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SEPTEMBER 12, 2005
By Olga Kharif Vonage: The Growing Sound of Static Even as investors anticipate a hot IPO, the slather of rivals piling into the Web-based call market could well mean that reality falls short of expectations Even though the official papers haven't yet been filed, that Vonage plans to go public is considered a given. One of the biggest providers of Web-based calling, Vonage is expected to make its debut before year's end in an initial share sale that could raise as much as $600 million and rival that of Web-search engine Google (GOOG ) in terms of media buzz and investor interest. BOOMING GROWTH. Vonage "can go public in almost any type of equity market," says Tim Walsh of investment bank Lane Berry, who adds such an IPO "ought to be well received." It's not hard to see why. Vonage is a trailblazer in voice over Internet protocol (VoIP), a technology that slashes communication costs by digitizing voices and calls the same way e-mail travels over the Internet. As consumers drop regular phone service in favor of cheaper Web calling, the number of VoIP subscribers in the U.S. may rise threefold this year, to 3.25 million. By 2009, 28.5 million people will use Vonage-like services, according to researcher Yankee Group. "Moving to an IP phone is inevitable," says Yankee analyst Kate Griffin. SHRINKING SHARE? Still, would-be buyers of Vonage stock have reason for pause. Vonage's rivals -- cable-TV providers, telecom carriers, and a growing number of Internet-based companies -- are rushing to elbow the outfit out of the market it pioneered. And some are making headway. Over the course of 2004, Vonage's share of the VoIP market slid from 61% to less than 30% of subscribers, estimates Griffin. And its share is likely to slip more as larger competitors introduce and strengthen their own offerings and the VoIP market becomes more crowded. There are an estimated 1,100 VoIP-service providers in North America alone, according to surveys by telecom-gear maker Sandvine. These aren't just tiny startups, but also giants like AT&T (T ), soon to become part of SBC Communications (SBC ), and cable operators including Time Warner Cable (TWX ) and Cablevision (CVC ). Already, telcos and cable companies are responsible for 18.1% of VoIP minutes used in North America, vs. less than 5% a year ago, says Dave Caputo, CEO of Sandvine, which tracks VoIP calling on its customers' broadband lines. WIDER CHOICES. And the VoIP push by the biggest players has only begun. When SBC completes its purchase of AT&T, it plans to start aggressively marketing AT&T's CallVantage VoIP service, which hasn't been advertised for a year, says an SBC spokesperson. The carrier also plans to spend lavishly on new features, such as notifying customers via their TVs of incoming calls and allowing them talk via the set, without having to run to the phone. The idea is to integrate VoIP with SBC's video, wireless, and high-speed Internet services -- a range of products that Vonage, specializing in voice, can't match. Following two limited trials, BellSouth (BLS ) plans to offer a consumer VoIP service next year. Cable providers also have a leg up on Vonage because they can offer bundled services that include Web-based calling, fast-Internet access, and hundreds of TV channels. Time Warner Cable offers five different packages, ranging from $84.90 to $162.90, all of which include digital phone service. And the more products a customer buys from a single provider, the more loyal they become. Customers who buy three products as part of a package are typically 50% less likely to switch. "It will be hard for [Vonage] to compete if they don't offer a bundle," says Jon Arnold, founder of VoIP consultant Jon Arnold Associates. STIFF COMPETITION. Vonage may find it tough to compete on other fronts, such as customer service and marketing. Time Warner Cable offers professional installation of its gear, while Vonage clients have to install equipment on their own. Large service providers can market Internet-based calling to subscriber bases numbering in the millions. Vonage boasts about 1 million customers. What's more, a raft of big players is poised to encroach on Vonage's turf. Yahoo (YHOO ), Microsoft (MSFT ), and Google are all aggressively pushing into PC-to-PC Web calling. That's "their first step into IP waters," says Mitch Mitchell, a vice-president at consultancy A.T. Kearney. "Then, the race is going to be on." If these companies start offering VoIP calling services for phones as well, these cash-rich companies will be in direct competition with Vonage. PC-to-PC calling leader Skype (rumored to be considering an IPO), could eventually compete directly with Vonage, too. "VERY VULNERABLE." Time for an IPO may be of the essence. If Vonage waits to go public and its market position erodes further, the share sale may not catch on. There are industry rumblings that Vonage execs were unsuccessful in a bid to sell the company -- the preferred exit strategy for its backers. A Vonage spokesman declined to comment for this story. "Vonage is very vulnerable," says Tom Taulli, an analyst with investment bank Instream Partners. On the plus side, Vonage's size means the company can respond to market disruptions and customers' demands more nimbly than its bigger rivals. And it's already got a widely recognized brand that will get even more traction now that Vonage sponsors MTV's popular reality show The Real World. But as is the case on the MTV show, things can get ugly fast in a crowded house. The same can be said of a crowded market.  Kharif is a reporter for BusinessWeek Online based in Portland, Ore.
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