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Vonage Hope Vaporizes

Jonathan Berr

The flop of the Vonage(VG Quote) IPO is only the beginning of the troubles facing the Internet phone company.

Shares of Vonage opened with a thud Wednesday. Vonage posted the biggest decline of any IPO during its first day of trading this year, according to the research firm Deallogic. Shares fell 13% to $14.85 after pricing late Tuesday at $17.

"People may have been hesitant to buy into a hyper-growth company losing so much money," says James DeStefano, an analyst with Renaissance Capital, which invests in IPOs. "People are looking longer term at the risks of this company, at the growing competition."

Internet voice service is increasingly being offered by large Internet, telecom and cable companies at little or no cost. In fact, eBay's(EBAY Quote) Skype and other large companies are now offering some of their Internet phone services for free.

"We are really in a race to zero," says independent consultant Jon Arnold of J Arnold & Associates in Toronto. "The real money in this play is in the video. Voice is the sweetener."

Verizon (VZ Quote), which is making a huge push into the television market, recently cut the prices on its Internet phone service. Comcast (CMCSA Quote) and Time Warner's(TWX Quote) cable unit also are trying to gain phone customers.

Vonage is already feeling the effects of competition. As of March 31, Vonage had an accumulated deficit of $467.4 million. First-quarter revenue from its 1.6 million customers was $119 million.

That financial performance, coupled with the growth in competition for video, was enough for David Menlow of Iporesearch.com to urge his clients to take a pass on the Vonage IPO.

"The money isn't going to be in voice over IP," he says, referring to the technical name for Internet phone service. "If Vonage had something that was totally unique, we would have taken a different tone." Vonage is one of the most recognized brands on the Internet, thanks to the full-court press of advertising on both the Web and on television. In fact, the company was the largest buyer of Internet advertising for the past two years, according to Nielsen//NetRatings.

Though Vonage has appealed to customers fed up with what they see as the high costs and poor quality of traditional phone service, investors weren't won over on the first day of trading.

Another possible issue for investors is the nature of the team behind Vonage.

Public investors now hold 20% of Vonage. But early stage investors hold 45% and founder Jeffrey Citron controls a 31% stake. Vonage cautioned investors about Citron's prior association with Datek Securities, a daytrading firm that ran afoul of the Securities and Exchange Commission.

Citron settled the SEC charges against him without admitting to any wrongdoing, but the company warned in its prospectus that Datek's reputation could end up working against Vonage by scaring off possible customers.

On top of that, there's the thing where insiders might want to sell once their lockups expire in six months.

The prospectus says 124.5 million of Vonage's 155 million shares are "restricted securities" subject to a 180-day lockup. "We expect many of these shares will be sold when these lock-ups expire," Vonage says.