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Tuesday, August 01, 2006

Why Vonage Wasn't Worse

Vonage (VG), as expected, threw out some horrible earnings numbers this morning. The stock is down 4.5% at $6.77, but there is a reason the stock reaction wasn’t considerably worse.

The company lost $74.1 million for the quarter, or -$1.16 EPS, on revenues of $143.4 million. It was only expected to lose -$0.57 EPS.

Its net customer adds were the second best ever with 256,000 net subscribers adds. The company is forecasting for losses to continue declining and based on the current projections it expects adjusted operating profits as soon as the first quarter in 2008. Marketing costs are running almost 50% higher than last year, with marketing this quarter at $90 million (compared to $88 million last quarter). The sequential churn rate was up from 2.1% last quarter to 2.3% this quarter. It also showed what its IPO-FUBAR trade cost the company: $18 million to indemnify underwriters for the subscriber clients that refused to pay for the IPO shares.

The company guided fiscal year-end 2006 revenues of $600 million to $615 million, and said it expects 2.3 million to 2.45 million subscribers. The company currently has 1.85 million subscribers.

It had over 5.3 million shares in its short interest on last available data, which compares to 31.25 million shares at the IPO and an average daily trading volume of 2.35 million shares. This short interest is acting as some support, and the fact that we now have the company quantifying its projections on a post-IPO basis is helping as well. The current market cap is $1.09 billion. This company did botch its IPO as one of the worst ever, but the investment bankers may be just as much or more to blame than the company. All models have VG losing money and growing subscribers out through 2008.

The company WILL have legal exposure to the botched IPO as it has class action lawsuits galore from the value falling so much, but even the class action suits may have a shot at consolidation since there are so many overlapping cases. Because the company announced patent acquisitions AFTER the end of the quarter, it is not accurate to rely on the exact cash statements noted on the balance sheet. But that is what we have to rely on for now. It ended the quarter with $597 million cash and equivalents; plant and equipment of $124 million; and Total Assets of $827 million. It listed total liabilities (not reflecting future law suit losses) at $479.6 million, and claimed net stockholders' equity at $347.55 million. This net equity number will come down through time, but if you choose a static loss of say $50 million per quarter before (and throw in IF) they reach operating break-even or profits in Q1 2008 then they will burn through $300 million between now and then. Factor in additional patent acquisition costs and legal settlements with telecoms of say another $100 million, and it appears as though the company can sustain operations until it swings into a break-even or net cash flow positive basis. You also have to assume that the class action lawsuits (court dates and/or settlements) will be well out into the future.

Understand that these numbers are partly arbitrary based on what the company is forecasting. Management probably knows by now that if they offer guidance they do not feel they can reach then they are just opening themselves up for even more liability on a personal and professional basis. The stock is down 4.5% at $6.77 (only $0.27 above the $6.50 post-IPO lows), but it looks like the street is doing some homework now and trying to quantify the actual current values on the balance sheet and factoring in forward subscriber numbers to make sure the company won't fail.

You can be fairly certain that the company will have to operate with what it already has since the street is probably not going to throw additional funding toward the company. If you were evaluating Vonage solely on the last quarter earnings you would be saying SELL, SELL, SELL!!! But if you are evaluating the actual feasibility of the company as a going concern or as a surviving entity, you have your answer as to why the shares aren't trading much worse. The verdict on their financial survival is not yet out, but the notion that you can actually start to make calculations and can start to at least try to quantify the odds of their survival is keeping the stock from falling off a cliff.

Jon C. Ogg
August 1, 2006

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