Internet Outsider

Vonage IPO: Next Up...Lawsuits?

Vonage continues to impress. 

• It fails to sell itself before pursuing an IPO. 
• It fails to drum up enough institutional interest in its IPO. 
• It offers to let its customers in on its IPO--and then sticks them with overpriced shares. 
• It insists on upsizing its IPO and maintaining the $17 price, hosing everyone unlucky enough to get stock.
• It says its CFO will go on CNBC to address customers who have lost more on the IPO than they've ever paid in Vonage bills. 
• It realizes that this might violate quiet period rules and cancels the CFO's appearance. 
• It reportedly suggests it will pacify "alienated" customers by paying for their IPO purchases--thus alienating non-customers whose underwater stock won't be paid for.

Depending on how this bizarre customer-IPO-insurance plan is effected, it seems possible that Vonage will bail out alienated customers with money just raised from non-customers, thus adding injury to insult.  (Where in the "Use of Proceeds" section of the IPO prospectus does it say, "A portion of the proceeds may be used to insure customers against IPO losses"?).  Given the company's phenomenal cash burn rate, such payouts will reduce the time Vonage can remain in business without another financing, thus either hastening its demise or hastening IPO-buyer dilution. 

And what happens if/when the SEC forces the entire IPO to be rescinded, something that seems possible at this point?  How much cash will Vonage have left in the bank?  (Approx. $175 million)   How long will this last?  (Approx. another four months at the Q1 burn rate).   Will an IPO remain an escape option?  (Who knows?)  If not, what will?

Meanwhile, the stock continues to tank. 

UPDATE:

The WSJ reports that Vonage now says it is going to go after customers who refuse to pony up for their IPO shares.  This is fair--the customers should pay--but it won't help customer relations.  How exactly will Vonage force its customers to pay up?  By threatening to cut off their Vonage service?  By, more likely, suing them?  (And thus prompting any customer who hasn't yet cancelled because of their IPO losses to cancel because of the lawsuit).  And, meanwhile, how will the sued customers respond?  By paying up?   By, more likely, collectively suing Vonage for blowing the IPO?  It gets better (worse) all the time...

As Goes the Housing Market, So Goes Advertising

Well, okay, that's a stretch, but the link between the prognosis for the housing market and the economy seems strong (as goes housing, so goes the economy), and when the economy stumbles, advertising is often the first expense to get cut.

In 2000, I shudder to recall, advertising-driven companies (on and offline) were the first to crater, and they were followed shortly thereafter by all manner of other industries, like dominoes.  Some will undoubtedly argue that, even if there is a recession, Google and Yahoo will be fine, because search and other forms of pay-per-event advertising have a crystal clear ROI.  These bulls will point to the success of GoTo (Overture/Yahoo Search) during the last recession as evidence: While the rest of the online world as we knew it was ending, GoTo grew like a weed. 

And to some extent, this is true.  Search should weather an economic storm better than other forms of advertising, because even penny-pinched advertisers will know where each search dollar is going.  But weathering the storm is different than being "fine", and some Google and Yahoo customers will cut back (if only because their customers are cutting back).  Also, when GoTo was powering through the last recession, search was a cute little $100 million business.  It is now approaching a $10 billion business, and, as such, is far more exposed to the vicissitudes of the economy at large. 

So as the housing market continues to weaken, do not make the mistake of thinking that this is an isolated micro-event that is irrelevant to the big boys of online advertising.  It isn't, and like the rest of us, Google and Yahoo will probably feel the pain.

Microsoft to Buy eBay? Bold... But Futile

The NY Post reports that Microsoft and eBay have been having merger discussions, and that, ironically, the talks have cooled of late because lawyers are concerned about anti-trust issues.  Suffice it to say that if such a deal were blocked because of monopoly concerns, regulators would merely be demonstrating an astounding inability to grasp current market dynamics.

But more to the point--Is an eBay-MSN merger a good idea?  In a word, no.  It's a bold idea, certainly, one that illustrates Microsoft's seriousness about making MSN more than an also-ran.   But eBay doesn't need a portal draped on top of it, especially the third-ranked portal, and owning eBay won't save MSN.  The entity would have a fighting chance as a stand-alone company, but Microsoft seems determined to keep strangling its Internet division by keeping all its businesses all under the same roof.  As a result, post-merger, eBay's talent would rapidly depart for greener and less-humongous pastures.  And as Microsoft struggled to integrate, staff, and manage a huge new business it knows nothing about, Google and Amazon would get a dream opportunity to chip away at the eBay seller base.

