Court's Ruling Hurts Vonage, As Does Cable

Vonage Holdings has two claims to fame: pioneer in Internet calling and worst-performing initial public offering in the past 15 months.

Shares in Vonage VG plunged 14% Friday to 4.17, a day after a federal jury said it must pay Verizon Communications VZ $58 million in damages for infringing on patents.

Vonage, which plans to appeal, also must pay Verizon future royalties if it continues to offer its service using the same technology.

Vonage faces a possible service shutdown. Verizon has filed for an injunction and a hearing is slated for March 23. Vonage has 2.2 million customers.

Vonage's stock has dropped 75% since it became a public company in May. While Vonage pioneered Internet calling, along with Skype, its growth has been derailed by cable TV companies that sell digital phone services.

"Vonage is a train wreck still in motion," said David Menlow, president of IPO Financial Network. Vonage's stock decline is the worst among 192 IPOs larger than $50 million since January 2006, he says.

In 2004, Vonage shook up the telecom industry by unveiling unlimited voice over Internet protocol service for $25 a month. The VoIP service requires high-speed Internet hookups that users buy separately from phone or cable TV companies.

One Vonage weaknesses is that it can't offer a bundle of services -- phone, broadband Internet, TV and other products -- as can cable and phone companies, says Paul Brodsky, an analyst at TeleGeography.

"Vonage was the poster child for VoIP, but cable firms offer an attractive bundle," Brodsky said.

Last quarter, Vonage added 166,000 customers, down from 204,591 in the third quarter and 207,252 a year earlier. For the quarter, Vonage lost 42 cents a share on $181.5 million in revenue.

Vonage isn't the only VoIP startup struggling against bigger rivals. Since cable firms began ramping up phone services two years ago, they've also hurt growth at VoIP firms 8x8 EGHT, SunRocket and others, Brodsky says.

Unlike Skype, Vonage didn't hit pay dirt via acquisition. EBay EBAY bought Skype for $2.6 billion in cash and stock in 2005.

Skype's software works on personal computers, while Vonage's VoIP adapter kit replaces regular phones. Before its IPO, Vonage mulled selling itself but couldn't find a buyer, analysts say.

"Vonage missed the brass ring on the carousel," Menlow said.

Other VoIP startups seem in the same boat. 8x8's stock has traded below 2 since January 2006, while Fusion Telecommunications FSN shares trade for well less than 1.

Some VoIP firms have disappeared, while some VoIP entrepreneurs have moved on. Jeffrey Pulver, who founded the forerunner to Vonage, Min-X, is now involved in an Internet TV project, says his spokesman, Alan Weinkrantz. Skype's founders have started Joost, an Internet video firm.

In his blog, Pulver said Verizon's lawsuit could stifle competition. "I hope and trust this decision does not curb innovation and progress in VoIP," he wrote.

Blair Levin, analyst at Stifel Nicolaus, says the outcome of the Verizon-Vonage case will likely spill over to the rest of the VoIP sector. Vonage "has become a lightning rod for patent suits," Levin said.

Sprint Nextel S has filed a patent suit against Vonage. A trial is slated for September.

Copyright 2007 Investor's Business Daily, Inc.