Vonage Crack-up Continues

By Ian Wyatt, Big Idea Investor | VG | Jun 06, 2006 | comment

Vonage Crack-up Continues

By Vijay Balkissoon, Staff Writer, Big Idea Investor 

Fresh off an IPO that saw its shares sink by 12.6% in the first day of trading, - which amounted to the worst first-day U.S. IPO performance in two years - the bad news keeps coming for voice over Internet protocol (VOIP) pioneer Vonage Holdings (NYSE: VG).  

In an unconventional IPO marketing plan, Vonage made shares in its $531 million IPO available to current customers, a decision that has made the company the subject of a class action lawsuit brought by customers who bought shares.

A suit filed on Friday June 2 in U.S. District Court in New Jersey claims that because of a lack of interest from institutional investors, Vonage pre-sold 13.5% of IPO shares to customers in violation of National Association of Security Dealer (NASD) rules, specifically Rule 2310. 

Rule 2310 states that in recommending a security to a customer, an NASD member should have "reasonable grounds" to believe that security is "suitable" for that customer.  A statement released by the law firm representing the investors, Motley Rice LLC, says that Vonage, "crammed investors into the Vonage IPO regardless of their suitability."

Whether Vonage is guilty of improperly marketing its IPO will be for our judicial system to decide.  But the company's behavior in the wake of the IPO fiasco is certainly giving it quite the public relations black eye. 

Initially, Vonage said that it would repurchase shares from dissatisfied customers who participated in the IPO at the original IPO price, thereby making them whole.  However, the company subsequently backtracked and now says that it will "pursue" customers who refuse to pony up for the IPO shares they requested.  While we are strong believers in shareholder rights, we simply have to ask the question: what were those 10,000 Vonage customers thinking when they bought into this deal?

Vonage has shown impressive revenue growth of 240% from 2004 to 2005, but that revenue growth has come at a hefty price.  Advertising and marketing expenses have grown 335% over the same period.  In 2005, the company blew an incredible 94% of their revenues on marketing.  The high cost of acquiring customers has led to widening losses and cash burn.  In 2004, the company lost between $0.35-$0.40 a share.  In 2005 that loss had grown to $1.60, and in 2006 the company is on pace for a loss of $2.42 per share according to consensus estimates.

In the post-.com era, investors have understandably been allergic to throwing cash at unprofitable companies that are already hemorrhaging cash.  If Vonage was a fast grower in an industry with a significant barrier to entry, perhaps we would be reporting a different story.  But in Vonage's case, competition in the VOIP space is only intensifying.  Verizon (NYSE: VZ) and Comcast (Nasdaq: CMCSA) have been pushing their own low-cost VOIP solutions.  And eBay's (Nasdaq: EBAY) Skype remains free for all calls made within the U.S. and Canada. 

First-mover Vonage remains the most well-known name in the space thanks to a huge investment in advertising and marketing, but others have tread that path before - remember TiVo (Nasdaq: TIVO)?  As an investor, it is challenging to understand how Vonage will be able to compete with the cable and telecom companies that already have millions of established relationships with customers, strong brand recognition, and many times the advertising budget of the relatively small, $1.9 billion market capitalization Vonage.

Are you interested in finding the next emerging technology stock poised for big gains?  At Rising Star Stocks, we focus on finding small companies that are revolutionizing the way we live our lives. Get our 38-page special report, Four Disruptive Technologies for the Next Decade. The report is complimentary with a 30 day trial membership to Rising Star Stocks.  Just click here now to start your trial membership today!  Inside the report you'll also receive four of our top tech stock picks for 2006 and beyond.


NetEase Exceeds Expectations 

By Big Idea Investor Staff

In the last of our series of updates on Growth Report Editor Ian Wyatt's January article, "Three Undervalued Growth Stocks for 2006" (click here for an update on Bronco Drilling and here for YouBet.com), we conclude today with an update on China's leading Internet and online gaming provider, NetEase.com (Nasdaq: NTES). NetEase recently announced first quarter results that exceeded earlier guidance. 

For the quarter, NetEase's revenue grew at a healthy clip, rising 9% on a sequential basis from $60.4 million in the fourth quarter of 2005 to this quarter's $66.1 million.  Revenues for the first quarter of 2005 were $39.6 million, translating into an impressive 62% increase from the comparable year ago quarter. 

Driving much of the revenue growth are Fantasy Westward Journey, the number one online game in China, and Westward Journey II, a four year old game that stubbornly remains in the top three.  

Although online gaming is NetEase's bread and butter, the firm actually derives its revenues from three distinct sources.  The first of which, online gaming itself, accounts for 85% of the firm's earnings.  Revenues from online gaming increased 12% from $50.0 million in the fourth quarter of 2005 to $56.2 million this quarter.  Year over year, $56.2 million in revenues is a 72% improvement from $32.7 million. 

Advertising revenue saw a quarter over quarter decline of 11% from $8.6 million to $7.7 million.  However, year over year, $7.7 million represents a 36% increase from $5.5 million in the year ago quarter.  Management attributes the slight drop between advertising revenues from the fourth quarter 2005 and this quarter to a seasonal element.   

The smallest of the unique revenue streams, wireless value-added services, saw an increase to $2.2 million from $2.1 million in the fourth quarter of 2005, amounting to a slight 2% increase.  Compared with the first quarter of 2005, this quarter's $2.2 million was a 13% decrease from $2.4 million. 

All in all, the aggregate increase in revenue led to a significant increase in net income.   

Net profit for the quarter totaled $36.6 million GAAP and $39.9 million non-GAAP, which adds back approximately $3.3 million in stock-based compensation costs.  The non-GAAP figure of $39.9 represents a 16% increase from the previous quarter's $34.3 million and a foretelling 108% increase from the first quarter of 2005, in which net income was $18.6 million.   

On a diluted per ADS basis, NetEase reported earnings of $0.26 compared with $0.13 for this quarter, 2005. 

Looking forward, NetEase is in the enviable position of having two new online games, Datang and Tianxia, on the verge of entering the beta phase of testing prior to wide scale release.   

NetEase's shares currently trade at a reasonable 19X 2006 consensus earnings and a low 16X 2007 earnings. 

Additionally, in an another sign that bodes well for investors, NetEase's board recently approved the repurchase of up to $50 million worth of outstanding American Depository Shares in open market transactions.   

What should investors make of the company? Growth Report Editor Ian Wyatt remarks, "at these low pricing multiples and considering the growth opportunities that seem to abound for NetEase, we are changing our rating on NetEase from a Hold to a Buy and increasing our target price to $27.50 from $21.25."

Do you want to receive further updates on NetEase.com? How about the latest news on the very best in growth stocks? Take a no-risk 30 day trial to Growth Report today and start receiving our weekly portfolio update emails.  Click here.

Comments on this article

There are no comments for this entry yet.

Add your comments