean a trend line here.

As the big broadband cable companies and telcos aggressively market their VoIP services in attractively priced triple and quadruple-play packages, and the IMs increasingly add and market inexpensive (if not free) voice services, Vonage will have no alternative but to market even more.

Now, consider if you will Vonage's admission that:

Marketing costs per gross subscriber line addition were $239 for the second quarter 2006. The comparable amount for the year-ago quarter was $236.

That tells me that Vonage is spending more for each subscriber attained. This could be because of inflation in advertising rates charged by websites and media outlets Vonage is advertising on, as well as the need to spend more to articulate service differentiation. More ominously, the increased subscriber acquisition costs could be a sign that the low-hanging fruit of the technologically curious early adopters has already been picked, and it will only keep costing more and more to compete in the mass market. 

Customer premise equipment ("CPE") subsidy, a measure representing the net cost of a Vonage-enabled device per gross subscriber line addition, was down $3.32 to $24.68 for the second quarter 2006 from $28.00 in the year-ago quarter.

This could merely be an artifact of greater equipment purchasing efficiencies attributable to bulk purchases made on the expectation of more subscribers. OK, but are these subscribers sticking around?   

Average monthly customer churn for the second quarter 2006 was 2.3% versus 2.1% the prior quarter. The increase was attributable in part to the rapid growth in subscriber lines during the first half of 2006, a period in which approximately 800,000 gross lines were added.

Huh? Vonage seems to be saying that because we've added more lines, a greater percentage of our customers are leaving us. To me, this is akin to saying that newer customers are less likely to stick around than loyal older customers are.

If these newer customers are responsible for a 9.5% rise in churn, what does that say about the plausibility of using these new customers as part of your argument that because you have all these new subscribers, you hold the promise of turning the corner?

Instead, this tells me that the type of new subscribers you are getting are those that you have reeled in by price rather than VoIP functionality, and if they don't see a fair balance between price and quality they are going to leave as soon as they experience one more episode of bad call quality, or are woo-ed away by a triple play from a company they already get their broadband from.

Or, from a cheaper IM alternative. 

What's next? More woo-hoo ads and Vonage-sponsored race car drivers? If you can tell me how that's going to instill consumer confidence in the next six months as one big honkin' combined class action suit against Vonage hits the mass media,than you are smarter than I am.

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