Vonage Debt Due in December, Bondholder Note Extension Is Best Bet

Vonage Holdings Corp. has approximately $250 million in debt that comes due this December, and the company’s got a bit of a crisis on its hands. Refinancing debt is difficult even for the most well-run companies right now, thanks to the subprime mortgage crash, multimillion-dollar corporate write-downs and a generally tanking economy. So what will Vonage, a company that has never recorded a profit and that’s paying millions in lawsuit settlements, do?

The embattled VoIP provider has a couple of options it can pursue, but no one can guarantee a positive outcome.

Vonage Holdings Corp. Ownership
Ownership Information

Source: Thomson Financial, 2008

Chris Roberts, director of Tejas Securities Group Inc.’s research division, tracks distressed debt, emerging growth and special situation securities; he follows Vonage closely. He says the best circumstance would be for Vonage to convince its bondholders to extend the terms of their notes. The company is worth more as a going concern than an insolvent one, he says. “So I think there should be some motivation to work with Vonage.” However, if noteholders don’t “play ball,” Roberts says, Vonage will file for bankruptcy.

There’s also a chance Vonage could raise another type of security, such as preferred, Roberts says. It would be a small chance, he adds. “With their stock at $2, I don’t think that happens because preferred typically is convertible into common. And I think they’d have to dilute themselves way too much.”

Jon Arnold, principal of consultancy J Arnold & Associates, has a different suggestion. “It’s almost like taking them private would be the way to go,” he says. For example, Covad Communications Group recently sold itself to a private equity firm. Its finances weren’t as in bad shape as Vonage’s are, Arnold says, but the point applies. “The scrutiny and the rigors of being a public company have made it very difficult for Vonage to grow,” says Arnold, who analyzes Vonage as part of his IP communications research.

To be sure, Jeffrey Citron, interim CEO for Vonage, knows his company’s situation has reached critical levels. He declined to talk with xchange, but has, in recent interviews with other outlets, stated that debt refinancing is a top priority. But Roberts says refinancing is a long shot.

“I doubt that will happen in this market,” he says, adding, “The capital markets are much less friendly” than they were even a year ago. That’s because dominant players like investment banks Merrill Lynch and Bear Stearns are suffering billions of dollars in losses due to the subprime mortgage meltdown. It’s the ripple effect of big companies affecting the well-being of smaller ones.

For a time, it looked like Vonage might make a good takeover target. That window of opportunity has closed, it seems.

“There’s too much debt in the company,” Roberts says. “You’d have to assume that debt. The other problem you have is, I’m not 100 percent certain that all the litigation risk is gone. I’m worried that someone might pop their head up and sue again.” Vonage last year lost multiple patent infringement suits, most notably to Verizon Communications Inc.

Besides, Sprint, the carrier that looked like the best one to buy Vonage, now has too many problems of its own, Arnold says. Analysts long have thought that Sprint would profit from having Vonage in its operations, but the wireless provider now is focusing on reversing subscriber and financial losses. Given the timetable for Vonage’s debt, a Sprint takeover no longer looks like a practical option, Arnold says. With that in mind, the best thing Vonage can do is pump money into research and development to make itself more cutting-edge and relevant, he says. “We all can see that there really isn’t a viable market for standalone landline VoIP, and that’s pretty much what they have.”

It comes down to two scenarios, says Roberts. The bull case is that Vonage can convince bondholders to extend the debt for a few years, perhaps with the promise of a higher coupon percentage and warrants to buy outstanding stock for a set amount, such as $2 per share. The bear case — the direction the market is leaning — is that the VoIP space is too crowded and customers want service from a cable company, not an independent provider with financial troubles.

Vonage could be headed for a turnaround, though. In early January, the company said it expected to report 2007 sales of more than $800 million and churn not higher than the 3 percent reported in the third quarter of 2007. It also unveiled some customer premises equipment it hoped would reinvigorate its appeal to consumers. Overall, though, it will be investors’ reaction to Vonage’s debt refinancing strategies that determines the company’s future. Arnold, for one, hopes Vonage is successful. “In the interests of this industry, we really would rather see Vonage succeed than fail. There aren’t too many alternatives out there left to the big telcos.”

Covad Communications Group www.covad.com

J Arnold & Associates www.jarnoldassociates.com

Sprint www.sprint.com

Tejas Securities Group Inc. www.tejassec.com

Verizon Communications Inc. www.verizon.com

Vonage Holdings Corp. www.vonage.com

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