Telecom Industry: Vonage

Michael Ding, Dilshoda Yergasheva, Remen Okoruwa, Trieu Ton, Tae Yoon,

Steven Zhu

Porter’s Five

• Threat of Substitutes– Uncountable:

• Cellular phones• Landlines• Email• Other means of communication

Porter’s Five

• Supplier Power– Minimal: Inputs are rather cheap

• Buyer Power– Vonage has tried to differentiate its product by

offering a slew of nifty, yet unnecessary, feature– Price sensitivity is critical – Number of people accessing telecom services

worldwide is growing

Porter’s Five

• Buyer’s Power– Many available substitutes available– Broadband connection necessary for VoIP to be

used (foreshadowing….)• 55 million in the US: most broadband service provided

by cable companies

• Barriers to Entry– Telecommunications at large is difficult– VoIP is easy to enter due to low start-up costs and

materiel required

Porter’s Five

• Barrier’s to Entry– Proprietary Knowledge: Vonage has been subject

to four IP lawsuits from AT&T, Sprint, Verizon, and Klausner Technologies

• Rivalry– Intense: one must develop a differentiated,

appealing product while navigating a maze of patents and competing with just about everyone

Strengths• A leading VoIP provider in US

– 2.45 million customers• Low-price service competitive against landline phone companies• Good customer service

– PC World’s 2006 World Class Award VoIP winner• Computer-based phone services are gaining much attention and has

room for great improvement in a such technological era. – Subscriber line has increased greatly and continuously since 2003– Continuing to improve on expenses and gains

• Second quarter of 2007: adjusted loss from operations declined to $18M, a 70% year-over-year improvement

• Second quarter 2007 revenue grows to $206M• An increase of 43% from $144M in the year-ago quarter• Direct margin improved to 64% of revenues from 61% a year

ago

Weaknesses• Competition with cable companies

– Top seven US VoIP providers include 5 of the largest cable companies

– Prone to patent trouble– Not a feasible acquisition target

• Competition with other VoIP providers

• P/E is N/A, which seems very mysterious…

• Almost went bankrupt after the Verizon incident on June 19, 2006 (for the infringement on five of Verizon’s patents related to VoIP service).

• Not great brand name

Opportunities

• Expanding global market• By being part of a still relatively new

industry, Vonage still has much room for development in its technology and services.

Threats

• Cable providers in the US “removing the middleman”• Other VoIP services

– Cheaper than Vonage

– Free (Skype)

• Revenue and customer base growth may not meet expectations or be sufficient to pay off debt

• More patent trouble• The company is not financially stable at the moment, with it’s stock

price down to almost $2.00• Bankruptcy

Legal issues with Verizon

• Verizon sued Vonage for patent infringements• The company was ordered to pay $58M• Moreover, Vonage had to refrain from signing

new customers up• Recently confirmed the lack of workarounds

that would allow it to operate without Verizon’s Patent infringing

• RESULT: stock falls down 26%, loss/share =$1.04, SEO resigns, 3d quarter net loss = $161.8M ($100M more than a year ago) -> Investors =

THERE IS MORE…

• Settlement for the AT&T patent infringement lawsuit ~ $39M/ 5 years

• Speed of this settlement is a clear indication that Vonage has no intensions to defend itself in court against its far wealthier competitors

• Since October 8, Vonage has settled patent lawsuits with Verizon, Sprint Nextel and voicemail firm Klausner Technologies for possibly $200m.

Competitor Analysis

• Large (bundled service): – AT&T – Qwest Communications – Verizon

• Small (lower rates): – Voip.com– Cordia– Phone Power

Standard Valuation Metrics

• Current P/E is not available, but the 5 year P/E, when calculated using the DCF, turns out to be 10.

• Growth in Earnings per Share: EPS -2.48

• Price/Sales (ttm): 0.42

• Enterprise Value/Revenue (ttm): 0.40

Financial Analysis

• Cash & cash equivalents < current liabilities – 210 mil < 260 mil – Long-term investments = 60k

*Numbers in millions 2006 2005 2004

Net Income -338 -262 -70

2007 Q3 2007 Q2 2007 Q1 2006 Q4

-162 -34 -72 -117

VG WACC

VG DCF

Generous Estimates

• 20% YOY growth from 2009 onwards

• 5% capital expenditures from 2011 onwards

• Artificially low discount rate of 6.74%

• No changes in working capital

• Total expenses are actually less than revenues from 2009 onwards

VG

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NOPAT

• Even with such approximations, Vonage will continue to lose money until 2009

• They do not have enough cash on hand to keep making losses

Future Profits

So What’s It Worth?

• Assuming everything goes perfectly for Vonage, it’s stock is valued at…

• $2.33

• Current Price: $2.10