Is Vonage Wasting Your Money?


Stock buybacks are generally considered a bullish signal on Wall Street. They return capital to shareholders, while declaring management's belief that its own cheap shares are its best return on investment. As long as profits remain consistent, share repurchases can even increase earnings per share, by dividing the same amount of earnings among a smaller pool of shares outstanding.

But don't forget -- a company isn't obligated to repurchase shares just because it announced its intention to do so. So don't use the announcement as a reason to buy by itself. Rather, use it as a launching pad for additional research.

Gray clouds forming
For VoIP specialist Vonage (NYS: VG) , the second-quarter earnings report seems to make a turning point in what has been a long, torturous path down. The stock has climbed 28% since it reported adjusted EBITDA of $35 million, up $3 million from the first quarter, though still lower than last year's record earnings. Adding to the healthier picture was its ability to reduce customer churn from 2.8% down to 2.5%.

Vonage isn't alone in doing a better job of keeping its customers, as enterprise-facing VoIP specialist 8x8 (NAS: EGHT) reduced its churn -- or the number of customers who leave the service -- to just 1.7%, down from 2% in the first quarter. Unfortunately, magicJack VocalTel (NAS: CALL) doesn't reveal this important business metric.

When it rains it pours
Part of the improvement in customer retention at Vonage has been the reintroduction of service agreements. Like Verizon (NYS: VZ) or AT&T (NYS: T) , requiring you to hang around for two years, Vonage reintroduced the option for its customers in February so that those who disconnect in the first 12 months of their contract will be charged a disconnect fee. It says it expects more of them to opt in for that agreement and believes that will help it reduce churn further.

To me, it seems a risky ploy. While there are many who still remain tethered to a wireless carrier for years at a time to get access to new smartphones, the growth of the prepaid plan has shown customers want to be free to move when the mood strikes them. And T-Mobile recently announced it was eliminating speed throttling on its prepaid plans, albeit for a fee, in an effort to attract more customers to its service.

The benefit to leaving one of the Big Three wireless carriers and their ball-and-chain contracts is that you could move to a service that best met your needs at that moment without having to run out the clock on a big disconnect fee. Vonage seems to be walking backwards -- and making a mistake -- by trying to force its customers to stay.

We'll need to check on the anniversary the reintroduction of the agreements next year to see whether they're really reducing churn or if it's just a matter of having customers wait out the agreement period before moving on.

Raining cats and dogs
The stock-repurchase agreement Vonage announced is modest, allowing for the buyback of 50 million shares, but it's going to achieve that reduction by the end of next year, so at least it offers investors a defined timetable and will be using its available cash resources.

Revenues were still lower in the quarter than they were last year (or sequentially even, and operating expenses were higher. It did end the quarter with $72 million in the bank, a higher balance than it had at the end of 2011, so it should have the wherewithal to make the repurchases.

Singing in the rain?
At just seven times earnings estimates, Vonage seems cheap, but stocks are often cheap for a reason, and there have been plenty of reasons for investors to bid its stock down. Its enterprise value does go off at a very cheap four times free cash flow, and though there remain many risks to its business, I'm willing to rate it to outperform the broad market averages on Motley Fool CAPS, where jasecio agrees it's time for a turnaround.

Admittedly, most of the investment community is still pitted against the VoIP proivder, but tell me in the comments box below whether you think Vonage's focus on the customer along with its new initiatives will be enough to dial up additional growth.

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Fool contributor Rich Duprey holds no position in any company mentioned. Check out his holdings and a short bio. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

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