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Saturday, September 16, 2006

Weekend Edition: Vonage Doubles Down

Stocks: (VG)(VZ)(CMCSA)(EBAY)(TWX)

In a move that many would consider foolhardy, the founder of Vonage, Jeffrey Citron, told Reuters that the company would continue to invest extremely large sums in customer acquisitions. He acknowledged that investors might not warm to the idea for at least two quarters, But, Wall St may not warm to it at all. He also made the observation that the company could lose money at the current rate and not run out of cash for 10 quarters. Talking about when the cash is gone is not always considered good investor relations.

According to the Vonage 10-Q, the company spent $90.2 billion on marketing in the quarter ending June 30. In the same quarter in 2005, the marketing number was $60.9 million. Between the two periods, revenue did rise from $59.4 million to $143.4 million. But the operating loss also rose, from $65 million to $73.6 million. The 10-Q also says that the company believes that its strategy of increasing marketing costs is what will eventually lead to profitability.

A close look at the numbers indicates that the Vonage strategy may work. Subscriptions rose from 847,849 as of June 30, 2005 to 1,853, 253 at the end of June 1006.

The 10-Q also acknowledges that customer service at Vonage has been less than ideal as the customer base has grown so quickly.

Although Vonage’s shares have dropped from their $17 IPO price to slightly below $8, Mr. Citron may be stating an obvious, buy largely unacknowledged true. If the company does not grow, it will die. As in the satellite radio business, a certain critical mass is essential to success, especially in a business with well-heeled competitors.

The knock on Vonage is that it will be crushed by cable firms like Comcast and Time Warner cable. They have the broadband connections to the home and can offer bundles VoIP, broadband and TV service. The large telecoms, like Verizon, are trying to build similar services through fiber-to-the-home.

Right now, Vonage has something that most of its competitors do not. Along with eBay division Skype, Vonage is almost synonymous with VoIP. The company’s huge marketing expenditures have gotten it that important distinction.

Vonage has now stated publicly that it will not take its foot off the gas. If it can gain a critical mass of four or five million subscribers before the cash runs low, it may just confound it legion of critics.

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