The most complementary assets Microsoft would gain in such a merger would be PayPal and Skype.  Alas, unless the company intends to spin-off eBay's marketplace business, this seems an awfully expensive way to get them.

Concept Grades:

Boldness, Vision, Ambition, etc.: A-

Chance of Practical Success: C-

Yahoo-eBay Shotgun Wedding

Yes, fine, the Yahoo-eBay alliance is a "win win."  Amid all the delirious cheering, though, it seems worth noting that it's also a "Because we're getting our butts kicked." 

What I wonder:

1. Now that they are thick as thieves, could eBay be persuaded to flip Skype to Yahoo?  I haven't heard diddly about Yahoo Messenger for Voice, and Skype is still going gangbusters.  I don't care what eBay says--Skype would still be much better off merged with the Yahoo communications suite than the eBay commerce and payment platforms--and as a Yahoo mail and Skype customer, I'd like everything in a single package.
2. Could Jeff Bezos ever be convinced to put himself out to pasture and sell Amazon to eBay?  The two companies are pretty much in the same business now, and eBay would benefit greatly from Amazon's design, distribution, and merchandizing expertise.  With its limited cash flow, Amazon is severely constrained in the Google-inspired investment arms-race, and one wonders how long it can keep up. 

Disclosure:  I own both eBay and Yahoo.  And Amazon, for that matter.

Google-Dell Deal Still Not Good News (for Google)

This time, financial details aren't being disclosed, but assuming Google is forking over $1 billion over three years (as previously reported) to install a pack of software on 100 million Dell computers, this still isn't good news.  Here's what I thought about it back in Feb.  For the counter-argument, see the comments on that post.

According to the WSJ, Google is considering paying Dell up to $1 billion over three years to install Google software (presumably Google Pack) on new Dell PCs.  At first glance, this seems like good news: World domination!  In fact, it's likely bad news, at least over the intermediate term.

First, $1 billion in operating expense is real money, even for Google.  Applying the $333 million per year tab (call it $250 milllion after tax) to 2006 estimated free cash flow of $2.5-$3.0 billion would reduce it by up to 10%.  It seems doubtful that Google would be able to generate enough incremental revenue from the deal to offset this, at least initially.  If Google were to extend the same program to other PC makers, moreover, the tab could run over $1 billion a year--with, again, no guarantee that it would result in offsetting revenue or users.

Second, despite the fact that this deal will likely whip the anti-Microsoft hordes into a frenzy--DIE, REDMOND, DIE!--it bears noting that the terms are strikingly different than those of Microsoft's software distribution deals: Namely, the money's going the other way. Given enough capital, anyone could pay Dell to put anything on new PCs.  It doesn't speak well of Google's dominance and market leverage, therefore, that it might have to pay Dell $333 million a year to install software that it is already giving away for free.

Third, the users Google attracts through its Dell deals would come at a higher cost per user than all of its previous users to date--a trend that should not warm the hearts of Google shareholders.  Unlike most software that comes pre-packaged on PCs, Google's software and services are already available for free to anyone who wants them.  One reason Google has been so astonishingly successful is that a lot of people have wanted its services, and the only reason Google would offer to pay Dell a cent is if it feels the word-of-mouth marketing wave has run its course.  Bottom line, the rumored deal terms suggest that Google's next hundred million users are going to cost more to attract than the last hundred million, which means lower margins.

Could the distribution strategy be positive over the long-term?  Yes.  It could allow Google to get deeper hooks into users than through its search engine alone, and it could allow it to reach users (newbies) who never would have downloaded Google Pack.  It could also allow Google to hurt Microsoft by putting pressure on the amount Microsoft can charge for Windows, but aside from the satisfaction of undermining a former world domineer, this won't help Google generate more cash for shareholders.

In any event, the rumored Dell deal is a long-term bet that would likely cost shareholders and the company significant cash flow in the intermediate term.  And although Google and its shareholders love to jawbone about the importance of the long-term (and they're right to--really), in the shorter term, sadly, the latter have a habit of voting with their feet.

UPDATE: Several good comments below about how Google will be able to skim a revenue stream off the Dell deal from third-parties who want their software included in Pack.  I still don't think this will amount to enough to offset the cost, but it's worth considering.

