Monday, June 19, 2006

Vonage Holdings-Unsafe at ANY Price

This is just way toooooo much.

What a waste of time. This truly is the #3 box that Munger describes at Berkshire Hathaway. At Berkie, there are three boxes, the inbox, the outbox, and the too difficult to understand box.

Maybe this is easily understood and should have be queued up immediately for the outbox.

Vonage (VG) as all of us have witnessed, appears to have been one of the more mis-priced IPO's in some time. The swoon from an intial $17 to its current half price special at $8.50 resembles a death spiral more so than a correction.

Today's news that Verizon is suing Vonage over alleged patent infringements just adds to the confusion if not disgust. Vonage and its Vonage America subsidiary were served with the lawsuit which relates to seven patents by Verizon Services and Verizon Laboratories.

One certainly must wonder about the quality of due diligence that the seemingly hapless investment bankers practiced. One would have thought that the intellectual property owned by the business would have been thoroughly assessed. But wait, there it is ...big as day...under risk factors, a completely disclosure of what existed at time of issue.

As the prospectus indicates, "We may be subject to damaging and disruptive intellectual property litigation." As it further adds:
We have been named as a defendant in three suits currently pending that relate to alleged patent infringement. See "Business—Legal Proceedings—Patent Litigation." In addition, we have been subject to other infringement claims in the past and may be subject to infringement claims in the future. We may be unaware of filed patent applications and issued patents that could relate to our products and services. Intellectual property litigation could:
  1. be time−consuming and expensive;
  2. divert attention and resources away from our daily business;
  3. impede or prevent delivery of our products and services; and
  4. require us to pay significant royalties, licensing fees and damages.
Needless to say, for a value investor, in my view, there is no price at which this becomes an attractive Ralph Nader's description of the Corvair, Unsafe at any Speed, this may well be unsafe at any price.

Though it is easy to rail against the ineptness of the investment bankers, the investor has some responsibility to him/her self to check out a few facts.Maybe those risk factors mean something!

Let's think about this. Start off with the first risk cited. "We have incurred losses since our inception and we expect to incur losses in the future." Seems pretty clear to me. You were depending entirely on hope, or some greater fool to take you out of this misery.

The prospectus adds that so far the accumulated deficit was $467 million. Revenues for 2005 were about $270 million compared to marketing expenses of $243 million. Seems excessive somehow to get back essentially only one dollar of revenue for each dollar of marketing that you put up. Perpetual motion of the worst kind. Did trends improve...well, not really much, first quarter revs were $119 million and marketing costs went to $88 million. Still spending roughly 75 cents to get a buck.

What is the competitive position? Where is the competitive advantage? Vonage competes with many companies having far greater financial resources, traditional telephone service providers, cable companies, wireless providers,'s all there in the prospectus. As it states," Most traditional wireline and wireless telephone service providers and cable companies are substantially larger and better capitalized than we are and have the advantage of a large existing customer base." It adds further, "Until recently, our target market has been composed largely of early adopters....Attracting customers away from their existing providers will become more difficult as the early adopter market becomes saturated."

So let's see, in picking off the low hanging fruit, we have lost almost half a billion dollars, it now takes us 75 cents to buy a buck's worth of revs, but the outlook is more difficult???

Thes first two risk factors should have proven sufficiently discouraging. There were only another 25 or so that followed.

Customer service at least according to this one blogger appears to be deteriorating.

"Just sending this out as a warning to anyone who considers signing up for Vonage. I’ve had the service since August and honestly, it was pretty good. Over the last month or so, however, the quality has been degrading considerably and so I attempted on several occasions to contact customer support.That didn’t go well. Hold times are frequently in excess of 45 minutes to an hour, and once connected the support representatives are completely clueless with regard to problems with service. They’ll offer to send you to Tier 2 support, which means another half hour or so of holding. Once there, you’re just as likely as anything to be told that the problem lies with your ISP and to try it again later. On the 24th, I signed up for SoftPhone, Vonage’s PC-based additional line service. The login credentials provided to me were incorrect and as such, I never used the service. I called again and was on hold for 90 minutes before I gave
up. I called back this morning to cancel my account."

Well, post deal, Vonage has a balance sheet with equity of $433 million and debt of $278 million. The financiers' preferred got paid down to zero. Operating loss in the first quarter was $82 million. SG&A to run this empire in the first quarter was merely $53 million. Net cash flow used in operating was about $75 million.

I do have empathy for those who have been sold a bill of goods in committing to this offering. But the warnings were quite straight forward and candid. The company's risk factors are quite explicit. In MD&A, the company is forthcoming in its strategy: "We are pursuing growth rather than profitability." "We have chosen to increase our marketing expenses significantly, rather than seeking to generate net income." "This strategy will result in further losses which generally have increased quarterly since our inception."

My conclusion is hardly earthshaking. Too many risks, better financed competitors, apparent reputation for difficult service, and a profitless strategy. Intellectual property that has already been subject to lawsuits with another just in. The stock is unsafe, in my view, at ANY price.

Disclaimer: Neither I, my family, or clients have a current position in Vonage or Verizon.


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