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MARCH 11, 2005
Vonage Puts Its Money on the Line CEO Jeffrey Citron discusses how quickly the Net-based phone service is adding users and the marketing cost involved
Founded just four years ago, Vonage Holdings has mushroomed into the largest provider of Internet-based phone service in North America. The company's offerings let consumers and small businesses make unlimited local and long-distance calls over their broadband Internet connections for $25 a month. The residential market for Internet phone service is set to triple this year, to 2.8 million subscribers, according to researcher Yankee Group. That rapid growth has attracted major players such as Cablevision (CVC ) and Time Warner (TWX ) to the market. Though Vonage has an early lead, it remains to be seen how long it can compete against well-funded giants. Vonage Chairman and CEO Jeffrey Citron spoke with BusinessWeek Correspondent Justin Hibbard on Mar. 1 about the outfit's prospects. Edited excerpts of that conversation follow: Q: I know Vonage is private. But since it's 10-K season, can you give us your version of a 2004 annual report? A: The business is very healthy. We ended the year with 390,000 users. We crossed 400,000 or so the first week of January. The fourth quarter was our best quarter on record. We added 115,000 net people to our service. That's about 9,500 or so a week. Over the last nine quarters, we've added more users to our network than any other provider out there. The No. 2 player is Cablevision. They ended the year with about 270,000 users. They added about 6,500 a week last quarter. Time Warner is third. They ended the year with about 200,000. They added around 7,000 or so a week. There's not a fourth provider with over 100,000 users yet. Q: How is the current quarter looking for Vonage? A: This quarter, we're adding well over 10,000 users a week. It's still early, but it appears this will be the 10th quarter in which we'll add more users than any other provider in North America. We'll beat the 115,000 net new users we added last quarter for sure. Q: How's customer retention? A: We have great retention factors. We don't lose that many customers. We measure churn every day. Churn is total size of the customer base divided by how many we lost. We do that every day and come up with a figure for the month and for the quarter. Our current monthly customer churn is below 2%, which is very good. The 10,000 net new customers a week is how many we added minus how many we lost. Q: How much does it cost to acquire a new customer? A: On average, between $150 and $200 per customer. It's a highly volatile number. It varies between channel, time of year, and media type. We distribute our product through different channels. Direct response is our biggest business. That's our advertising programs. That could be TV advertising, print, outdoor, radio, or online. We also have a program with retail partners like Best Buy (BBY ), Circuit City (CC ), CompUSA, Office Depot (ODP ), Sam's Club (WMT ), Staples (SPLS ), and Radio Shack (RSH ). Those partners now account for about one out of five Vonage subscribers on a net basis. Q: Can you give us a hint of your revenues? A: The average revenue per user is around $30 a month. So, 400,000 users, $30 per user, it's not hard to figure out our revenues. The customer base is very stable. You can pretty much predict what our revenues are going to be like from our existing customer base. The more difficult thing to predict is the rate of growth. How many customers we add is clearly a very volatile number. It's hard to figure out long-term how our revenues will look. Q: Is the company profitable? A: It depends on how you look at it. Clearly, we're spending more on marketing than we earn in free cash from the existing user base. For quite some time now, we've been generating free cash from the existing user base, and significant amounts of it. We take that cash and invest it in marketing to get new customers. Of course, it doesn't cover our entire marketing tab. So we fund the remainder with our balance sheet. We have a very strong balance sheet because we've raised a lot of capital. Most recently, we raised $145 million last year. And we still have a lot of it in the bank. Q: When will the company be able to fund all of its marketing from free cash flow? A: That's a question for the board. That's something they look at on a pretty regular basis. I'm sure over time we'll slow down the rate at which we increase the marketing spend every year to a more appropriate level, in which case we'll cross over to generating actual free cash. That's a question of what's more important to us. Do we get a better return on equity by trying to generate our own cash and using that as our sole funding mechanism? Or do we get a better return by leveraging ourselves? In Vonage's case, leverage means going out and selling stock in the company through private equity sales. Q: Will you have to raise more capital? A: Who knows? We clearly have a plan to fund off of our existing balance sheet. We, as a matter of corporate governance, don't discuss any potential, current, or future financing plans. But we still have a lot of capital that we raised from the last rounds in the bank. We're clearly going to spend that capital -- no doubt about it. Whether or not that's the right time to cross over and fund our operations from that point on from free cash flow or whether we do future financings, that's a decision for our board to discuss. Of course, our company has the ability to access capital through a variety of mechanisms. It could be through additional private equity sales, public offerings, or debt offerings. 
BW MALL
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