Last week, Vonage (News - Alert) announced its fourth quarter results and provided a mixed bag from which many conclusions could be drawn. Every type of service provider faces its own challenges in today’s market, whether it is a telco, a cableco or an over-the-top provider like Vonage. They may all be chasing the same customer, but each has a distinct set of issues and competitive pressures. I’ll explore as many as I can in future columns, and with Vonage’s recent news, the time seems right to spend some time on them.

 

I’ve been commenting about Vonage on my blog and with the media for a few years now, and have always viewed them as the Great White Hope for competition in the U.S. telecom market. This column only has space to focus on their current situation and will try to assess whether they still offer hope.

 

Before considering some of the key Q4 numbers, let’s remember there seems to be no middle ground with this company. Most people either love or hate Vonage, and it’s not hard to find voices for either camp. The Vonage bashers have three main contingents — competing service providers, unhappy customers, and investors. Vonage lovers would primarily be happy subscribers, but it’s safe to say this audience is shrinking and less vocal these days. Actually, there’s a third point of view about Vonage, but you don’t hear much about them. This is the indifferent audience, made up largely of people who have written Vonage off already, and simply stopped paying attention. There is validity to their position, but it does not really help us understand what to make of the company’s current performance.

 

There were certainly many positives in the Q4 results, including:

 Of course, there is plenty to be concerned about:

Clearly, Vonage is no longer the RBOC-killer threat that had all the telcos running scared in 2004. This was before the cable operators got into VoIP, and Vonage was able to dominate a nascent market. That all changed with the bundle, which has proven more appealing to the mass market than a standalone landline replacement offering like Vonage. It is very easy to poke holes in their business model, and the market never warmed up to Vonage as a public company. The growth prospects were there, but not the profits.

 

To be fair though, nobody has found residential VoIP to be profitable yet, but at least the cablecos can afford it as a loss leader to capture a larger share of wallet with the bundle. As Vonage’s numbers bear out, it costs around $7.00 a line to deliver service, and with an ARPU around $28.00, there is lots of margin available provided your operational expenses can be spread out across a broad range of services. Vonage doesn’t have that luxury, and with a singular offering, the economics do not add up.

 

So, where does Vonage go from here? The short term prospects are not bright. They no longer have the cash on hand to finance the debt, and unless they can renegotiate, Vonage could be forced out of business by year end. Capital markets of course are shaky right now, and heading into an election year, there is a lot of uncertainty which does not favor Vonage. The cable operators now dominate the VoIP market, and it is becoming increasingly difficult to acquire new customers. Compounding this are the black eyes suffered by VoIP last year by two other well known players — SunRocket’s demise and Skype’s (News - Alert) service outage last summer. Vonage’s continued high churn levels reflect the state of confidence subscribers are having about their long term viability and VoIP as a primary line service. Finally, as Web-based alternatives proliferate, the race to zero for voice continues, making it more likely that Vonage’s ARPU will go down, not up.

 

Vonage is trying to strengthen its value proposition with new features such as visual voice mail and virtual phone numbers, and planned features such as outbound fax and ContactBook, but it essentially remains a landline replacement service. I agree with Jeff Citron’s position that there will always be a market for best of breed services like this, but it’s increasingly becoming a niche, as the bundle continues to win the day. Furthermore, most of the global growth potential for residential VoIP lies outside the U.S., where Vonage has limited presence and brand recognition. Their survival rests primarily on how they do in their home market.

 

Customer service is another major issue, and is the most important aspect of the business that is fully within their control to fix. The recent launch of MyVonage and the V-Portal as well as new features are important steps in the right direction, but one could argue it’s too little, too late. Actually, this should be somewhat qualified, as service quality problems can be deliberately created by the last mile operators who want to make Vonage look bad and cause subscribers to go back to their incumbents. To whatever extent this is true, Vonage has to rise above that and find ways to become exceptional providers of customer service. In my view, it is far more important for them to protect the base they have worked so hard to build so far, than it is focus on growth for the sake of scaling the business.

 

If you strip away the litigation issues — which they have weathered — and the turnover in senior management, many attractive elements remain. Vonage is on track to becoming a billion dollar company, and if there were no patent suits, and if they could get their marketing spend under control, they would have a very profitable business. There may be very few people left who believe this, but if I was in line to cash out my convertible debt with Vonage, I would look more closely at those numbers before pulling the plug.

 

It’s not clear to me if Vonage is better off being acquired or partnering with an established carrier, but I do know that the monthly revenue stream from 2.6 million subscribers is too valuable to be thrown away. Let’s not forget there’s a wireless spectrum auction coming up, and I wouldn’t rule this out as a factor in what happens to Vonage later in the year. They may no longer be the Great White Hope of telecom competition, but nobody has a more valuable brand in VoIP. The Q4 numbers may provide plenty of reasons to bury Vonage, but I don’t think I’m alone in picking out the good pieces and seeing reasons to believe.

 

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