Vonage IPO: A New Way To Piss Off Your Customers

I don't mean to jump on the sick-horse-kicking bandwagon, but it appears Vonage has invented a new kind of leverage.  The company reserved about 14% of its IPO shares for its customers.  In other circumstances, this might be seen as a perk: Buy the service, get hot stock.  In this case, however, at least in the early going, it's proving to be an efficient way to engender widespread customer frustration. 

At this writing, Vonage customers who took the company up on its offer have lost 15% of their money.  Some of them, presumably, are now selling their stock to non-customers who were savvy or fortunate enough to wait until the stock started trading.  Even if the stock recovers from here, Vonage customers will no doubt remember that they could have done better.  And if the stock continues tanking...well, then, even Vonage customers who love the VOIP service will feel nothing but bile toward the company.

To put this in perspective: A Vonage customer who bought 100 shares of stock at $17 ($1,700) is now down about $200--the equivalent of about 8 months of Vonage bills.  Looked at differently, customers dumb enough to take Vonage up on its apparently generous offer will now pay twice as much for the VOIP service for the next 8 months as customers who just said "no, thanks."  One doubts that this will foment the delirious customer evangelism and loyalty that some companies enjoy.

Given the difficulty Vonage had generating institutional demand for its IPO (witness the tanking stock), a cynic might suggest that the apparently customer-friendly IPO gesture was actually just a savvy capital-raising move: "Our customers don't know jack about IPO valuations--so let's sell 'em stock!"  Or, perhaps, Vonage is just so confident in the future of its company and stock price that it is sure its currently chagrined customer-IPO-buyers will be grateful later.

In any case, if the stock stays in the tank, it will be interesting to see how many customers quit Vonage's service because they have lost money in Vonage's stock. 

UPDATE

An anecdotal report from the AP along these lines:

Anthony Sgroi of Bergen County, N.J., has had Vonage service for a year and half, and asked for 1,000 IPO shares. He received 300. Other Vonage customers on an online forum reported similar allocations, indicating strong interest from the group.

It wasn't the company's long-term prospects that attracted Sgroi to the deal, however.

"I'm not a big stock market guy ... when I got the option to buy the IPO, I figured it was a chance to make some quick cash," Sgroi said. "I was planning to sell within a week or so anyway."

He sold the stock Wednesday morning at a loss. Now, he plans to cancel his Vonage account and switch to the local cable company's competing service, which he said would save him $10 a month.

"I'll try to recoup some of my losses that way," Sgroi said.

AOL Spaces: Great Idea, Five Years Too Late

No, I haven't checked out the new AOL MySpace killer (AIM Pages), and, yes, I suspect this admission will prompt a dozen comment bombs railing about how analysts don't even bother to use the products of the companies they are analyzing.  So be it.  My prediction: Even if the AOL product is ten times as good as MySpace (whatever that means), it is going to bomb.

Why?

For the same reason that AOL instant messenger still dominates instant messaging: it's where the people are.  MySpace is about community, and MySpace has the community. Unless MySpace suddenly unplugs itself or sells out, the community isn't going anywhere.  (Yes, I know, the AOL product is built for AIM users, so there's a built-in community, but most AIM users who want MySpace-like features are probably already using MySpace).

True, for an AOL (and Time Warner) shareholder, this situation is agonizing.  AOL is about community, too--or was--and five years ago, AOL ruled the MySpace demographic.  All those people that today use iPods, MySpace, Skype, and craigslist?  Five years ago, they all used AOL.  Now, most of them wouldn't be caught dead using AOL.

Whose fault is this?  A combination of AOL's former management, who decamped to run Time Warner (and failed), and Time Warner's current management, who celebrated arrogant AOL's self-destruction right up until the moment they realized they, too, were going down with the AOL ship.  After finally waking up two years ago, they've made a few smart, bold moves, but only a few.  And, unfortunately, in the "space space," as well as in VOIP, portals, music, and a half-dozen other promising spaces, it's too little too late.

P.S.: I tried to find AIM Pages, after all, just to make sure I wasn't making an ass of myself.  I couldn't.  So perhaps the WSJ hallucinated.

P.P.S.: Given that MySpace is launching a Messenger product, there is probably a smart partnership or sale opportunity here.  Time Warner clearly doesn't want AOL.  There is clearly still value in AOL.  Perhaps Rupert would like AOL?  If nothing else, it would save MySpace the hassle of having to break into the IM market.

