Verizon Goes for Vonage's Jugular

Over the past year, I've received emails from Research In Motion (Nasdaq: RIMM  ) and Vonage (NYSE: VG  ) assuring me that patent litigation would not disrupt the services they provide me. Given RIMM's big profits, I wasn't worried about my BlackBerry fading to black. But Vonage is a different story, given its lack of profitability and the deep pockets of its latest litigation-happy opponent, Verizon (NYSE: VZ  ) . In this case, it seems Verizon's vying to vanquish Vonage -- with a vengeance.

Vonage provides telephone and fax services over the Internet, at a big discount from traditional telecom services; its offerings start at $14.99 a month. I love the service, I've had no problems with it, and I can't resist a good deal.

Unfortunately, consumers' windfall has been shareholders' nightmare. Since its IPO in May, the company's shares have lost roughly 77% of their value.

Vonage's struggle to reach profitability, and its sagging share price, must certainly please its competition. But the company's woes won't keep Verizon's attorneys at bay. Last June, the major telecom filed suit against Vonage for patent infringement, and a jury recently ruled in Verizon's favor. The damages include $58 million and an ongoing 5.5% royalty on future sales.

That's essentially chump change for Verizon, but its actions clearly demonstrate that it wants more than mere royalties from an unprofitable business. Don't expect a settlement here; Verizon is seeking a permanent injunction against Vonage. U.S. District Judge Claude Hilton now says he will grant the injunction, but he'll allow a stay for two weeks. Vonage will push hard to get that stay extended to 120 days.

In addition to distracting Vonage's management, Verizon's suit will force the company to take defensive action and develop some sort of workaround system. Given Vonage's more than 2 million customers, that sounds expensive and unpredictable.

It's true that Vonage's market cap is selling below its $544 million cash hoard, and that the company nearly doubled revenues in its fiscal-fourth quarter. Nonetheless, the chances of a buyout here look slim. Vonage posted a net loss of $286 million last year, and its litigation exposure is extremely difficult to quantify.

As if this weren't enough, Vonage is also preparing to fight another patent suit against Sprint Nextel (NYSE: S  ) , with a trial slated for September.

All in all, it's no surprise that investors dumped almost 10 million shares of Vonage last week. The shares fell on 25% on Friday. Management released a statement this morning condemning Wall Street for overreacting, which helped shares regain 16% thus far today. Still, even if the company wins its multiple court battles, it's already sustained considerable and worrisome damage. That leaves me exploring alternatives for phone service, just in case my Vonage pulls a vanishing act.

Vurther voluminous Voolishness:

Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares mentioned in this article. He is ranked 1,590 out of 24,619 in Motley Fool CAPS. The Motley Fool has a disclosure policy.


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