Rule #1 Finance Blog

With Investor Phil Town

RULE #1 & IPO’S: VONAGE

Here’s a letter from Todd:

Phil,

As a customer of Vonage, I have been given the opportunity to participate in an IPO offer.  Vonage plans to go public with approval of the SEC at a price of $16-18 per share.  Given the fact that there are no historical numbers, obviously the Rule #1 methodology would say to stay out of this.  However, the offer does sound appealing.  In your experience, do most IPOs move up from the initial price or stay around the initial price?

Obviously, Google comes to mind with an $85 open price and
is now trading for $402 (of course this is probably extremely rare).
I’ve attached the prospectus for you to review if you’d like.  Only
current customers of Vonage are eligible for the offer.  After
purchasing the Master’s program from Success Magazine, I have very
limited funds and will only purchase about $1000 worth if I decide to
do it so it will not be the end of the world if I lost it.  What do you
think?

Thanks for any advice,

Todd

 
 

Here’s what I told him:

Hi Todd,

The Vonage offering is interesting.  Vonage is the leading VOIP
business — making phone calls using broadband internet that is already
in the home.  They are spending major millions to build their brand
Moat
and are in the process of going broke doing so … but they are
hoping that they get the big slice of the pie as million of users shift
to lower cost VOIP telephone calls off of land line calls.

Frankly, they’ve got a good plan.  I barely use my home phone any more
at all and if they give me a cheap alternative, I’m going to cut it
off.  Between the internet and my cell phone, I’m happy.  No need to be
paying an additional $65 a month for a couple of phone lines when I can
do it cheaper with Vonage.

I’m saying this because I want you to understand why companies like
Citigroup, Deutsche Bank, UBS, Bear Sterns, Piper Jaffray and Thomas
Weisal Partners are willing (for only several dozen million dollars in
fees) to put their sales forces out there selling this offering. 

That
said, one of the first things the prospectus tells us is that they’ve
been losing money hand over fist and will continue to do so.  The
offering document you sent me does have numbers in it back to 2003.
And those numbers are UGLY!!!  The only good number of the Big Five is
Sales — which are increasing, but Equity is negative, EPS is negative
and Free Cash is negative.  And a rough glance at ROIC is negative.  So
four out of the Big Five numbers sort of suck.

So here’s the question for a business buyer like yourself, Todd: How
much is Vonage worth today? 

And the answer?  Who knows? 

There is no
way to predict where this business is going to be in ten years.
None.  They are trying to build a brand moat but who knows if they will
get there.  Seems to me a telephone business brand isn’t worth the
paper it’s printed on.  Telephoning is a commodity.  Can you really tell
the difference between the phone call you make with AT&T vs. Bell
South?  Commodity businesses don’t have moats.  They are essentially
just a pricing business and the winner, if you can call it that, is the
one with the lowest price who can still not go bankrupt.

I just got off a radio show with two CFP’s.  They were not so happy
with Rule #1.  In particular they took exception to the idea that
buying a stock could have any certainty to it.  They viewed a stock
purchase as the equivalent of buying a lottery ticket.  Their words.

Well, most of the time, they are right.  Buying something like Vonage
is absolutely like buying a lottery ticket.  It’s a total crap shoot.
It has no moat and probably can’t create much of one.  And it is the
farthest thing from Rule #1 investing that I know.

On the other hand, the fact that many stocks are lottery tickets does
not mean that all stocks are lottery tickets.  Our job as Rule #1
investors
is to know which is which. 

Frankly, if you have a Certified
Financial Planner who doesn’t know the difference you might want to
switch to a CFP who does.  But good luck finding one.  These guys have
grown up in the Efficient Market Theory school of investing and have
‘"diversify and hold" engraved on their diplomas.  Truth is, when you
tell people the secret to great investing is to find a $1 of value and
buy it for $0.50, people either get it right away or no matter how much
you discuss it, they don’t get it ever.

Hopefully, Todd, you get it.  And if you do, you will see that it is
pretty much impossible to know the value of Vonage… which means you
don’t know if you are paying $0.50 for the $1 or $5 for the $1.  And
that makes this deal a lottery ticket.

Now go play.

Phil