VG

Ramifications of Skype – Microsoft for Vonage (VG)

May 11th, 2011 by Yehuda Fruchter   |   No Comments

What’s are the possible ramifications for VG of the acquisition of Skype by Microsoft?

Of course, the potential bearish implication is that MSFT will soon completely dominate VOIP, making it extremely difficult for a much smaller company, like Vonage (VG), to compete and grow. However, even if this is true, and I’m not clear it is, the outcome for VG may still turn out quite positive.

This is because the possibility of MSFT dominating VOIP must have many other very large telecom companies quivering. Specifically, the traditional operators must be quite terrified of a potential huge loss of revenue as MSFT integrates Skype and more traffic is sent over Skype bypassing the traditional networks. Essentially, with MSFT now behind Skype, there is humongous threat developing for the large traditional telecom operators, especially in the wireless arena.

For a good summary of the potential impact for the large telecom operators, see this article on Bloomberg: Microsoft Skype Deal May Strain Relations With AT&T, Verizon

What can these operators due to protect themselves? I think that they must obviously move quickly to combat Microsoft/Skype and the quickest defense would be to purchase a major VOIP player, like VG. So my prediction is that a large telecom company will soon buy out VG at a premium to the current price. It just seems inconceivable to me that other large players in the telecom market will simply sit idly by and watch MSFT grow Skype. They must take some action, and an acquisition seems like the most natural response given the new urgency created by Microsoft/Skype.

The price of VG on an acquisition: I don’t have a clue, but as I have mentioned in previous member-only posts, the current valuation of VG, given its strong cash-flow, is surprisingly still cheap, especially as compared to Skype’s valuation.

Disclosure: Affiliates of Envoy Global Research, and its principals, own shares in VG. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

VG Becomes Ten-Bagger: Continue to Hold On

February 15th, 2011 by Yehuda Fruchter   |   1 Comment

Congrats to all our readers. Today VG (current price: $4.20) became a 10-bagger. I first wrote about VG back in August 2009 at $0.40, when the company was left for dead. Fast forward to January 2011, and VG’s turnaround is now completely evident for all to see, as demonstrated by the company’s Q4 results reported today.

What to do now? As unbelievable as it may seem, I would still hold on to VG for now (though of course taking some profits is always wise). The company’s valuation (EV/Sales approximately 1.3) while obviously now normalized, still does not reflect a growth (i.e. hype) scenario. As such, if VG were to gain traction with new services, the stock price could still appreciate further. 2.5X EV/Sales seems conceivable, depending on how investors perceive the company.

Disclosure: Affiliates of Envoy Global Research, and its principals, own shares in VG. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

VG: Continued Debt Repayment Will Reward Shareholders

May 6th, 2010 by Yehuda Fruchter   |   No Comments

There were many positives in VG’s earnings announcement yesterday, but the one that I think is the most exciting for investors is the company’s $23 million debt prepayment. Aside from reflecting significant cash-flow improvements at the company, the debt prepayment suggests strongly that management will be aggressively looking to improve VG’s mangled balance sheet. Importantly, during the conference call, Marc Lefar, VG’s CEO, remarked:

“Over the next year, we anticipate making substantial prepayment offers to debt holders as the company continues to generate cash.”

As I’ve mentioned in the past, VG’s continues to generate improving EBITDA, but unfortunately the company’s high interest debt (raised during the peak of the financial crisis), continues to consume a huge portion of free cash-flow. However, if the company succeeds in prepaying a significant portion of this debt and is then somehow able to refinance other portions, VG’s shareholders should be rewarded. This debt prepayment combined with low churn, continued progress on the top-line, and eventual subscriber growth, should send the shares sharply higher over the coming year.

Disclosure: Affiliates of Envoy Global Research, and its principals, own shares in VG. We first wrote up VG at $0.40. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

More Thoughts on the Vonage Mystery

November 10th, 2009 by Yehuda Fruchter   |   No Comments

After one has traded for some time, it becomes apparent that the biggest investment profits happen unexpectedly and are in retrospect not in the least bit correlated with underlying business conditions. The game of investment then becomes about positioning one’s capital in low-risk situations hoping for that unexpected success. Vonage typifies this investment strategy.

