Tech Check

Vonage Story Getting Worse

Just when you think the Vonage story couldn't get any worse, the company reaches deep down and comes up with more disaster, more tragedy, and what will almost certainly be more controversy.

Vonage announced today that the company's CEO, Michael Snyder, was leaving the company and its board, effective immediately. He'll join an estimated 180 other Vonage employees who were fired today as part of a massive reorganization designed to try to keep the company afloat.

Snyder is being replaced, at least temporarily, by Vonage founder Jeffrey Citron who actually held the CEO's job until just before the company's IPO last year, but he was asked to give up that position because of reputation issues. Citron was under investigation for fraud by the SEC at the time, and while Citron later settled those charges by paying the SEC $22.5 million, Vonage itself pointed to Citron's reputation as a risk factor in the company's pre-IPO filing, stating it could "adversely affect our ability to enter into business relationships."

The quick timeline here: Vonage goes public in a botched IPO that immediately derailed any momentum the company might have enjoyed. Then, the company finds itself embroiled in a bitter patent infringement case with wireless kingpin Verizon that it loses. The company is slapped with $58 million in damages and a 5.5% royalty fee. Ouch.

But wait, there's more.

The judge in the case also issues a permanent injunction against Vonage from using Verizon's VOIP technology, but that ruling is stayed pending appeal. Then, another blow: Last Friday, the judge issues an order preventing Vonage from signing up any new customers. Also stayed, pending appeal. Someone called that a kind of slow death that'll choke this company right out of business. That's a nice protection for anyone considering signing up for this service, but for the 2.9 million already using it, it's too little too late.

Vonage is in deep trouble. Shares hit an all-time low this morning and are down 83% since the IPO. It's so bad that one of its underwriters, Citigroup, issued a "sell" rating on the stock a week and a half ago. When was the last time you saw that?

As far as the IPO is concerned, Clayton Moran at The Stanford Group tells me this morning: It's the worst I have seen. The scary thing is that it could get worse and if this ban on subscribers is upheld, we think the stock drops to $2 a share and the company is in financial jeopardy and potentially it goes out of business some time down the road. That is the worst case scenario but this is the worst IPO I've ever seen and it could actually get worse from here."

Sally Cohen, the VOIP analyst at Forrester says, "Vonage will have to make strides to cut their subscriber acquisition cost to reduce subscriber turn if they're going to subscribe, as well as successfully accomplish a work-around for their patent problems. If not then their survival is at risk."

That's pretty dire. The company had given indications that a technological workaround was in place and that service to its customers would not be interrupted as this case winds its way through the court. But on a conference call today, all Vonage executives would say was the workaround was in the "design phase."


"They really need to work hard in reducing their subscriber acquisition costs," says Forrester's Cohen. "We know that most consumers are satisfied with the telephony service they're receiving at home today. In fact 87% of consumers say they don't want to switch their home phone service. So Vonage is paying a lot of money to bring these reluctant consumers over to their services. They need to figure out a way to convince consumers it's worth the switch without spending so much money."

How much money? Vonage says today it's spending about $275 per new subscriber. With nearly 3 million subscribers, these guys are spending a fortune. Do the math. 3,000,000x$275=a whole hell of a lot of money!

This is ugly. No two ways about it, and the experts covering Vonage say it could actuallly get uglier.

"We were telling investors to sell the stock shortly after the IPO and up to until very recently. Now we are telling investors to avoid the situation completely. We think the risk is too high and the uncertainty too great and is hard to determine what will happen because it is all in the hands of the court right now," says Stanford's Moran. "It's not worth rolling the dice."

The next chapter in this tailspinning drama will unfold in the US Court of Appeals for the Federal Circuit on April 24. Questions?  Comments?