Daiwa EuroTelcoblog No. 36, Thursday 1st April, 2004: Vonage in London

We hosted a couple of client meetings today with Vonage CFO John S. Rego, who provided an update of operations and some other interesting data points which we summarize below. For more detail on the Vonage service, consult our EuroTelcorama Issue No. 2, or email me for a copy.


Canadian launch underway

Vonage launched its Canadian business at 3AM London time today, and had its first two customers within five minutes. Illustrating the thin structure of the network, Canada is covered from three data centers, which took a total of three days to set up. The company has had to re-skin the website in French (the cost per word they quoted to us was extortionate - I'm in the wrong industry!), and customer care will also now have to encompass French (probably good experience for a company looking to tackle the Swiss market).

Financial update

Cumulative capex for Vonage to date stands at around $12m, and elements of recurring costs continue to fall. We think the blended termination rate from telco partners is now nudging below $0.01 per minute based on the traffic growth generated to date (175m calls, 700m minutes), and the hardware involved in the network also continues to offer considerably better performance at lower price points (the IBM blade servers employed by Vonage have halved in price over the past 12 months but offer 150% more capacity). Bandwidth and co-lo costs also continue to trend down nicely. On-net calls now account for 5% (this was 4% during our last series of hosted meetings in October), suggesting that the network effect is taking root, which is beneficial for margins. Customer acquisition costs, as expected, have trended down to the $100 level, compared to over $300 when the product launched nearly two years ago. The company is now strongly profitable at the EBITDAM (EBITDA excluding marketing costs) level.

The $75m financing rounds recently completed will fund this year's marketing budget (we think Vonage's projected monthly marketing spend has roughly doubled from this time last year) and the European/international expansion (we think targets for 2005 may include some Pacific Rim territories and possibly a venture into Latin America). In the US market, Vonage is currently buying 1,000 televisions spots per month, and is doing around 500m internet impressions at some very high profile websites, which the company tracks weekly for customer conversion rates. European expansion plans are still evolving, and we think some business development meetings have been taking place this week. A UK launch is expected late Q2/early Q3, with Switzerland to follow, and Mr. Rego claimed to be broadly encouraged by the direction of regulation in Europe so far.

The company is roughly doubling headcount to facilitate the international expansion, though by telco standards it will remain incredibly lean (at 1 - 1.5m US subscribers projected in 2006, Mr. Rego expects Vonage's US operation will only have 1,000 employees). The US business looks to be on track for its target of 300k subs this year, and has added 43,000 in Q1, to stand at 134,000 currently.

ARPU trend

Blended ARPU is now $36, and the company is starting to see an identifiable ARPU contribution from premium features (recall that these carry very high gross margins). Virtual Phone Number penetration now stands at 15% (up from 6% at our last briefing) and the recently-launched softphone is estimated to have penetration of around 2% with no significant marketing yet. Vonage focuses on features as a key differentiator, and the development shop is continually working on new ideas (some of which we heard about but cannot share). The SIP proposition allows most new features to be rolled out completely across the network within a 36 hour period, allowing Vonage (and similar businesses) to structure product and pricing changes very quickly. A case in point is the recently-developed Basic 500 plan, which Vonage refers to as a "non-consumer" package, i.e., it is targeted at households which have cellphones and broadband service (cable), but no PSTN line (this segment was clearly identified as one of the top three spending in the Pew research which we cited in our EuroTelcorama Issue No. 5, and also the most likely to have tried VoIP). Thus, the platform available via SIP allows a service provider such as Vonage to opportunistically attack a relatively small (but lucrative) specific segment of the market relatively easily and quickly. No wonder we are now seeing a number of incumbents embrace this model, particularly when it opens up new revenue recapture opportunities (as in the BT and TeliaSonera adaptations).

The longer view

As for longer term developments, Vonage is currently trialling video telephony devices (we think we're probably 18 to 24 months away from deployment) and a variety of Wi-Fi handsets (some featuring video). Mr. Rego is cautious on the time required for a full migration of voice telephony to IP (his personal estimate was stated at 20 years, though he cited others in industry who think five years may be adequate), though he looked forward to a time in the nearer term when the scale of VoIP (access independent players such as Vonage, as well as access-based players like the MSOs) may be significant enough that the various service providers could adopt a bill-and-keep model for terminating traffic which would go some way toward displacing the PSTN. He expressed enthusiasm for technological and regulatory developments which will diversify broadband access options (naked DSL and Wi-Max were mentioned of course, and powerline in particular seemed to be a key area of interest).

Takeaways

We still think Vonage is one of the best (and certainly the best known) examples of how a disruptive technology can be harnessed and marketed as a common-sense alternative to conventional telephony. Perhaps the greatest validation of its business model is in the plethora of companies in Europe looking to do something similar (we documented two in Germany just last week, and hope to speak soon to a Spanish service provider with some interesting views.) We are curious to see how the company positions itself in the increasingly harsh UK market, where even a conventional CPS service provider like Carphone Warehouse has now taken onboard the free on-net calling practice employed by the VoIP world. Those looking for a Vonage IPO may have to wait some time, because based on our impressions from today, we don't think one is imminent, despite a lot of interest and speculation. However, our EuroTelcorama No. 2 feature on Vonage contained a list of stocks associated with the company in some way, and investors determined to get a piece of Vonage can add to that list 3i (III LN), which led the $40m funding round in early February.