Patent Ruling Impact

By Alan Sipress
Washington Post Staff Writer
Friday, April 6, 2007

Verizon has thrown a lifeline to rival Vonage Holdings, suggesting that the Internet phone provider could continue serving its customers despite a judge's ruling ordering it to stop using a crucial technology connecting its network to the public telephone system.

The compromise proposal came this week ahead of a hearing in Alexandria today that could decide the fate of the heavily marketed Vonage.

U.S. District Judge Claude M. Hilton is scheduled to rule this morning on Vonage's request that he stay his earlier decision, which barred the company from using several types of technology found by a jury to be in violation of Verizon's patents. Vonage, which argues that it did not infringe on the patents, has asked for a reprieve of at least 120 days while it appeals the month-old verdict.

Without a means of connecting its online callers to regular telephones, Vonage -- which has never made a profit -- would quickly go out of business, according to industry analysts. Vonage executives have said that predictions of their company's demise are "greatly exaggerated." They said they were developing a "work-around" technique if the company could no longer use the disputed technology.

Vonage was founded in 2001 and advertised itself as a cheaper alternative that used high-speed Internet lines and circumvented the conventional phone. The New Jersey company helped make Internet telephony a mainstream product in the United States, spending millions of dollars on Internet and television ads that talked about flat-rate long-distance service and featured its hallmark off-key jingle.

Some industry analysts said it was too early to speculate about how Vonage's patent case could affect other Internet telephone providers using similar technology. But a Bernstein Research report issued this week characterized Vonage's troubles as adding to the problems of smaller players in the industry; growth in Internet phone service will largely be the province of large cable companies like Comcast, the investment firm wrote. "The center of gravity has shifted away from the start-up providers (most notably Vonage)," it said in its report on Tuesday.

In its filing, Verizon said there were no legal grounds for giving Vonage a reprieve from the judge's order that it be permanently prohibited from using the technologies. But Verizon acknowledged that the judge may be reluctant to order a total ban if he believes it could do "irreparable injury" to Vonage. In that case, Verizon said, Vonage should be allowed to continue providing existing services to its 2.2 million customers but not add new ones. If a partial stay is ordered, Verizon asked that Vonage post a bond of at least $251 million to cover what Verizon says will be its lost revenue while the case is appealed.

"That was a deft move by Verizon," said Rebecca Arbogast, a telecommunications analyst at Stifel Nicolaus. Vonage executives have said they would try to win a reprieve from the federal circuit court if Hilton does not give them one, but Arbogast said a partial stay could make it more difficult for Vonage to win a full stay from the appeals court.

A partial stay may not be enough to save Vonage over the long run, and customers could be forced to turn elsewhere for service. The company has fallen out of favor with investors and faces stiff competition against package deals offered by the phone and cable giants offering combinations of Internet, phone, wireless and television services. Even smaller Internet telephone providers, such as CharterCommunications, are eager to woo Vonage's existing customers.

"Vonage is going to be in tough shape if it can't add new customers for the next year," Arbogast said.

The costs of Vonage's court battle, including the $58 million in damages already awarded by the jury, the bond and interest payments demanded by Verizon as well as attorneys fees, are also taking a toll on the financially troubled company. Vonage sold shares to the public last year at $17, but the stock price declined steadily and closed down 25 cents yesterday, at $3.37 a share. Citigroup, which helped underwrite Vonage's public offering, last week put out a "sell" recommendation on the stock.

Last week, Vonage notified the Securities and Exchange Commission that it would not be able to file its annual earnings report on time because of the ongoing litigation. Vonage said it was waiting to see whether it would be required to post bond to secure a stay and how much interest it might have to pay.

Separately, Vonage said in a regulatory filing yesterday that one of its directors, Betsy Atkins, resigned from its board last week.

Staff researcher Richard Drezen contributed to this report.

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