A story is emerging that some folks on Wall Street think Vonage is shopping itself around as a takeover target, rather than an IPO. S1′s have been filed, but there has been no further action. Furthermore, Vonage continues to chew through massive amounts of capital, without any sign of abatement.
Vonage may be the worst choice for an IPO this year. Why? Two words: price elasticity. In economics, price elasticity is the notion that propensity to buy varies in proportion to price. Drop the price, volume goes up. For some kinds of products, notably commodities, this relationship holds true. It’s the classic "Vinnie — drop the price, we’ll make it up on volume!" gambit.
This graph is something I sketched out from publicly available FCC data. It shows daily usage (in minutes) of the telephone, sketched against price. Notice how, as price drops, minutes increase. Voice minutes, it turns out, are price elastic.
Now, consider the following thought experiment. What happens if the price of the underlying commodity (voice) drops to zero, or near zero? After all that’s what’s happening in voice today. The graph I sketched out shows the cost of minutes at about 10 cents. It ends in 2001. Today, in 2006, that cost is at 2 cents, and still in free fall.
If the price goes to zero, usage should skyrocket. If usage skyrockets, then the costs associated with running the network also rise. Cost basis increasing, revenue decreasing… does this sound like an IPO to you? Not on your life!
Not only does Vonage have the problem just described, it also has all of the same customer retention, and customer acquisition costs of the big telcos. It simply started with a lower cost basis, which allowed it to price itself aggressively into the market. Despite what Vonage says, its business is no different from the incumbent carriers — the guys who are losing land lines at 10,000 lines per day.
So I find myself drawing the same conclusions as Om Malik:
Who is going to buy them? Isn’t that the billion dollar question? Gorbatenko suggests Qwest, but I find it hard to buy into that. I think like the IPO, finding a buyer would also be a big challenge for the company.
And that, my friends, is the crux of the problem. Buying Vonage, or buying into the Vonage IPO, could be the ultimate triumph of greed and stupidity over common sense.
Friday March 31 — Update: This generated quite a bit of traffic. Suffice it to say, there’s some solid research and thinking behind what I am saying here, which is going into a presentation I am preparing for VON Canada on Monday. I’m writing about the IP Telephony industry in general. It just happened that the Vonage piece appeared yesterday in CNN and I had some ready analysis to contribute to the discussion. Stay tuned.
