Vonage's Vile Outlook

Don't miss Tom Gardner tonight on CNBC's "On the Money," airing at 7 p.m. ET. 

Changes are afoot at Vonage (NYSE: VG  ) , but at this point, aren't we just waiting for the other shoe to drop? The Internet-based telephone service provider announced cost-cutting initiatives and its CEO's resignation this morning, as the company struggles in the courtroom, marketplace, and bottom line.

Michael Snyder, who came over from Tyco (NYSE: TYC  ) to run Vonage just 14 months ago, will step down. He will be replaced by Vonage founder and chairman Jeffrey Citron, for now. That move may not sit well with a market that remembers Citron as the one tagged with a $22.5 million fine to settle securities fraud charges at Datek.

Slashing expenses will trim $140 million of annual overhead at the company, with a $30 million reduction through layoffs and $110 million hacked off the marketing budget. You may be relieved to find that you'll be seeing fewer of those Vonage commercials, but investors should wonder how that will affect new accounts.

After closing 2006 with 2.2 million lines, the company added another 166,000 lines in the quarter that ended in March. The company's churn is running at a monthly rate of 2.4%. Replacing those departing customers isn't cheap; Vonage is spending $275 per gross subscriber addition in marketing expenses.

The moves come just as patent-rich Verizon (NYSE: VZ  ) is dealing Vonage body blows with legal fisticuffs. Verizon has been awarded verdicts against Vonage pertaining to three different patents. Even though a judge at one point ordered Vonage to stop signing new accounts, the company can now continue to do so as it endures the appeal process.

Worst-case scenario? Vonage dies. Best-case scenario? Vonage lives on but will probably have to pay Verizon for using its patents and will find its money-losing operation becoming even more of a bleeder.

It's been a long downward spiral for Vonage, and things have only gotten worse for the company since its disappointing IPO last year. It may be the edgy name in this niche, but giants like Comcast (Nasdaq: CMCSA  ) , AT&T (NYSE: T  ) , Qwest (NYSE: Q  ) , and Verizon, of course, are already here.

On a less intuitive level, Internet telephony software players like eBay's (Nasdaq: EBAY  ) Skype are also keeping markups honest in this tricky sector. Should you follow Snyder's lead and walk away? An optimist would argue that it can't get much worse; Vonage shares have tumbled more than 80% since going public fewer than 11 months ago. However, until Vonage proves that it's not an eventual path to zero -- perhaps by soliciting buyout bids -- it just feels like a bad call for investors to make.

Other dark chapters in Vonage's past:

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Longtime Fool contributor Rick Munarriz regrets touting Vonage a few years ago as a much-anticipated IPO. He changed his tune once the company actually filed, though. He does not own shares in any of the stocks in this story. He is part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. Tyco is an Inside Value pick. The Fool has a disclosure policy.


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