Vonage in Predicament After Public Offering

By Kathleen Day
Washington Post Staff Writer
Saturday, June 3, 2006

Imagine being chief executive of a high-technology company and having to choose between alienating a relatively small group of shareholders who also happen to be the firm's customers or a much larger group of shareholders who aren't.

That's the predicament facing executives at Vonage Holdings Corp., the best-known provider of Internet phone service, after its less-than-stellar initial public stock offering last week, according to public filings and officials familiar with the company.

The company sold more than 31 million shares at $17 each during the IPO, raising about $530 million, which Vonage has said it will use to grow its business. But becoming a publicly traded company also brought Vonage a giant headache.

As part of the IPO, the company took the unusual move of offering shares to qualifying customers, contacting them via the Internet and telephone. In the end, about 10,000 of Vonage's 1.6 million phone subscribers bought about 4.2 million shares.

The problem, as the company says in public filings with the Securities and Exchange Commission, is that Vonage may have violated securities laws by offering its customers the shares on an Internet site that failed to provide a link to a prospectus, a legal document detailing to prospective investors all aspects of the stock offering, including any risks.

The company fixed the problem by making it impossible for any customer to accept the offer of buying stock without first having to open a prospectus, according to filings with the SEC and sources familiar with the offering.

But in the handful of days since the offering, the value of Vonage stock has plummeted, falling below $12 a share (it closed up 35 cents yesterday at $11.98).

Many customers who made a commitment to buy shares began to complain that they shouldn't have to honor that contract.

Vonage on Tuesday issued a statement saying it expects customers to fulfill obligations to buy shares for $17 each. Behind the scenes, company officials, who intended the offering to secure loyalty among existing customers, are loath to sue customers because of the obvious bad publicity such tactics would bring, according to securities experts familiar with the offering.

That's the crux of the problem.

If Vonage allows its customers to walk away from their obligations to buy shares, then its non-customer shareholders are likely to argue that they, too, should be permitted to get out of having to pay $17 a share for stock now worth much less. By law, all shareholders must be treated equally.

Shareholders who are Vonage customers would likely argue that they are not the same as non-customer shareholders because they were offered shares via an Internet solicitation that didn't provide access to a prospectus, experts said. That glitch, they might argue, entitles them to get out of any obligation to buy shares.

Vonage believes it could defend itself by arguing that although its solicitation might have been faulty, the company made up for the mistake by ensuring that no one actually could accept the offer without first seeing a prospectus, said the sources, who spoke on condition of anonymity because they are not authorized to talk about the offering. While the company is confident it would win a suit forcing customers to fulfill a commitment to buy shares, the victory would surely cause a loss of clients -- the opposite of what the public offering was intended to do.

But if the company lets customers break their commitment without taking legal action, non-customer shareholders might sue Vonage to also be allowed to walk away. These shareholders would argue that the violation Vonage made in its solicitation to existing customers was a glitch that was soon remedied, erasing any legal distinction between shareholders who have Vonage phone service and those who don't.

What actually will happen could take weeks to sort out, the sources said, and will depend on how the company's stock performs and how many of Vonage's customers protest promises to buy shares.

Vonage spokespeople would not comment on the situation, nor would officials for the investment banking units at Citigroup, UBS Warburg and Deutsche Bank, which handled the IPO.

© 2006 The Washington Post Company