Vonage Raises $200M

Vonage Raises $200M

May 9, 2005

By Justin Hibbard

In March, Deal Flow told you that privately held broadband phone company Vonage Holdings Corp. was raising $100 million in its fifth round of funding. Turns out the company managed to raise twice that amount. Tomorrow, Vonage will close a $200 million round led by Bain Capital with participation from the company's management and previous investors 3i Group, New Enterprise Associates, Meritech Capital, and Institutional Venture Partners.

That's the largest VC funding on record this year, according to researcher VentureOne. A source says Vonage is valued at approximately $1.1 billion after the financing. (Vonage wouldn't comment on valuation.)

Including the new round, Vonage has raised about $410 million since it was founded in 2001. Just nine months ago, it closed a $105 million round, much of which is still in the bank, says CFO John Rego. Why raise more? "Growth, growth, and more growth," Rego says.

Here's what that growth looks like. Vonage ended last year with 390,000 phone lines, up 400% from 2003. The company currently has more than 650,000 lines and is adding more than 15,000 a week. At that pace, it will have about 1.2 million lines by year-end. Rego says the company expects to have more than 2 million by the end of next year. Considering that Vonage's average monthly revenue per line is about $30, the company could generate about $292 million in revenue this year. (That updates my previous back-of-the-envelope forecast.)

In addition, Vonage has begun a global expansion, having recently introduced its service in the U.K. and Canada. By year-end, it will likely launch its service in an Asian country, too. "Some of the funds will be useful for that," Rego says.

Marketing remains Vonage's largest expense. (You may have seen these TV commercials.) At the current growth rate, the company is spending about $9 million to $12 million a month on average to acquire new customers. Without that expense, the company would be cash-flow positive, if not profitable. But for now, it's plowing all of its free cash flow--plus money from its treasury--into marketing.

There's a method to the madness. Rego says building the largest customer base possible will ultimately lower Vonage's expenses. For example, the more calls it handles, the lower its termination fees (i.e. the cost of connecting Internet calls to the public switched telephone network). Eventually, the cost of acquiring customers could come down as consumers learn about voice-over-Internet-protocol (VOIP) service.

A land-grab for the exploding Voip market is underway. IDC predicts the number of U.S. residential Voip subscribers will grow from 3 million this year to 27 million by 2009. Cable and phone companies are determined to saw off a big wedge of that pie. "We haven't seen them play real hardball yet," says Will Stofega, an analyst at IDC.

Comcast rolled out Voip service in January and aims to have eight million customers in four years. Cablevision ended last year with more than 272,000 Voip subscribers. Unlike Vonage, big telcos can bundle Voip with other services and market to their installed customer base, giving them an advantage in marketing.

Then there's Skype, the two-year-old Voip upstart that claims to have two million users worldwide, leading Morgan Stanley analyst Mary Meeker to call it the "the most rapidly growing product from an acceptance standpoint the world has ever seen." Vonage doesn't consider Skype direct competition since Skype started as a free service that lets Internet users talk only with each other through their computers. But last year, Skype introduced a paid service that lets Internet users call regular phones. Skype claims one million people now use that service. The company spends little on marketing, relying mainly on word of mouth and publicity.

To keep growing, Vonage may have to raise money again before long. I'm putting odds on a 2006 initial public offering. It will be a controversial deal.