Internet Phone Companies Ripe for Sale?

Posted: 03/2005

Internet Phone Companies Ripe for Sale?
By Josh Long

As more phone and cable giants sweep into the Internet phone market, Vonage Holdings Corp. and other VoIP startups like 8x8 Inc. could face escalating pressure to sustain growth and differentiate themselves from their larger rivals.

Will the Internet phone startups be a target for acquisition by larger competitors? Analysts say it is improbable, particularly in the short term. The Internet phone companies new calling plans are much cheaper than traditional voice packages and the upstarts have so few customers relative to the biggest phone and cable providers. Verizon Communications Inc., for example, has 57.3 million access lines, compared to the 400,000 lines Vonage  the No. 1 Internet phone company  had at the beginning of the year.

Does the Bell company snap them up? Why? The Bell companies have enormous resources, says IDC analyst Will Stofega.

The Internet phone companies could become targets after they have a large enough customer base and the technology is proven, says Michael Callahan, president and managing partner with financial consulting firm, RKP Steering Group. This is the first inning of the game and none of those companies have made a career, he says.

Vonage is the leader in the VoIP market, followed by CableVision Systems Corp. and Time Warner Cable. CableVision revealed in early December it had about 250,000 voice subscribers. Time Warner Cable, the second largest cable company, anticipated ending 2004 with about 200,000 subscribers.

Analysts say Verizon and the other regional phone companies are in no hurry to migrate millions of switched phone customers to unlimited VoIP calling on the cheap. VoIP providers sell such packages for as little as $19.99 per month; in contrast, Verizon offers unlimited calling on its circuit-switched network for between $45.95 and $69.95, depending on the state and the package of features.

Callahan says Verizon selectively will market VoIP service to its DSL customers. The company had 3.3 million DSL lines at the end of the third quarter and is offering its Verizon Online DSL customers unlimited VoIP calling for $29.95 during the first year. The phone giant has not revealed the number of customers subscribing to its VoIP service called VoiceWing nor offered forecasts.

While the major telcos have tens of millions of circuit-switched phone customers, the voice business largely represents a new area of growth for the biggest cable operators. The cable companies are aggressively expanding into the regional phone companies breadand- butter business  voice  and cable titan Comcast Corp. is planning to expand VoIP to 20 markets reaching 15 million homes by the end of the year. The No. 1 cable operator plans to make service available throughout its network by the end of 2006, it and anticipates achieving 20 percent market penetration by the fifth year, according to a presentation at an investor conference. The Philadelphia-based company already has 1.2 million circuit-switched phone customers through its 2002 acquisition of AT&T Broadband.

Vonage CEO Jeffrey Citron tells PHONE+ he anticipates Comcast quickly will become one of the largest VoIP providers, although he does not think Comcast will sign up 1 million subscribers by the end of the year. That is Vonages goal. We think we should be able to hit a million users, Citron says. That figure would represent up to one third of the 2005 U.S. VoIP market under one research firms estimate. Frost & Sullivan projects 3 million to 4 million customers this year, with about 16 million subscribers in 2008.

Compared to the biggest phone and cable companies, the pureplay Internet phone providers can only grow so much because they have limited capital, says Frost & Sullivan analyst Jon Arnold. Vonage has raised $208 million.

Another advantage for the traditional phone and cable companies: they have tens of millions of subscribers. IDC analyst Stofega says he anticipates the big companies will begin taking market share from the pure-play VoIP providers in 2005. Not only do the likes of Comcast and Verizon dwarf the startups in terms of revenue and customers, they also have the networks to deliver other lucrative communications services, including high-speed Internet access, wireless services and television.

Vonage has a good affordable voice alternative to your telephone, Arnold says. But really that is all.

Citron says the company is comfortable with its primary service and will expand to support advanced services like wireless high-speed Internet access. In January, Vonage announced a partnership with telecom equipment maker UTStarcom Inc. to introduce a portable Wi-Fi handset later this year. Vonage has not announced any plans to offer cellular phone service.

Citron also made clear offering video service is not part of Vonages strategy. Were not in the business of selling video, he says.

Huw Reese, vice president of sales and marketing with California-based 8x8, cites many reasons he feels 8x8 delivers a service that is distinguished from the cable company offerings. For starters, 8x8 has developed its own end-to-end technology, which Reese asserts gives the company better control over quality and reliability. Reese also says 8x8 has a video phone and designed a virtual office retail phone package for small and medium businesses. Those businesses are generally not passed by the cable companies, he says.

Another reported advantage: portability. A snowbird migrating to his winter home can take his Internet phone adapter on the road from, say, New Jersey to Arizona; not all the cable companies selling IP phone service offer the portable capability.

Then, there is price. 8x8 offers unlimited calling in North America for $19.95 per month. Reese says he has not seen a cable company offer service for below $29.95 per month. But despite the low prices, CableVision and Time Warner Cable have a much larger number of voice customers than 8x8. 8x8 ended the third quarter with 26,000 lines.

Were making sure our customer-acquisition costs [are] at such a level that we get profitable customers onto our service, says Reese, whose company has raised $26.2 million over the last two years. We are trying to be cautious somewhat and sensible in terms of the amount we spend and the amount of customers we acquire.

Reese says that does not mean the opportunities are limited considering the size of the market. The market is not just the United States. The market is the world, he says. 8x8 reports that about one in 10 customers live outside Canada and the United States even though the company does not advertise outside the United States.

Frost & Sullivan analyst Arnold says the Internet phone companies will probably be less attractive as acquisition candidates if they really cant muster a subscriber base. He notes an exception: If the startups woo a certain customer segment, such as the ethnic market or gamers. Vonage is probably the only one of those guys who would become a serious acquisition candidate by a bigger player, the analyst says.

Vonages Citron says it is inappropriate for him to discuss a possible merger or acquisition, and he declined to discuss other possible finance options, such as an initial public offering.

Says Reese of 8x8: Certainly our desire at this time is to remain independent and we are pursuing our business in such a way we are intending to create a long-term, viable business  i.e. a business that is profitable. 8x8 posted a loss of $3.7 million on revenue of $2.5 million for the quarter ending Sept. 30.

Analysts are still waiting for massive developments to trigger extraordinary growth in the IP phone market.

Its a very, very, very early market, IDC analyst Stofega says. No one really knows what is going to jumpstart this market.

Arnold has an idea: naked DSL. With the exception of Qwest, the regional Bells high-speed Internet customers also must purchase a local phone line from the Bell, he says. The analyst says the VoIP market could explode once that restriction is removed because customers would no longer be obligated to keep their plain old telephone service. Once you have naked DSL, the consumer really has no reason to keep their POTS line if they trust VoIP, he says.