People do stupid things.
That is the tagline in the TV commercials from
, which has become something of an expert in stupidity. You remember the ads: They used home-video excerpts of people doing face plants on treadmills, shutterbugs slipping in fountains and children tossing bats through plate-glass windows. The message was that spending too much on phonebills was just as stupid.
Today, it's clear that Vonage's motto also serves as a warningabout its IPO last month. There is another, more explicit caution inthe helpful text superimposed over the antics of those haplessdaredevils: "Do not attempt."
In fact, one of those commercials is spookily prophetic ofVonage's IPO. It features a snowmobile careening over a large bank ofland. Everything seems glorious for one brief moment, then the snowmobile flips -- just as the institutional investors did once Vonage's IPO was launched -- and the rider takes a hard and painful fall.
Therein lies the moral of the Vonage IPO: Do not attempt stupid things. It's an investment rule of thumb that ranks right up there with "buylow and sell high."
Neither rule is terribly helpful, though -- nobodybuys high on purpose, just as anyone doing something stupid is thinkingthey're being smart. So, let's look closer at the IPO in hindsight tofind more valuable lessons that can help investors avoid pain next time around.
1. Don't necessarily invest in what you know
For a start-up that was pioneering a new service, Vonage did a goodjob keeping customers happy. Churn rates were often below 2%, even ascompetitors began cropping up. And the company's subscribers more thantripled last year to 1.46 million. So, it's not at all surprising forVonage customers to channel Peter Lynch and say, "I like this company. Iknow its service is great and people are signing up like crazy. So, I'llinvest in what I know."
Lynch's maxim is so simple that it can be a little deceiving.Investing in what you know is only helpful as a starting point forinvestors. It's simply an excellent way to identify a stock, not alicense to plunge in head first. A more accurate, if less catchy,phrasing of what Lynch meant is, "Invest in what you know, but make sureyou know as much as possible." This brings us to the next lesson fromthe Vonage IPO.
2. Read the whole prospectus, no matter what
Like it or not, the people who write prospectuses are oftenaccountants and, even worse, lawyers. Not lawyers like John Grisham, butlawyers like the one who wrote the terms of service for your credit cardaccount. You may not enjoy reading the 144 pages of dishwater prose, butyou must agree it's less painful than losing 30% of your investment in afew days.
The prospectus showed clearly the dark side of Vonage's wonderfulservice. To sign up all those new subscribers, Vonage spent $400 millionon marketing, or 82% of its cumulative revenue. That ratio is severaltimes higher than that of most phone companies. The marketing tab racked up a$467 million operating loss in three years. Vonage was spending nearly twice as much money as it was bringing in.
All of this information was clearly spelled out in the prospectusthat Vonage had filed with the
Securities and Exchange Commission
, as was the news that its growing losses led banks to turn Vonage down when it went looking for new loans lastsummer -- a huge red flag.
A class-action suit filed against Vonage, its underwriters and itsboard members (including former Homeland Security honcho Tom Ridge)claimed Vonage's prospectus was "materially false and misleading." This allegation itself is at best misleading. There was enough scary stuff in theprospectus to repel any sensible investor. Even if more bad news hadbeen left out, it wouldn't have made any difference.
3. Watch for changes in subsequent filings
Vonage neglected to include an active hyperlink to its prospectus onthe Web site it set up for customers to buy shares in the IPO -- and inemails it sent to customers inviting them to participate. That prospectus explained that the company's plan "could be determined to be an illegal offer in violation of Section 5 of the Securities Act, in which case recipients could seek to recover damages or seek to require us to repurchase their shares at the IPO price."
This is terrific news for investors who don't want their Vonageshares anymore, but it appeared in only the last of the nineprospectuses that the company filed with the SEC. Most of those filingswere made to update or add information. And some of that new informationcan be very revealing.
Here's a great trick to make it easy: Copy the text from the firstprospectus and paste it into a Microsoft Word file. Then do the same forthe latest prospectus in a second file, and use the "compare documents"function under the "tools" menu. It will highlight any text that hasbeen added or changed.
In addition to the above disclosure about the possibly illegalaspect of the IPO, comparing the two prospectuses revealed that Vonage was out of compliance with the FCC's rules on emergency-call services, that customer-care problems were growing more common in early 2006, and that the company was starting to worry about "increasing competition" from companies bundling a VoIP service with their cable and phone services.
In the long run, Vonage may well turn into a strong long-terminvestment. If the company doesn't have to shell out some of the moneyit raised to pay back disgruntled investors, if it can hold on customersin the face of growing competition and if it can clean up its incomestatement to the point where a larger company will want to buy it, thenit could become a hot stock.
Maybe at that point investors will have made enough money to buy a shiny new snowmobile.