Michael Shulman

Live Well, Thanks to Dying Companies

by Michael Shulman   08/25/08

Less than a year after its initial public offering, Vonage's (VG) voice-over-Internet broadband telephone services conjured up little more than dead air for investors on the long side. But those of us who played it on the way down were able to turn the company's woes into some serious short-side profits.

Now, I know some of you will hear the word "short-side" and be intrigued but also feel a little bit guilty at the thought of profiting from a company's misfortune. However, had we not identified Vonage as a company that was breaking down -- and if we hadn't purchased put option contracts to serve as our bearish bet on this company's prospects -- we wouldn't have made an average 108% gain when we closed out two winning positions in this "bad company"!

Vonage was a pioneer in third-party services for individuals, and investment bankers begged it for several years to go public, which it did in May 2006 in what is generally viewed as the most-bungled IPO in living memory. The stock not only fell by 50% soon afterward, but the company had also offered customers stock from the IPO, assuming the price would go up. Oops!

The company then compounded its mistake by declaring that those customers not wanting to accept and pay for their shares would still have to. Double oops -- the company managed, in one week, to alienate its customers and its investors.

It takes real talent to pull off that kind of a double-play -- and yet they turned it into a triple-play late last year when brokerages serving those customers unwilling to pay for IPO shares told these folks to either pay up or have their assets frozen.

Real good customer relations and retention, eh?

The ChangeWave Shorts service launched in October 2006, and a short-side play on Vonage was our very first recommendation. We had been receiving steady feedback from ChangeWave Alliance survey data, showing that consumers were increasingly turning off to Vonage. The quirky commercials were attracting attention, sure, but those weren't enough to keep customers plugged in to the company's VOIP services.

At the time, its competitors were offering VOIP for significantly cheaper prices, and Verizon's fiber-to-the-premises initiative had arrived, as did increased competition from cable companies offering bundled phone, Internet and cable services to customers. How was Vonage to compete?