A bull case on Vonage (NYSE:VG)? Please, try to suppress your laughter. After all, top investors like Sears Holdings' Eddie Lampert and Berkshire Hathaway's Warren Buffett have made big bucks on incredibly down-on-their-luck companies, right? So why not Vonage? Let's take a look.
Perhaps the company's most valuable asset is Vonage's brand. While Vonage has faced significant challenges from its bust of an IPO and the Verizon (NYSE:VZ) patent-infringement suit, these issues are unlikely to affect consumers, most of whom simply want a good service at a cheap price. It's that simple.
Like eBay (NASDAQ:EBAY) and Amazon.com (NASDAQ:AMZN), Vonage moved to capitalize on its first-mover advantage with tons of marketing. As of the end of 2006, the company had shelled out $678.8 million for advertising on the Net, television, print, and radio. The company has also established key relationships with retail giants Target, Wal-Mart (NYSE:WMT), and Best Buy (NYSE:BBY).
Thanks to its aggressive branding initiative, Vonage has built a massive footprint of 2.4 million lines with roughly 1 million of those coming in 2006. Looking at Q1, we see that cash from operations still came in negative but continued to show clear improvement. To improve cash flows, Vonage has implemented annual prepay programs and now accepts check payments.
The subscriber base is also a powerful leverage point for ancillary premium services. Take a look at Vonage Text. This cool service automatically transcribes voice mails to text, which you can then access from your email or mobile device. The fee is $0.25 per message. Other premium services include faxing, virtual phone numbers, toll-free phone numbers, and soft phones.
To allow for growth, Vonage has built a highly scalable network. The system relies primarily on low-cost software instead of circuit switches or dedicated softswitches. It means that the capital expenditure for each additional line is about $40.
What about the heavy net losses? This is a big concern, but Vonage is taking action. The company is moving from heavy branding to measurable, direct marketing approaches. This means focusing on targeting market segments, encouraging customer referrals, and even installing retail kiosks across the country. The goal is to hack about $140 million in total expenses for 2007.
While Vonage has certainly made lots of progress, the company still faces the overhang of the Verizon patent litigation. As seen with companies like Research In Motion (NASDAQ:RIMM), these kinds of fights can be frightening for investors. What if the service is shut down? What about ongoing royalties? What about more lawsuits?
If you look at the history of high-tech, though, there are not many examples of well-known companies dying from patent litigation. Vonage has a top legal team and will fight like a cornered beast for its survival. At the same time, the company believes it has found workarounds for two patents and is developing a solution for the third one.
The irony of the litigation threat is that Verizon never would have gone for Vonage's jugular had it not believed Vonage to be a threat. Indeed, Verizon should have concerns over Vonage. It has a strong consumer brand, a scalable infrastructure, and an extensive distribution network. Vonage's cost cuts will take effect in the next two quarters, which should help with cash flows. And if Vonage makes progress on the litigation, there is likely to be a nice move in the stock price.
This is certainly not to imply that Vonage is without risk. Vonage is pushing a disruptive technology and business model. But if the company can continue to expand its business and minimize the impact of the Verizon litigation, Vonage does look like an attractive investment option.
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Fool contributor Tom Taulli, author of The Complete M&A Handbook, does not own shares of any company mentioned in this article. Best Buy, eBay, and Amazon are Stock Advisor selections, while Wal-Mart is an Inside Value selection. Tom is currently ranked 1,161 out of 29,574 rated investors in Motley Fool CAPS. The Motley Fool has a disclosure policy.
