Vonage Phones In

Justin Hibbard

Vonage CEO Jeffrey Citron stopped by yesterday. For a mile-a-minute New York talker, he was deafeningly silent on the subject of his company's future financing plans. (We mentioned Vonage as a potential IPO candidate in a story last week.) But he gave us an update on his four-year-old company, which, for those who don't know, is the largest provider of Internet phone service, also known as VOIP (voice over Internet protocol). By my back-of-the-envelope calculation, if Vonage keeps adding customers at its current pace, it could earn as much as $223 million in revenue this year, which would more than double its revenues last year. That's a lot of dough, and it explains a crazy rumor I heard recently about Vonage's valuation. ($1 billion. Citron wouldn't comment.)

How did I arrive at my revenue projection? As of January, Vonage had 400,000 subscribers, who sign up for a month-to-month calling plan. The company is currently adding more than 10,000 net new subscribers per week on average, Citron says. Its average revenue per subscriber is about $30 a month. So, add 40,000 subscribers each month, multiply each month's number of subscribers by $30, and you see where I'm going. By year-end, Vonage could be collecting $25.2 million in monthly fees from about 840,000 subscribers.

With all those Benjamins (and Grants and Jacksons) rolling in, you'd think Vonage would be profitable. Technically, it isn't. To acquire new customers, the company is spending hand over fist on marketing--its single largest cost. Chances are you've seen its "people do stupid things" TV commercials. The VOIP market is in its early land-grab period, and naturally, Vonage wants the biggest share. The company spends $150 to $200 on average to acquire each new customer. Given that Vonage stands to add about 52,000 new customers this year at its current pace, it could spend as much as $78 million this year on marketing.

To finance that spending, Vonage has raised a boatload of venture capital--$210 million in total, $145 million of which was raised just in the past year. Citron says the company still has a lot of that money in the bank. If Vonage were to pull back on marketing, it could break even on the free cash (i.e. money left over after paying its bills) generated from its current customers. Right now, the company ploughs all of that cash--plus cash from its treasury--into marketing to acquire more customers. So, the company's board has a tough call to make: when will Vonage start generating enough free cash to cover an acceptable amount of marketing without draining additional money from its coffers? Even when your company is throwing off gobs of cash, it's hard to stop upping your marketing budget when new potential customers seem to materialize every day.

Citron puts the conundrum this way: "Do we get a better return on equity by trying to generate our own cash and use that as a sole funding mechanism, or do we get a better return by leveraging ourselves, which means selling stock in the company through private equity sales?" Why private? Why not go public and get a higher valuation? Citron: no comment.

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