Long-Forgotten Vonage Has 65% Upside

Thesis:
Buy VG a $627mm mkt cap provider of low, cost, high quality communications services such as voice, messaging and phone (landline and mobile) around the world over the web using VOIP to Earn a 62% Return over the next 18-24 months

Consensus’ 2014E EBITDA $133mm overlooks how much Vonage has invested in its marketing and distribution channels, new selling approach of 375 part-time sales agents organized in community teams selling directly to ethnic groups; the increased number of stores with assisted selling to more than 300 in 2012, planned investments of $30 to $35mm in implementation of software solutions and purchase of network equipment to expand its network, along with strong pipeline of new products: Vonage World Plus, Extensions and Basic Talk brand launch nationwide through exclusive partnership with Wal-Mart.

The Street also overlooks VG’s focus on increasing shareholder value through aggressive share repurchases. For ex., my model has FCF growing at 2.3% on avg annually over the next 5 yrs, transforming VG’s FCF from $81mm in 2012A to $90mm in 2017E. Also, on a 2014E EBITDA basis, I am 12.3% higher than consensus estimate.

Background:
VG, a $627mm mkt cap provider of low cost, high quality communications services around the world over the web using VOIP (12A Sales by Geo.: U.S. (95%), Can. (4%), UK (1%), employs 966 people and services 2.3mm subscribers.

VG’s superior technology (59 patents) and FIRST to Market approach and keen focus on under-served population segments that need to make domestic and international calls and strong customer service (Improvements in the overall customer experience have contributed to lower churn, which declined from highs of 3.6% in July 2009 to 2.5% at the end of the 2012.) positions the company for the overall weakness in the traditional landline telecom industry and the new opportunities in international calling and mobile device usage.

A substantial FCF play, generating EBITDA margins of 17.6% and 14.5% in 2011A and 2012A, respectively. FCF Yield has averaged well over 10% annually the past 3 years. I think VG is well positioned to benefit from improving sentiment toward the company and telecom segment.

VG continues to aggressively repurchase shares. Authorized a program to repurchase up to $100mm of its common stock by the end of 2014. This new authorization replaces the prior $50mm plan, and is in addition to the $33mm, or 14mm shares, VG purchased since beginning the program last August.

Valuation:
I looked at the upside and downside in a bunch of different ways. On a DCF basis, gets you to $3.49, excluding NOLs of ~$0.73. Upside feels like ~$4.76 using my 2014 EBITDA estimate, peers’ avg 2014E EV/EBITDA multiple of 6.1x, including NOLs of $0.73. Downside feels like ~$2 using the lowest EBITDA figure and EV/EBITDA multiple over the past 5 years, including the NOLs, and the average price shares were repurchased for in 2012. Based on my back of the envelope LBO valuation, I think the company could easily be taken private at $3.51.