Technology

Sprint: Say Bon Voyage to Vonage


Although acquiring the Web-phone services provider could hold some advantages for the telco giant, analysts say it should stay focused on core operations

Sprint Nextel, beset by customer losses and lackluster products, has enough on its plate without going after Vonage. That's the prevailing sentiment a day after telecommunications publication Light Reading suggested that Sprint may be considering a purchase of the troubled Internet-calling provider.

Vonage (VG) stock initially rallied in the aftermath of the Apr. 16 report. It's not hard to see why a Sprint (S) takeover would appeal to shareholders of Vonage, now locked in a patent dispute with Verizon (VZ). Sprint's deep pockets could help Vonage stay in business as it battles on in court and tries to find a so-called work-around, or another way to provide the calling services that a court says violate Verizon patents. What's more, the merger would head off another legal scuffle—this one with Sprint, which also alleges patent infringement by Vonage.

Strategy Shift?

But investors and analysts say this is no time for Sprint to be considering salvaging Vonage. Sure, the company would be inexpensive and could go for something like $1 billion, if that. But its outlook is weakening amid the patent dispute, and its customer base of 2.2 million is expected to shrink at a rate of more than 27% a year. "It's a bad deal for Sprint," says Michael Mahoney, managing director at EGM Capital hedge funds in San Francisco. "I'd look at it as a distraction from [Sprint's] primary challenges."

Sprint has those aplenty. In the fourth quarter, Sprint lost 306,000 so-called postpaid subscribers—those who pay on a monthly basis and are more valuable than those on pay-as-you-go plans.

Wall Street would view a Vonage acquisition as a shift in strategy. Over the past few years, Sprint Nextel has been trying to transform itself into a wireless-only company. In 2006, Sprint spun off its local calling business into a company now called Embarq (EQ). Today, 85% of Sprint sales come from wireless services. By acquiring Vonage, Sprint would be jumping back into the local calling game.

Other Suitors

The deal would hold some potential advantages for Sprint, which could partner with Vonage to offer a bundle of different services. Consultancy IDC predicts that in 2010, 44 million Americans will use Web-calling services, up from 10.3 million last year. But allying with Vonage could bring Sprint into conflict with cable-TV partners such as Comcast (CMCSA) that sell their own Web-calling services. "Sprint right now is very committed to the joint venture," says Michael Gary Nelson, an analyst with Stanford Group. "They view their relationship as strategic. This would mark a change in that strategy."

And a step away from the joint venture seems unlikely given that only at the end of March, the partners unveiled Pivot, a service linking wireless and home phone with cable TV channels. The program, now available from Sprint and cable companies in eight metro areas including Portland, Ore., offers a variety of services, such as programming digital video recorders via mobile phone and unlimited calling between home and mobile phones.

Instead, Vonage may be a more attractive buy for another wireless player, such as T-Mobile, owned by Deutsche Telekom (DT), which has been trialing a Web-calling service for the home and is not plagued by financial troubles, says Will Stofega, an analyst with IDC (see BusinessWeek.com, 8/14/06, "T-Mobile's Trial Balloon").

A Distraction

A local calling company like Embarq could also benefit from expanding its customer base with a service like Vonage. An acquisition by a company like Level 3 (LVLT), which owns its own network and may wish to jump into consumer services, could make sense as well, says Mahoney. Neither Sprint nor Vonage would comment on whether they are in merger negotiations.

Sprint is taking several steps to revive growth and keep customers on board. It recently engaged a new advertising agency to turn its marketing around, and it introduced a slew of attractively priced calling plans. But a turnaround will take time, and the company doesn't need the distractions likely to come with Vonage, which on Apr. 24 goes back to court. There, it will try to win a stay of an earlier decision barring the company from recruiting new customers, pending appeal.

Christopher King, an analyst with Stifel Nicolaus, says acquiring Vonage would by no means be a major acquisition. "It's going to be a rounding error for Sprint," King says. "But I'd rather see Sprint focused on its core operations."

Kharif is a senior writer for BusinessWeek.com in Portland, Ore.

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