When I first bought the stock at $0.40, it seemed low risk, as there was no danger of imminent bankruptcy, and yet the stock was priced as if the company was already bankrupt. Then suddenly out of nowhere in late August, Vonage’s (VG) stock proceeded to climb up nearly 500% in a matter of days. Until the other day, I haven’t had a clue as to what caused this phenomenal rise, and naively I attributed it to some “market” discovery of the value inherent in VG’s stock. However, after reading VG’s 10Q, I have come to a different conclusion.

In the 10Q, VG says:

“From August 27, 2009 through September 8, 2009, we received Notices of Conversion from certain holders of our 20% senior secured third lien notes due 2015 (the “Convertible Notes”) indicating their desire to convert a portion of the Convertible Notes. The Convertible Notes were converted into shares of our common stock at a rate equal to 3,448.2759 shares for each $1,000 principal amount of Convertible Notes, or approximately $0.29 per share.”

Can it be a coincidence that VG’s stock started its meteoric climb about a week before Aug. 27th, and then peaked on August 26th, the day before VG was informed of the Notice of Conversion? I don’t think so. Since it is quite commonplace for convertible note holders to short the stock of the underlying equity for hedging purposes, it seems clear that VG’s convertible note holders were (and some still remain) short at least an equal amount of shares of VG (and likely much more), as the rate in which the notes convert. Surely, other funds recognizing the short pressure of the converts, played lemmings and shorted VG as well. As such when the decision was made to convert, a massive amount of shares needed to be covered, fueling an incredible rise in VG’s stock.

The question, of course, remains why the Convert Holders decided to convert when they did? Why exactly did they have to convert? Why not remain short VG equity and long the converts? I don’t really have an answer to these questions, except to say that apparently they no longer felt they should be hedged in VG. This implies that they foresaw greater upside, than downside, in a non-hedged equity position, then in a hedged convert. Given the preponderance of insider trading, you are free to interpret this statement, as you see fit.

As for myself, since I am currently still long some VG, I am naturally biased to bullish argument. However, I wonder whether the lack of artificial selling pressure from the convert overhang will help the price or will the lack of artificial buying pressure from short covering hurt the price? Or will new buyers emerge that actually believe in VG as an investment? As always, investing leads to circular reasoning and infinite loops of logic. The best hope is probably for another round of good luck!

Vonage (VG) Delivers Strong Earnings Again

November 5th, 2009 by Yehuda Fruchter   |   Comments Off

I’ve received quite a few emails asking about Vonage’s (VG) results the other day. Here are my thoughts:


Vonages Stock Price Now Presents Two Classic Market Anomalies That Generally Reward Patient Investors
I remain completely baffled by the tendency of the Market to emphasize non-cash accounting results over cash-flow metrics. In addition, I do not quite understand why the Market, in many instances, focuses on present quarter results, as opposed to underlying business trends that will influence future financial results.

I will not attempt to explain these irrationalities here, other than to say I’m grateful that the Market displays these irrationalities and therefore provides a means of generating investment profits. It should be obvious that the underlying free cash-flow and the future expectations of a business, are the only important factors in determining the equity value of an enterprise. As such, when the Market focuses on non-cash accounting charges and magnifies business results that reflect the past, rather the future, there is quite likely a profitable investment opportunity for those with patience.

In the case of Vonage, the company’s recent results are a classic example of the above two-mentioned Market anomalies, i.e. a focus on meaningless accounting metrics, and a focus on the past, instead of the future.

Vonage’s Underlying Cash-Flow Continues to Improve Despite Reported Accounting Losses
Despite the fact the Vonage reported a major accounting loss for the quarter due to a non-cash charge related to the embedded derivative associated with Vonage’s convertible issue, the truth is that the accounting loss was completely non-cash and unrelated to the important financial metrics of the company, all of which improved sequentially (Note: Sequential growth is far more important than year-over-year growth, though Vonage offers both at this point).

