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Why Vonage Holdings Corp. Stock Jumped 20% Today

By Anders Bylund - Jul 30, 2015 at 3:52PM

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The digital communications vendor is trading in low-margin consumer accounts for a sharp focus on business users.

Although we don't believe in timing the market or panicking over market movements, we do like to keep an eye on big changes -- just in case they're material to our investing thesis.

What: Shares of Vonage Holdings (VG -0.91%) were up 20% at 3:45 p.m. Thursday, touching fresh multiyear highs in the process. The maker and operator of Internet-based communications tools reported second-quarter results in the early morning hours, edging out Wall Street projections on both the top and bottom lines.

So what: Your average Vonage analyst had been expecting second-quarter earnings of $0.08 per share on $219 million in sales. Vonage topped both targets with adjusted earnings of $0.09 per diluted share and sales of $222 million. In the year-ago quarter, these metrics stood at $0.07 per share and $219 million, respectively.

Excluding the impact of three recent tuck-in acquisitions, Vonage's business-grade services saw a 38% year-over-year organic sales increase, landing at $49 million. Including those deals, business sales surged 118% higher. The company now serves 403,000 seats, or individual business-class end users, up from 217,000 a year ago and 338,000 in the first quarter.

On the other hand, consumer sales fell 11.7% year-over-year to $173 million. The number of subscriber lines dropped 12% lower year-over-year, including a 2.8% decrease in the second quarter alone. In Vonage's words, the company is leaving some revenue on the table in order to double down on higher-quality customers. Moreover, marketing and support budgets are being weighted more heavily toward the business division, which delivers higher lifetime value per customer and a generally more predictable target market.

Starting from a GAAP earnings base of $8.3 million, Vonage produced $29 million of free cash flows in the second quarter. That's a 64% increase over the year-ago period.

Vonage logo

Image source: Vonage.

Now what: Vonage is shifting gears at the moment, moving out of the consumer business in favor of a heavy business-grade focus.

That's not a recipe for torrential sales growth, but profit margins are indeed improving. Adjusted net margins moved from 6.6% in the year-ago period to 9.1% in this quarter, thanks to a 14% reduction in sales and marketing costs that still delivered a mild revenue gain.

I'm not sure that Vonage has found a magic bullet here, but the business focus is certainly paying dividends for now. Those juicy cash flows give management the flexibility to keep growing by strategic acquisitions, as long as Vonage can find micro-sized targets with strong technologies and customer lists.

Can Vonage shares keep climbing above these eight-year highs? I don't know for sure, and the company certainly isn't firing on all cylinders even now.

But let me just say this: Our Motley Fool CAPS system has been rating Vonage a one-star stock out of five since time immemorial. Two-thirds of your fellow investors don't expect Vonage to beat the market right now. And that verdict is starting to look a little too harsh.

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