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The right time for VoIP
Shares of Internet phone companies have been beaten down so much they now might be worth the risk.
June 2, 2005: 5:56 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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Hanging up on VoIP: Investors have dumped shares of pure play Internet phone companies Net2Phone and 8X8 during the past year.
Hanging up on VoIP: Investors have dumped shares of pure play Internet phone companies Net2Phone and 8X8 during the past year.

NEW YORK (CNN/Money) Internet phone technology, or VoIP to the tech savvy, may finally be ready for prime time.

More and more consumers are signing up for services that enable phone calls over the Web...usually at a much lower price than what big telecom companies offer over the traditional phone network.

But many investors have continued to shun companies that offer VoIP. Since early January, shares of VocalTec (Research) and 8X8 (Research) are each down nearly 45 percent, Net2Phone (Research) has fallen 50 percent and Trinsic (Research) has plunged more than 80 percent.

Fusion Telecommunications International (Research), which focuses on VoIP services outside the U.S., went public in February and has fallen about 33 percent from its offering price.

The only VoIP stock that has done reasonably well recently is deltathree (Research), up about 10 percent this year.

In the past, I've taken a couple of looks at this sector and I've been skeptical. Not because I don't believe in VoIP (which stands for voice over Internet protocol), but because of the risk.

The VoIP companies are small and compete against the established telecom giants and cable companies. And most lose money and will do so for a while.

Even so -- with shares down so far, some of the VoIP plays are beginning to look absurdly cheap.

VoIP stocks finally look reasonable

Take Net2Phone. The company's market value is about $125 million but the company has nearly $90 million in cash on its balance sheet and just $17.8 million in long-term debt.

Eric Buck, an analyst with Janco Partners, said the company has struggled in its attempts to team up with small and mid-sized cable companies to offer VoIP services. Because it is not going directly to the consumer, its success is dependent on its partners. But Buck thinks these risks are more than reflected in the price.

"The negativity is overdone and there is an opportunity for Net2Phone," Buck said.

8X8 has a market value of under $100 million even though the company has no debt and $32 million in cash and investments.

And deltathree, which has its own VoIP service that it markets directly to consumers and also partners with larger telecom companies to offer VoIP, has a market value of about $110 million, no debt and $17 million in cash and investments.

"The sector has a lot of value," said John Buckingham, manager of the Al Frank fund, which owns Net2Phone and deltathree. "I bought deltathree because it has a lot of cash and is getting closer to profitability. The business is viable. And Net2Phone's cash, net of its debt, is equal to about half the share price."

Executives from several public VoIP companies expressed optimism that investors will soon embrace the sector. Speaking at a lunch at SG Cowen's Technology conference in New York on Wednesday, Paul White, chief financial officer of deltathree, predicted that there will be more VoIP IPOs.

And Sarah Hofstetter, senior vice president with Net2Phone, conceded that the lack of one major well-known public VoIP company is a bit of an issue plaguing the sector.

But help could soon be on the way. It appears the market clearly is waiting to see how an IPO from Vonage, the leading independent pure play VoIP service company, could do.

Could Vonage lead a VoIP surge?

Privately held Vonage has been extremely aggressive in terms of marketing and advertising (Gotta love those TV commercials. Woohoo! Woohoo-hoo!) and has signed up more than 700,000 subscribers as a result.

More importantly to investors, Vonage has attracted a significant amount of financing from venture capitalists, including Bain Capital, 3i and New Enterprise Associates. The company raised $200 million in its most recent round of funding last month, raising hopes that an IPO filing could be imminent.

"A Vonage IPO would bring increased attention to the group," said Buck.

Investors still need to be cautious though since most of the VoIP companies are not expected to make money in the near future. That's why some networking companies which make equipment used by VoIP service providers may be a less risky way to play the VoIP trend.

Mark Mowrey, an analyst who works with Al Frank's Buckingham recommends Avaya (Research) while Buck thinks Sonus Networks (Research) is a decent value. Both companies are expected to be profitable this year.

But consumer adoption of VoIP should accelerate now that the Federal Communications Commission is mandating that Internet phone companies provide the same type of 911 emergency services as landline and wireless carriers do. And as VoIP becomes more acceptable, the service providers should be able to generate decent gains in revenues...and eventually profits.

So the time for the investor to try and cash in on this is when sentiment is weak, not when the stocks have already taken off.

For more about consumer tech gadgets, click here.

For a look at news about the IPO market, click here.

Buck does not own shares of companies mentioned and Janco has no investment banking relationships with them.


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