The true measure of a company’s value is, of course, the underlying free cash-flow, which I define as EBITDA – Interest Expense – Taxes – Cap Ex. Since VG will never pay any taxes in our lifetimes, given its huge tax loss carryforwards, VG’s cash-flow is simply EBITDA – Interest Expense – Cap Ex. This figure is easily tallied from the company’s 8-K.

EBITDA for the quarter was $33 million, up dramatically year-over-year and also an increase sequentially. Interest expense was listed at around $14 million. Cap-Ex was said to have been $9 million. Applying some basic math, yields a free cash-flow number of $10 million or $0.05 per share, using the roughly 200 million diluted outstanding share feature. This equates to an annualized free cash-flow per share of $0.20 (Note: annualizing this number is justified, and probably even too conservative, due to the non-seasonality and improving sequential business/financial trends at the company). At current prices, this equates to a FCF yield of nearly 15%. Whether that FCF yield is attractive, is of course, dependent on the tastes of each individual investors and other investment alternatives, but I honestly have not recently found many businesses yielding this type of FCF for equity investors.

It also pays to note that VG’s free cash-flow is somewhat understated because of the company’s absurdly high interest rate on its current debt issues. Recent improvements in the credit markets imply a potentially much lower interest rate on debt for a company like VG. Though it may prove difficult, I believe a refinancing of the company’s “loan shark” debt will happen in due time, and a lower interest rate will dramatically increase free cash-flow. However, even without a refinancing, investors still need to calculate the effects of a lower interest rate, when valuing VG, since any potential acquirer of VG would surely make this calculation in determining a takeover price for VG. Obviously, a larger company would quickly replace VG’s current debt with new paper at much lower interest expenses.

Vonage’s Underlying Business is Showing Renewed Momentum
Of course, present financial results for a company are also meaningless, unless one believes that underlying business trends at the company are stable and hopefully improving.

In the case of Vonage, however, the business trends at the company are getting better. The issue with Vonage is that the new products that the company launched, were only available for part of the third quarter, so that the results of the quarter did not fully reflect the positive contributions of these new products. Notably, the company’s new Worldwide Plan, started late in the 3rd quarter, has been very successful, as detailed in the company’s press release (i.e. churn greatly lowered, referrals increased, ARPU up etc.). Interestingly, despite the fact that commentators will harp on VG’s loss of 50K customers this quarter, the reality is that this is a dramatic improvement from the 80K loss last quarter, and the new customer trends indicated in the press release imply a net gain of subscribers next quarter. Finally, I remain confident, as well, that the company’s imminent launch of new Mobile Worldwide Plans, will also be positively received, and help to further renew subscriber growth and reduce churn.

The positive effects of Vonage’s new products will, of course, only be evident in future financial results over the course of the next year. Smart investors should always anticipate the future, and sell on the future expected positive news, rather than react to current news and past events.


In sum, it appears to me that Vonage’s financial results and business metrics continue to show improvement, despite the obfuscation of accounting results and the timing of new product launches. Since the company’s stock price has yet to reflect these seemingly obvious positive developments, as well as other potential value-enhancing events, it seems that the stock still presents an excellent investment opportunity. I suspect that as the company’s accounting financial results become more transparent in future quarters, additional new products are launched, customer growth returns, and the speculation regarding the refinancing of the company’s debt and/or an acquisition by a larger company surface, that the stock price will increase dramatically.

Disclosure: Affiliates of Envoy Global Research, and its principals, own shares in VG. We first wrote up VG at $0.40. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

Vonage (VG): Significantly Better Than Expected Results, Turnaround Is Progressing

August 6th, 2009 by Yehuda Fruchter   |   10 Comments

Recent Financial Results Way Above Expectations

Even though Vonage (VG) (Recommend Price: $0.40, current price: $0.45) has always been a controversial stock, I don’t think there was much to debate about after the company’s recent financial report.