Disclosure: Yes, I still own the bag of rocks known as TWX.

Where Google's CAPEX is Really Going

Google is getting better at communicating, and this quarter's 10Q sheds some light on one of the most pressing questions about the company: Where all that CAPEX is going.  The 10Q provides a breakdown of some $332 million in Q1 CAPEX, and although this doesn't quite tie to the $344 million on the cash flow statement, it's pretty close.

The breakdown should relieve concerns (such as mine) that the company is spending hundreds of millions on dark fiber, NORAD-style data centers, frivolous engineering projects, etc.  It should increase concerns that the company is building seaside Googleplexes equipped with personal heliports.  To wit:
	Q1
	CAPEX
Information technology assets	112,039
Construction in process	138,374
Land and buildings	41,182
Leasehold improvements	38,762
Furniture and fixtures	1,786
Total	332,143

$112 million on servers is still a lot of money, but it is more comprehensible than, say, $1.5 billion.  $180 million on land, buildings, and construction is, sarcasm aside, probably reasonable for a company of this size, especially one playing catch-up on the infrastructure side (and Google is probably also smart to use its cheap capital to buy the land and buildings outright, although one imagines it could have gotten rock-bottom lease terms).  $40 million in "leasehold improvements" also seems reasonable, as does $1.8 million in Aeron chairs.

So maybe the outlook for free cash flow growth isn't as bad as it seemed.  Unless Google plans to become a REIT, approximately $750 million of the $1.5 billion in CAPEX estimated for this year should disappear.  When/if it does, this will provide a nice lever for cash flow acceleration.

Inaugural "Doh!" Award Goes To...

...Analyst Susan Kalla of Caris & Co., who, according to BusinessWeek, said a hypothetical Microsoft takeover of Time Warner would be a "great move."  Her thinking?  Microsoft could take advantage of Time Warner's low multiple without hurting its stock price.

I don't know Susan and it's certainly possible that she was misquoted.  If not, however, I have some questions: Where was she five years ago, when AOL bought Time Warner?  Would she care to expound on why a proposal frighteningly similar to what has been deemed the most disastrous merger in business history would be a "great move"?  Would she like to explain how the same company will be effective at competing against IBM and Linux on one end and sitcom production companies on the other?  Would she care to hazard a guess as to where the headquarters of this fantastic new $100 billion corporation will be located?  Would she...  Never mind.

Susan, we are proud to present you with the inaugural IO "Doh!" Award.

Full Disclosure: The true inaugural "Doh!" award should go to me: I thought the AOL-Time Warner merger was a good idea.

UPDATE: This award was originally titled a "Genius!" award, but one reader's comment reminded me that even geniuses occasionally have moronic ideas.  So, to focus the award on the idea rather than its progenitor, I've changed the name.

Ballmer Gets Checkbook, Vows Billions for MSN

Per the WSJ, Steve Ballmer announced that Microsoft will radically increase spending on its online business to keep pace with Google and Yahoo:

[Ballmer] said the spending would include $1.1 billion in 2007 on its MSN online business, compared with $500 million in 2005. "We will invest as much on this online opportunity as any of the other bigger players in the market," Mr. Ballmer told about 700 advertising executives [at a big shindig in Seattle].  A report from Reuters adds that the aforementioned $1.1 billion will be for R&D spending and that the company will up MSN's CAPEX from $100 million to $500 million.

Well, good, then we don't have to write off Microsoft in the online business just yet.  Alas, if Steve thinks keeping pace with Google is only going to cost this much, he's a tad out of date.  Google will likely spend CAPEX of $1.5-$1.7 billion this year, versus Steve's $500 million, to say nothing of next year.  As for R&D, meanwhile, Google exited Q1 on a run-rate of $1 billion, up more than 100% year-over-year.  Google's R&D spending for Q306-Q307, therefore, will probably be closer to $2 billion.  Microsoft's newfound commitment--which will probabably generate significant divisional losses--might allow it to keep pace with Yahoo's spending, but Google's should still leave it in the dust.

The WSJ adds that Ballmer said Microsoft was "impatient and determined" to play a bigger role in the online advertising market.  Again, good.  The only chance Microsoft has is if it is humiliated and pissed off.  Even then, I think the chance of real success is small, but absent this passion, it would be zero.

[Updated after original post to add data from Reuters.]