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Tickers in this Article: goog, msft, ebay, twx, cmcsa, cvc, vz, t, vg
At first glance, it looks like a generous offer. Privately-held, Internet telephony player, Vonage Holdings (VG), has allocated its customers 13.5% of the shares in its upcoming initial public offering. The group has reportedly sent out email and voicemails to customers, inviting them to buy stock.

Internet telephony is hot – and Vonage, with about 1.6 million customers, is one of the largest and fastest growing companies in the market. Besides, hot IPO shares are normally reserved for large institutional investors. It's rarely possible for retail investors to get a piece of one. So, you would think buying into the Vonage IPO would be snap.

But would-be investors should look before they leap. Take a quick browse through Vonage's filings with the SEC, and you'll spot plenty of red flags.

For starters, Vonage is losing money hand-over-fist. In every quarter since 2001, Vonage has lost money. In 2005 the company lost $261.7 million on revenue of $269.2 million. At this loss rate, half of the $530 million it plans to raise in the IPO will be gone in a year. On top of that, Vonage expects losses as far as it can see in the future. Google (GOOG), by contrast, was hugely profitable at its public offering.

As far as I can tell, nothing separates Vonage from the pack. Everyone from Microsoft (MSFT) to Google to Ebay (EBAY) to TimeWarner's (TWX) AOL peddles Internet telephony. Cable players Comcast (CMCSA) and Cablevision (CVC) both offer VOIP services, as do the big telcos Verizon (VZ) and AT&T (T).

These competing offerings are often bundled with other services, such as broadband Internet and television, while Vonage's offer is a standalone service. The average revenue per subscriber has fallen to $26.63 per subscriber--from $30.99 a year ago. It's hard to imagine how Vonage will ever squeeze a profit in this market.

It's not clear how the company will ever make money once its public offering is complete. Nothing in Vonage's filing indicates a serious efforts to expand services, or, more importantly, to get its costs below revenues. This failure to plan for profitability should be enough to scare away investors.

Then consider the valuation. Including the allotment to customers, Vonage is preparing to sell 35.7 million shares. At the mid-point of the indicated $16-18 price range, Vonage would have a market capitalization of $2.6 billion -- or about $1600 per subscriber. With no bottom on Internet telephony pricing in sight and Vonage's margins potentially going to zero even lower, that's an awfully high price to ask.

So, with such dismal fundamentals and little in the way of a proper plan going forward, why on earth is Vonage selling shares to its customers? The evidence suggests that the IPO is primarily a liquidity event, a way for the insiders and venture capitalists who have already poured hundreds of millions into Vonage to cash out while they can. In all likelihood, the "smart money" – mutual funds, pension funds and other big institutions – know that's the primary motivation and are steering clear of the deal. Vonage is betting that its retail customers aren't so smart.

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