Vonage sees ray of hope, but future remains shaky

Vonage reported several positive developments. Most notably, it reached an agreement in principle to settle intellectual property litigation with AT&T Inc. According to terms that still need to be finalized by the companies, Vonage would pay San Antonio-based AT&T $39 million over a five-year period. The agreement follows previous settlements with Verizon Communications Inc. of New York and Sprint Nextel Corp. of Reston, Va., that total a maximum of $200 million.

Shares of Vonage closed at $2.49 Thursday, an increase of 13.7%, that continued a rebound from below $1 in October amid uncertainty over whether the patent infringements could push the Holmdel, N.J.-based company into bankruptcy.

"The settlement with AT&T removes some uncertainty surrounding the company, and the operations also appear to be stabilizing somewhat," said Clay Moran, an analyst with Stanford Group in Boca Raton, Fla.

In another milestone, Vonage reported that it generated cash from its operations for the first time in its history. Revenues of $211 million were 30% greater than the $162 million reported in the third quarter of 2006, but the company still reported a net loss of $16 million for the quarter, excluding certain charges.

Vonage also added 78,000 net subscriber lines during the quarter, up 37% from 57,000 in the second quarter 2007. It ended a string of six consecutive quarters of declines in net subscribers.

"Growth had slowed during the past year, and it was difficult to say when this would end," Moran said.

The company reported that marketing expenses declined to $62 million in the quarter from $91 million a year ago and $68 million in the second quarter of this year, while the $206 in average marketing expenses it took to gain one subscriber was the lowest cost of acquisition in 2-1/2 years.

Company officials did acknowledge there was still a lot of work for the company to do to right itself, though it believes many problems are fixable. Key among those is its rate of customers ending service, which was 3% in the quarter and has been an ongoing concern.

While acknowledging that churn remains a problem, Vonage chairman and interim CEO Jeffrey Citron said during Thursday's conference call that most people who leave do so because of poor user experience, not because they are getting a better deal elsewhere; he argued those types of issues can be improved internally. The company is working at ways to provide better customer care to people setting up their service and those who have problems with their service, he argued. Nevertheless, he added that he does not expect to see an improvement in churn in the fourth quarter.

"Right now churn is one operating issue that very much remains and needs to be fixed if they're going to be successful," Moran said. "They say it's fixable, but it's been a problem for a while now, and it continues to go in the wrong direction."

Though Vonage appears to have staved off bankruptcy for the time being, it could still have some liquidity concerns. In December of next year, the company has $253 million in convertible debt that can come due. At the end of the third quarter, it had $194 million in cash, with $40 million of that restricted. Moran estimates Vonage will have somewhere between $200 million and $225 million when the debt is due.

"I think it's fair to say that we don't really view the situation as a good one," he said. "They have a lot of remaining challenges, but things have improved, and the risks have diminished, and that's why you've seen a relief rally in the stock over the past month or so."