After years of massive losses, Vonage (VG), has now successfully turned the corner on profitability, with EBITDA rising to $31 million in the quarter, up 50% sequentially, and nearly triple the level of a year ago. Free cash-flow was also positive this quarter at around $12 million. Incidentally, I was only expecting about $20 million in EBITDA this quarter.

VG Skeptics Still Abound Citing the Customer Loss Issues

Despite these better than expected results, VG stock price was highly volatile yesterday, and actually closed down a few percent. Whether the drop has anything to do with fundamental analysis is an open question, as the stock had rallied nearly 20% into the earnings release, so a slight sell off could be expected. In addition, it’s difficult nowadays with the proliferation of algo trading to to definitively attribute any short-term stock price movements to sound economic analysis.

Nevertheless, since it always pays to invert when investing, to use a Munger term, I’ll gladly consider the lingering bearish argument against VG. While in the past, bears rightly pointed to VG’s massive losses, and legal troubles, as reasons to avoid the stock, with those problems now behind the company the argument now has shifted to concern over VG’s customer losses. Notably, during the quarter, Vonage  lost about 88,000 customers, to end the quarter with 2.49 million customers. In addition, churn increased, and overall revenue dropped 3% year-over-year.

The Customer Loss Issue is not Relevant or Necessarily Important At This Junction in the Turnaround
Of course losing customers is not a recipe for long-term success, but still I offer these counterarguments to the “customer loss” concern at Vonage:

  • Revenue/Customer Declines Not Unexpected in This Economy

I can count on my hand the number of companies that are reporting revenue and customer growth in this economic environment. So the situation at Vonage is no way unique or out of the ordinary.

  • A Tripling of Profits on a 3% Decline Is a Bad Thing?

I find it extraordinary that anybody can complain about a roughly 3% drop in customers and revenue, when that situation in turn led to a tripling of profits. The point of a company is to make money, not lose money. If stalling growth plans for a period of time, is the only way to nurse a company back to financial health, that is the correct way to go. In every turnaround, the most important thing is to first stabilize the financial situation. Thereafter, one can focus on growth.

  • Long-Term Customer Losses Are Exaggerated and the Worst Case Is Not All That Bad

Of course the contention is that due to mobile alternatives, VG will continue losing customers at a rapid pace (as if even if losing 3% is necessarily rapid), and soon enough the company won’t have any customers. This, of course, is a major exaggeration. The company lost a mere 88,000 customers in the quarter, out of 2.5 million. Even if the trend of losses continues, and the company can’t reignite growth (a possibility of course, but equally possible is a return to growth), VG will still have another 7 years+ to milk the current customer base. In other words, in a worst case, there is still value in the business in “run-off” state, to use the insurance analogy, in excess of the current stock price.

  • Current Valuation Already Reflects a Non-Growth/Decline Scenario

The current stock valuation of VG, at about 2X EV/EBITDA, already reflects the non-growth, business will decline argument. As such, I do not see why this is even a worry. Everybody knows about this risk already and it’s priced in.

  • New Products Could Reignite Growth

Finally, though critics are focusing on VG’s current customer losses, they are not looking to the future growth prospects at VG. The company has several new services, including a much anticipated mobile product, which it will be launching shortly. At this point, the probability of renewed customer growth at VG due to these new products, is just as probable, as is the worst case scenario of continued 3% customer declines. So I see no reason to focus on the negative here, when a positive outcome is just as likely.

Summary: Risk/Reward Still Very Favorable
In sum, VG financial results while not entirely perfect, demonstrate a company undergoing a substantial turnaround. With a valuation that continues to reflect bankruptcy concerns, I believe most of the worst case is already priced into VG shares. At the same time, I think the upside case for VG in not in the least bit reflected in the current valuation. The stock price may appreciate dramatically in the year ahead, should financial results continue their positive trend, and should new product launches succeed in renewing customer growth, or even in the worst case stemming the decline.