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