Is it worth investing in internet telephony stocks?

published 22 March 2006

It's good to talk or so advertising campaigns have been telling us for years but it's often very expensive too. Competition may have brought the cost of calls down (unless, of course, you call home from abroad on a UK mobile), but the combination of landline bills, mobile-phone costs and internet charges means our final bills often come in higher than ever before.

No wonder then that the arrival of Voiceover Internet Protocol (VoIP) technology has caused so much excitement: using VoIP which breaks up voices into tiny bits of data and sends them, like an email, over the internet it is now possible to make phone calls via your computer to anyone else's computer anywhere in the world, any time, for free. All you need is a fast-speed internet connection, says Peter Munro in The Independent, and a headset, or special cordless phone.

Unsurprisingly, 175,000 new users a day are signing up to use VoIP with one of the first movers in the industry, Skype. The firm, which makes its money selling kit and charging for calls between computers and ordinary phones, earned $7m in 2004, but is expecting to make $60m in 2005-2006 and $200m the year after. A great business model? Ebay certainly thinks so, having acquired the company last September for an amazing £1.5bn.

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The numbers certainly look tempting. And it's inducing others to jump on board. Google launched VoIP software last August, Microsoft bought Teleo, a San Francisco-based VoIP provider soon afterwards, and in the UK, says the FT, Tesco is getting in on the game. Pledging to bring VoIP to the masses, it is to provide both a handset and the software for less than £20 (a Skype handset costs £70). However, the news attracting the most attention to this new area of telecommunications comes from US VoIP firm Vonage, which is planning to list later this year.

But there the good news ends. Look closer and you'll see that Vonage is "racking up large losses" $189m in the first nine months of last year. This is because each customer has a lifetime value to the firm of around $1,200 (unlike others, it charges a flat monthly fee for usage), but when you add up what subscribers cost the firm (acquiring them doesn't come cheap Vonage was the top buyer of internet advertisements in the US last year), they come to $1,324. That's bad news, especially as average revenue per subscriber is falling every month as Vonage cuts prices.

This alone may not deter growth investors'. But it really should: such investors should note that there is a reason why Vonage is cutting prices growing competition. VoIP offers all sorts of exciting possibilities, says Barron's, but don't be surprised to see it eventually lose its lead in the market to Comcast, America's largest cable company, which this year intends to roll out telephone services to more than 40 million homes.

Aim-listed PlusNet (PNT, 342p) is one of the success stories in the broadband and VoIP era, says Investors Chronicle. In a recent trading statement, it reported that broadband subscribers had almost doubled to 176,000 in 2005, boosting turnover by 27% to £35.2m. It's also riding the internet telephony wave: last September, it launched a service that allows voice calls to be made cheaply over the internet and has also launched wireless broadband, which lets users access the internet from laptops at WiFi hot spots in public areas. PlusNet's shares trade on just 14 times forecast earnings for 2006, an "undeserved" discount to rival Pipex, which trades on 24 times forecast earnings. "Buy".

Telecoms services business Spiritel (STP, 6.4p) also looks good, says Afxnews.com. After posting a small loss, related to investment in its VoIP product range (it offers a "plug-and-play solution" users plug their phone into their broadband router via a connector, bypassing their computer), in the first six months of this financial year, Spiritel aims to be profitable by April and says it is on track to become a "leading player" in VoIP telephony. The shares have fallen 60% over the last 12 months as investors have waited for good news to filter through. However, shares have shown some signs of life in recent months (rising 8% so far this year), so might make a good gamble for speculators.