Tech Investing

Vonage Shares Take a Wild Ride


In the midst of a summer rally for tech stocks, the runup experienced by Vonage Holdings stands out by any measure.

Shares of the Internet-calling company gained nearly 200% the week of Aug. 24, and that's after a 31% drop on Aug. 28, when the shares closed at 1.37. Between Aug. 12 and Aug. 26, the stock rose more than 470%. Vonage (VG) shares have enjoyed a 373% rally so far in August, a month when the Nasdaq composite index has gained just 2.5%.

Shares of Apple (AAPL), Intel (INTC), and Microsoft (MSFT) have risen sharply this summer, but nothing like the climb Vonage has seen.

New FCC Rules Likely The basics of Vonage's business don't explain the wild ride. On Aug. 5, the company swung to a $2.3 million second-quarter profit as sales fell a modest 3%, to $220 million. The company may be the beneficiary of future Federal Communications Commission rules that make it easier for Web-calling software to appear on mobile phones, but any such regulations would likely not appear before next year. Vonage announced an iPhone application and a cheap international calling plan in recent days, but that also fails to explain the sudden interest in its stock, investors and industry analysts say. "There's nothing based on the fundamentals that suggests this [rally]," says Ronald Gruia, a principal analyst at consultant Frost & Sullivan.

Investors are speculating that potential acquirers are getting out the green eyeshades on Vonage and other Web-calling software companies such as Skype, which owner eBay (EBAY) hopes to sell or spin out. Vonage doesn't deny that it's open to suggestions. "If someone were to approach the company with an opportunity that could benefit shareholders, we would certainly evaluate it," the company told BusinessWeek.com in a statement. One of Vonage's largest investors, Silver Point Capital, declined to comment.

The stock prices of several other public Web-calling companies have risen in recent weeks as well. Shares of Vonage competitor 8X8 (EGHT) have gained 24% since the beginning of August. "I certainly have seen a lot of interest [from potential buyers] given the financial results and valuations in the category," says 8X8 CEO Bryan Martin. But he says 8X8 "is not for sale at these [valuation] levels."

Skype Is a Factor The business of letting consumers make phone calls over the Internet while circumventing traditional telephone networks is garnering more attention these days. If the FCC makes it easier for Web-calling companies to offer their services over wireless networks, it could broaden a relatively untapped market. About 33.6 million wireless subscribers will use such services worldwide this year, according to market researcher IDC, constituting a tiny fraction of cell-phone users. The "voice over Internet protocol" market has also received a boost from Google (GOOG), which has been updating its Google Voice application and trying to distribute the service as an application on Apple's iPhone.

A Skype sale or spin-off could also whet investors' appetite for Vonage. On Aug. 28, the Web site TechCrunch reported that a group of venture capitalists, including recently formed Andreessen Horowitz and Index Ventures, are considering purchasing Skype. Index Ventures and Skype declined comment. Earlier this year, eBay announced plans to spin off Skype into a public company as early as 2010. But those plans could change if an interested buyer emerges.

In addition to financial buyers, industry players could have an interest in owning VoIP companies. Until recently, such large telcos as AT&T (T) and Verizon (VZ) and cable companies like Comcast (CMCSA) were seen as the logical acquirers of these companies. Now, tech companies such as wireless broadband service provider Clearwire (CLWR) or chipmaker Qualcomm (QCOM) could also potentially use a Web-calling service provider to make their products more appealing by bundling its products or services with Vonage plans, says one industry source.

Wooing Smartphone Users Bundled service plans are becoming more popular among VoIP subscribers. More than 75% of all users subscribe to the services as part of bundled offerings that include video or other services, IDC says. That's up from about 65% of subscribers in 2007. If the trend continues, it will narrow the market opportunity of Vonage and other specialists, says Rebecca Swensen, an analyst at IDC. "If they don't find a way to provide a more complete solution, it's going to be tough for them," she says. Vonage, which has 2.5 million subscriber lines, is losing users; it lost 88,643 lines in the second quarter.

Vonage is trying to make up the difference by appealing to smartphone users who want to be able to make Internet calls from their devices. Vonage has developed an iPhone application and is waiting for approval from Apple to distribute it. Apple has delayed that decision though, citing technical problems with the application. In an Aug. 27 statement, Vonage said Apple has "identified one issue, stating that it is 'simple to fix;'…We've made the requested change and resubmitted the application for approval."

An iPhone app alone likely won't re-energize Vonage's growth. For one, Vonage and iPhone users are demographically different. Consumers sign up for Vonage to cut their phone bills. But iPhone users are willing to pay high rates for the privilege of owning the device. Plus, Skype and other VoIP providers already offer iPhone apps, creating competition for Vonage on the platform.

Why the runup in Vonage shares now? "At some point this company will be bought out, but it's tough to get a deal done nowadays," says independent technology analyst Tom Taulli.

That may be, but speculators are betting a Vonage acquisition will happen sooner rather than later.

Olga_kharif1
Kharif is a reporter for Bloomberg News and Bloomberg Businessweek in Portland, Ore.

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