Vonage Should Learn From the Mistakes of Netflix

Internet-based voice calls are disrupting traditional phone services -- wired or not -- as we speak. That thesis just scored some support from VoIP specialist Vonage (NYSE: VG  ) and its second-quarter report.

Sales slid 2% year over year to $212 million, exactly matching analyst expectations. A drastically improved balance sheet led to 72% lower interest costs year over year, which in turn helped Vonage beat the Street's expectations for its bottom line. Adjusted earnings came in at $0.09 per share, $0.02 ahead of the analyst consensus.

Shares soared as much as 12% on the news. That doesn't make Vonage expensive, though. Shares have lost 19% of their value so far in 2012, even after this sudden jump, and are priced at just 1.2 times trailing earnings today. Citing the company's "sustainable cash flow, strong balance sheet, and the belief that its stock represents a highly attractive value," Vonage's board also introduced a $50 million share buyback program. The company is now authorized to buy back and retire about 11% of its currently outstanding shares by the end of 2013.

That's a shareholder-friendly move at first glance, but I think Vonage could put that cash to better use. Corporations are notoriously bad at creating shareholder value through buybacks, and Vonage could stand to pour some more cash into its marketing efforts. The company is fighting high customer churn and shockingly slow sign-up growth, even though its low-cost services are robust and seem timely in this age of squeezed consumer budgets.

The situation reminds me of Netflix (Nasdaq: NFLX  ) back in 2010, when the company funneled funds away from subscriber growth and into an ill-advised buyback program. The movie maven canceled that terribly policy two years later... replacing it with a dilutive load of freshly issued shares. Groan. I'm not saying that Vonage will waste its capital the way Netflix did, particularly since its shares are so much cheaper than Netflix stock ever was, but history points to a rocky road ahead.

Vonage can't afford to let direct rival magicJack VocalTec (Nasdaq: CALL  ) run away with the consumer market for VoIP services, and the company is not making inroads into the business-class market dominated by Cbeyond (Nasdaq: CBEY  ) and 8x8 (Nasdaq: EGHT  ) . It's high time to push the pedal to the metal, and buybacks won't help with that. I still like what Vonage is doing in general, but this buyback is a terrible move.

We just created a premium report on Netflix, replete with a full year of up-to-the-second analysis. Read up on the company and its recent history of unfortunate business decisions by clicking here. Vonage's board could certainly learn a thing or two from that story.

Fool contributor Anders Bylund owns shares in Netflix, augmented by a bull call spread laid atop those shares. He holds no other position in any of the companies mentioned. Check out Anders' holdings and bio, or follow him on Twitter and Google+. The Motley Fool owns shares of Netflix. Motley Fool newsletter services have recommended buying shares of Netflix. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinion, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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