Verizon's VoIP Offensive

A steep cut in the price of the company's Internet-based calling puts pressure on Vonage as it readies for an IPO, and could spark a price war

Take cover, Vonage. Just weeks before the Internet-calling pioneer plans an initial share sale, rivals are planning their competitive attack. Verizon Communications (VZ) on May 3 said it would slice the price of its Web-calling plan by $10, to $24.95, below the price of Vonage's comparable package.

Not only is Verizon cutting the price of its VoiceWing service to pennies less than Vonage's most popular unlimited calling plan for consumers, it's also offering free activation. That costs $29.99 at Vonage. What's more, Verizon's price change will automatically apply to current customers.


  The steep price reduction could spell trouble for Vonage. After a year of relatively stable Web-call pricing, the move could be the opening salvo of a new price battle among providers of so-called Voice over Internet Protocol (VoIP) phone services. While VoIP prices have typically fallen by 10% to 15% a year, they could drop by 20% in the next seven months alone, says Web-calling guru Jeff Pulver.

Steeper-than-expected price declines could dim Vonage's already iffy growth projections and delay breakeven, says Jon Arnold, principal at VoIP consultancy J Arnold & Associates.

In 2005, Vonage lost $261.3 million on $269.2 million in sales, according to an April filing with regulators. This year, losses could mount further, as Vonage plans to spend $360 million to $380 million on marketing, up about 50% from $243.3 million in 2005. Vonage generates an average $27 a month per line and spends about $221.35 on marketing per new line. So it already takes Vonage more than eight months to recoup costs. "We are pursuing growth, rather than profitability, in the near term," Vonage says in its filing.

Vonage is also clear on the implications of price pressure. Price competition "may result in reduced revenue, a loss of customers or a decrease in our subscriber line growth and may delay or prevent our future profitability," Vonage says in the filing. Analysts say the timing of Verizon's price cut is no coincidence. It "is an offensive strategy by Verizon to throw water on Vonage's [revenue and profitability] estimates," says Arnold. "Clearly, telcos do not want Vonage to succeed."


  Vonage and other VoIP providers, including cable-TV companies, have contributed to Verizon losing a whopping 9%, or 3 million, of its residential phone lines between March of 2005 and the same month of this year, according to the company's first-quarter results, announced on May 2. In the first quarter of 2006, Vonage gained 325,000 subscribers, its best three-month period ever. There's no way to know how many of these subscribers dropped Verizon's residential service, but clearly Vonage is having an impact.

For Verizon Chief Executive Ivan Seidenberg, the cuts are all about staying competitive. Indeed, uptake of Verizon's VoiceWing service has been less-than-stellar. The product boasts fewer than 50,000 subscribers, compared with Vonage's more than 1.2 million users, according to analysts' estimates. "We wanted to bring the product price more in line with the competition," says John Broten, executive director of VoIP services at Verizon. "It's a recognition that the marketplace was in a different place than we were." The U.S. VoIP market is expected to expand from 7.9 million subscribers in 2005 to 17.4 million in 2008, according to consultancy TeleGeography.

Faced with declining residential phone customer bases, other telecom companies are in the same boat, and may join in the tussle against Vonage. Chances are, AT&T (T) will slash prices on its $29.99 residential VoIP service, CallVantage, in the coming weeks as well, says Arnold. "I'll lay bets that AT&T follows suit," he says. The company is also expected to ramp up its promotions of the service this year. "We are not planning anything in response to Verizon," says an AT&T spokesperson. "Our pricing still remains the same."

There's little love lost between AT&T and Vonage. Back in 2004, the two companies engaged in a VoIP price war, one of several pressures that contributed to the decline that forced AT&T into the crosshairs of SBC.


  Bigger telcos aren't the only ones gunning for Vonage. Smaller VoIP players have been lowering prices as well. In December, startup SunRocket introduced a VoIP service costing only $9.95 a month. Until then, the lowest-priced VoIP service could be had for around $15. Other kinds of VoIP services, such as Skype, actually offer PC-to-PC calling for free, and will, over time, compete with Vonage and its ilk more directly (see BW Online, 5/3/06, "Skype Piles It On").

Some 67 companies offer VoIP services in the U.S. As they became more aggressive, Vonage's share of the VoIP calling market fell from 31% at the beginning of 2005 to 27% at the end of the year, estimates Stephen Beckert, an analyst with TeleGeography. Its share of VoIP revenues -- and the industry's sales growth in general -- could slip in the coming months as well.

In fact, if price competition heats up, in a few years VoIP could be completely free, provided as a standard feature in a bundle with Digital Subscriber Line (DSL), high-speed cable or wireless access service, says Pulver. "Unfortunately for some investors, from a business prospective, prices are going down, not up," says Pulver, who has an investment in Vonage. "In the future, people might not be paying anything for VoIP. We are now definitely accelerating the pace to the zero-sum game."


  Where does that leave potential Vonage investors? Not in a great place. Already, many investors worry about the company's ability to make money (see BW Online, 2/09/06 "Vonage’s Iffy IPO") "My concern is, telecom services that lose lots of money usually don't work out very well for investors," says Michael Mahoney, portfolio manager for EGM Capital hedge funds in San Francisco. "Telecom has always had a tendency to make people think, 'If you build a network or a subscriber base, there will be some enormous value realized.' And that's not always the case." Mahoney's still undecided whether to buy Vonage stock.

The Verizon price move adds an extra layer of anxiety. "One risk now is, some people who were excited about participating in the deal have made some assumptions [about revenue growth]," says Mahoney. The Vonage IPO is being spearheaded by Citigroup (C), Deutsche Bank (DB), UBS (UBS), Piper Jaffray (PJC), Bear Stearns (BSC) and Thomas Weisel Partners (TWPG), which are already shopping the offering to their clients.

IPO expert Tom Taulli says the stock price could come under pressure not long after the initial share sale, which is expected to raise nearly $500 million. "I don't see [the stock] being up 100% on the first day," he says. "The big elephant in the room is: How is this company ever going to make money?" Taulli believes the shares would trade down over the coming months, as the company, valued at $2.6 billion by this IPO, goes down to a more reasonable valuation of $1 billion to $1.5 billion.

Perhaps Vonage could try to offset price pressure by differentiating its offering through features. Already, on May 2, the company announced that it will allow subscribers of its unlimited consumer and small business calling plans to make free international calls to France, Ireland, Spain and a host of other European countries. It's also tinkering with making its service available on mobile phones that can access Wi-Fi (wireless fidelity) networks (see BW Online 4/26/06,, "Vonage to Make VoIP Mobile"). Still, these features alone might not be enough to appease consumers, who flock to VoIP primarily because of its low price.

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