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Vonage's Going-Concern Puts Debt Issue in Focus

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NEW YORK (Dow Jones) Vonage Holdings, which freed itself from legal binds last year, may find itself tied up with an unforgiving credit market in 2008.

The Holmdel, N.J., provider of Internet phone service has yet to report a profit, is facing diminishing cash holdings and has to refinance $253 million of debt in a credit market that's hardly friendly. Those prospects will likely lead to a formal warning about the company's ability to continue as a going concern and force Vonage to accept harsher terms or conditions - if it succeeds in striking a new deal at all.

"We think certainly it [the credit market] will affect Vonage like other companies," said Clayton Moran, an analyst at Stanford Group Co. "At the least, it will make it more expensive for them to refinance debt."

It's the latest threat to Vonage's existence. Throughout the latter half of last year, the company faced the prospect of shutting down its business after Verizon Communications Inc. (VZ) won a patent infringement lawsuit against it regarding technology related to the transferring of Internet phone traffic on to traditional switches. AT&T and Sprint Nextel later jumped on the bandwagon with similar lawsuits. Vonage eventually settled them all.

With the legal issues behind Vonage, company observers eye Vonage's $253 million in convertible debt, which can be put back to the company at the end of the year, as the next potential red flag. Lacking the funds to cover its debt, it will need to renegotiate or refinance its debt to survive.

The company ended the year with $190 million in cash, marketable securities and restricted cash, although only $150 million is readily available. The going concern note is required if a company doesn't have the cash on hand to meet its obligations. As a result, founder and Chief Executive Jeffrey Citron downplayed it.

"It's a matter of technicality," Citron said in an interview on Wednesday. "It's not new. I don't want to blow [the going concern note] out of proportion."

Since retaking the reins in April, Citron has maintained that dealing with the debt issue has been the company's top priority behind improving customer care.

The company, meanwhile, continues to lose money. It lost $11.1 million in the fourth quarter and $264.7 million for the year, partly attributed to legal settlements. The company's cash burn rate is "negligible," Citron said.

Profitability remains elusive for Vonage, but Citron said the company is close to it after reporting net income on an adjusted operating income before interest, taxes, depreciation and amortization.

Harsh Conditions

Vonage has hired a financial advisor and is talking to existing bondholders, Citron said. The company is hoping to get commitments from bondholders not to put the convertible debt back and to give Vonage more time, since the debt officially matures in 2010.

The company is also looking to potential new bondholders to make any potential gap between its cash and debt.

Another option is the possibility that Vonage may issue stock to fund the debt, Moran said. But given the stock's steady decline, it's unclear what the demand would be.

Since hitting an all-time high of $17.25 shortly after its initial public offering in May 2006, Vonage has lost nearly 90% of its value. Shares recently traded up a penny to $2.15.

The process is still early, with Vonage having just started following the resolution of its legal issues, Citron said, adding that he was confident new terms would be struck.

Still, the company faces headwinds as the credit market worsens and lenders seek stiffer conditions.

"Looking at the business trends, I would say that overall, the credit market is not that forgiving," said Ping Zhao, an analyst who covers the credit side of the telecom industry for CreditSights.

Motorola, for example, had protective language put in place when it issued its $1.4 billion in debt late last year. Bondholders demanded the condition that its notes would be paid back at 101% of the face value in the event of a change of control such as an acquisition.

While these protective measures became popular as a result of the increasing leverage buyout deals in the technology industry, they are indicative of the concern investors have over the state of the market, Zhao said.

"It's a safeguard in place," she said.

Outside of larger players such as Verizon, which recently priced $4 billion in debt last week with relatively light conditions, telcos and related companies will have a tough go in the credit markets.

Telecom was one of the worst performing sectors on the debt side last month as the risk premium on credit derivatives widened, Zhao said.

"Relative to the broader market, January has not been one of the good months for telecom," she said.

Citron acknowledged the credit markets were not "terribly accomodative to anyone," but said he thinks it will clear up.

Still, Vonage isn't waiting for things to clear up, but he said the state of the markets make the process last longer than it would have taken a year ago.

-By Roger Cheng, Dow Jones Newswires; 201-938-2020; roger.cheng@dowjones.com

(END) Dow Jones Newswires

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