Who Still Cares About VoIP? I Do!

Last month, I wrote a post wondering if VoIP is really happening, and it elicited some thoughtful dialog. August has been a busy month for VoIP, and I wanted to revisit things on a more positive note. There are definitely signs of life out there that show the VoIP glass being half full.

I�ll start first with Infonetics Research, as their latest research sets the stage at a high level. Their report show that the global VoIP business is up sharply, with 2007 data being the most current period. Residential and SOHO VoIP is up 52% in terms of revenues and 60% in terms of new subscribers from 2006. Overall, residential VoIP dominates, accounting for 74% of total market revenues. This segment will remain dominant, but business VoIP will grow more quickly, and is forecast to account for 41% of the market by 2011. This is good news for carriers who are targeting the business market, where most of the VoIP growth will come from SMBs. I don�t have access to the full report, but these top line trends tell a good story on their own, and ties in nicely with what some of the industry players are reporting lately.

Vonage is the most visible of these stories, and I�ll comment briefly on them first. Their Q2 numbers were released on August 7, and for my money there was more good news than bad. On the plus side, revenues are up, losses are down, and the churn rate has improved. It�s very easy to minimize this and focus on their challenges � the cumulative losses, sky-high marketing costs, tough competition, flat ARPU, management turnover, customer service issues, weak stock market sentiment, etc. However, this is a company that�s on track to hit $1 billion in revenues this year, and no pure play VoIP operator is close to this level.

Secondly, if churn continues to improve, so will their financials, and there�s no denying that the Q2 numbers are a big improvement. This is critical, not just to establish some positive momentum with subscribers and shareholders, but to improve Vonage�s chances with Silver Point to refinance their $253 million convertible debt that comes due in December.

While churn has improved from 3.3% to 3.0%, it is still high relative to Tier 1 carriers, and simply allows Vonage to stand still. The company may have acquired some 230,000 new subscribers in Q2, but 3 percent churn means they lost about as many, and reported a measly net gain of 2,080 subscribers. The realistic way to view Vonage now is not as a growth story, but one of maintenance. For all the marketing dollars being spent � and the spending is coming down � it is only sustaining the status quo, which is roughly 2.6 million subscribers. In my mind, there is nothing wrong with this as a strategy. Vonage has long been surpassed by the cablecos and will never challenge them again for market leadership. However, if they can defend their customer base, they do have a valuable asset, and one that can be profitable if managed effectively.

This brings me to my final Vonage thought � the recent appointment of Marc Lefar as CEO. This move was important, and given his roots at Cingular, he sounds like the right choice on two levels. First, I would have to think he knows a few things about retaining customers and hopefully he�ll keep the churn numbers going in the right direction. Secondly, he comes from the wireless world, which I believe Vonage needs to get closer to for survival. This is where the growth is, not just for new subscribers and bundling opportunities, but also for new services. Vonage is not the innovator it once was, but I think Mr. Lafar�s experience will help change this for the better.

Packet 8 is another operator reporting numbers this month, and while not as notable as Vonage, they say a lot about the evolving dynamics of the U.S. VoIP market. This company has a much longer history than Vonage but is only a fraction of the size. That said, they are also the second most important U.S. VoIP pure play, so it�s important to follow them. The main story coming out of their most recent results is the continued successful transition from consumer to business VoIP. This has been going on since late 2006, as they wisely saw the downward spiral Vonage was getting into, along with the ultimate futility of trying to compete with the cablecos. Good move.

Currently, the business market accounts for 56% of revenues, and while they�re chasing far fewer customers, the margins are better and the churn rate is lower. Packet 8 is a long way from being a money machine, but it looks like they�ve found their niche and seem to be doing a good job of defending it.

Aside from providing core VoIP telephony to SMBs, they�re enhancing the value proposition with business-oriented features such as IP trunking, mobility, hosted contact centers and hosted key systems. Peeking over to their residential offerings, they also have video calling and the Audio Production Store, a neat online marketplace for services to customize and enhance your greetings and messages. There�s no single thing here that makes Packet 8 stand out, but taken together, you have to like the moves they�re making to differentiate themselves in a very crowded marketplace.

Telio is not well known in North America, but I�ve been following them and commenting about them since going public around the same time as Vonage back in May 2006. I�m one of the few people in North America paying them much attention, and have long advocated that they have the right formula for success with VoIP. That has never been more apparent than in their Q2 earnings which have just been reported, with record results on many fronts. There are some basic parallels to Vonage, but the market dynamics in their native Norway are quite distinct, and Telio has proven that there is money to be made as a pure play VoIP operator. In my view they are the exception to the rule, but it can be done, and that�s why I�m writing about them here.

They have managed to avoid reducing VoIP to a commodity, and the numbers reflect this not just at the subscriber level, but operationally as well. Naturally, Telio operates on a much smaller scale than Vonage, and while they are fundamentally in the same business, the performance metrics are quite different. Telio reported 151,700 subscribers in Q2, which is up 13% from a year ago. They do not disclose churn, but I know it�s orders of magnitude less than Vonage, and largely explains why they�ve continued to grow. ARPU has remained steady at around $48 US when converted from NOK, and as the subscriber base grows, so does the top line.

Conversely, Opex per subscriber is about 20% lower than last year, demonstrating that economies of scale can be realized with their business model. As a result, profits are up, and gross margin has increased from 58% last year to 61% today. Telio is now solidly profitable, they remain the dominant provider for broadband telephony in Norway, plus they are expanding both geographically and into the business market.

I think it�s a great story and to me, Telio is the benchmark for success among pure play VoIP operators. It strikes me that if they can find a way to replicate their business model, Telio could become a platform play of sorts for expanding into other markets. Having established a base of profits and retained earnings, I wouldn�t be at all surprised to see them move in this direction in the near future.

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