Vonage's future questioned after latest setback

Will this be the beginning of the end for Vonage?

After Vonage's most recent setback this week, the industry is asking: What's next for the VOIP pioneer?

A U.S. federal judge barred Vonage from seeking new customers after the company was found a month ago to have infringed on Verizon patents on connecting VOIP networks to the public switched telephone network. Vonage was ordered to pay Verizon US$58 million plus royalty fees, and two weeks ago was enjoined from using any technology involved in the litigation.

This week, Judge Claude Hilton, of the U.S. District Court for the Eastern District of Virginia, partially upheld that injunction, pending a Vonage appeal of a patent infringement ruling, by prohibiting Vonage from signing up new customers for its VOIP service. While it can still serve current customers, Vonage's long-term outlook is in doubt.

"The question on everyone's mind is, will this be the beginning of the end for Vonage?" asks telecom industry analyst Jeff Kagan. "Will Vonage be a competitor next year or will they just be a story of a company that was?"

Kagan says Vonage can stay in business serving existing customers but cannot grow. That means it will have to lay off salespeople, cut advertising and adjust other sales and marketing activities, he says.

An inability to grow could translate into a slow death for the company, other analysts say.

"They've got to grow," says Will Stofega of IDC. "That's their whole thing: invest now, grab the customers. That's a big part of their strategy. If they can't get new customers... it's not looking good."

Kagan also says Vonage will have to negotiate with Verizon on the patents in question, but there is no guarantee the two can come to an agreement on their use. In the meantime, Vonage is believed to be developing a "workaround" solution so it can continue to operate while it awaits the appeal process.

"We believe its ability to implement a 'workaround' would be key to continue to operate," states UBS Warburg analyst John Hodulik in a recent investor bulletin. "We believe the company will soon be ready to have a 'workaround' solution to avoid any shut down of service."

Hodulik believes the workaround should also enable the company to keep penalties paid to Verizon low, were it to lose its appeal of the patent infringement case. These savings would be offset by any costs the company incurs in implementing the workaround, he states.

"In sum, the company's development of a workaround solution is a significant positive for the company and, if it also addresses Sprint's issues with the Vonage platform, will allow management to go back to running its business," Hodulik states.

Sprint is also suing Vonage. That case is expected to go to court in September.

What's unclear, however, is if Vonage is serving current customers with the workaround, or the Verizon patents in question. Vonage would not comment on the workaround speculation.

"Where is it?" Stofega asks. "I'm not aware of any service cut outs or outages yet. Does that mean they can continue using whatever they've been using, or is this the workaround?"

Kagan says the industry will have to watch and wait to determine if Vonage can survive and be a competitor going forward. But so far, recent history is not on the company's side.

"Everything they did from a certain point on was just the wrong thing," Stofega says. "From going public , from talks to buy them -- everything was just not the way to go. So much for the innovator's dilemma and disruptive technologies. They disrupted themselves out of the market."

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