Verizon, Vonage Fight Off Cable's Threat

The phone giants struggled in the second quarter, with companies like Comcast and Time Warner taking a big bite out of their growth

The Aug. 1 headlines announcing earnings from Verizon and Vonage provided investors with some good news. Verizon, the second-largest U.S. phone company, said sales jumped 26%, and reported a surge in wireless subscribers. Vonage, a provider of voice-over-Internet protocol (VoIP) calling, said sales more than doubled.

But a closer look at second-quarter reports from Verizon (VZ) and Vonage (VG) shows a more unsettling trend, one that may only worsen in coming quarters: Cable companies such as Comcast (CMCSA), Time Warner (TWX), and Cox are stepping up their attack on the leading telephone carriers. Some of these companies have been adding phone subscribers at a rapid pace in recent months. Verizon's shares closed 1.63% lower, at $33.27. Vonage's stock slumped 5.5%, to $6.70.


  In the past two quarters, Verizon had managed to more than make up for losses in residential access lines with gains in broadband subscribers. Not so in the second quarter. The company lost 1 million switched access lines, more than the 875,000 many analysts expected, while it gained only 440,000 broadband lines.

Vonage, which reported its first quarterly results as a publicly traded company, added 255,936 subscribers, fewer than the 300,000 expected by Wall Street. Churn, the percentage of customers who end Vonage service each month, rose to 2.3% from 2.1%.

Vonage's disastrous stock performance could be partly to blame for the higher churn. The stock has lost 60% of its value since an initial share sale in May.

The company said subscribers who pledged to buy more than 1 million shares have refused to follow through on their purchases. The scuffle that's ensued is doing little to foster good will toward the company, analysts say.


  Company-specific issues aside, cable providers are gaining traction. Comcast, for one, is pushing service bundles that include Web calling. It's also accelerating a rollout of Web calling. It expects the service, which now reaches 60% of the homes in its territory, to be available to 80% of the homes by yearend. On July 27, Comcast reported that it had added 306,000 voice calling customers in the second quarter, up from 15,000 a year earlier.

These days, communications providers are looking for growth wherever they can find it. VoIP services are expected to grow from less than $1 billion in 2005 to $2.6 billion this year, according to Telegeography. This is impressive growth, considering that overall telecom revenue rises by a measly 2.5% a year. "The overall pie is not getting a lot bigger," says Telegeography analyst Stephan Beckert.

As consumers and businesses drop traditional phone service in favor of wireless and VoIP, companies like Verizon could suffer. "It's unrealistic to assume the line loss is going to stabilize," says American Technology Research analyst Albert Lin. To fight back, Verizon is accelerating the deployment of fiber optic cables capable of bringing television and faster Internet connections straight to users' homes. The company added 111,000 customers of that service in the second quarter, bringing the total to 375,000.


  The company might also have to cut its Web-calling prices, or subsidize its digital subscriber line (DSL) offering, says Lin. In May, Verizon cut its VoIP package plan's price by $10, to $24.95, which is comparable to Vonage's price (see, 5/05/06, "Verizon's VoIP Offensive").

As tensions grow in the coming months between traditional telcos, newcomers like Vonage, and cable companies, Web-calling price wars could push Vonage's pricing down. It could even send its average revenues per user down by 2% in 2007, estimates Todd Rethemeier, an analyst with Soleil–Sur Terre Research. Even though the company's second-quarter sales hit a record $143 million, up 141% from a year earlier, the loss widened. "Vonage is having some really serious problems," says Michael Mahoney, portfolio manager at EGM Capital.

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