Vonage's lucky break?

A deal with a VoIP wholesaler could save Vonage from having to shut down its service due to an impending injunction.

Internet telephony provider Vonage, which is facing a possible shutdown of its service this week because of a patent dispute, may have gotten a stay of execution.

According to a filing with the Securities and Exchange Commission, the company has , owned by a company called VoIP Inc., that could provide it with a work-around for at least two of the three patents owned by Verizon Communications. Voiceone also offers wholesale voice over IP service to several large companies including Broadwing Communications, iBasis and Google.

Details of the contract between Vonage and VoIP Inc. have not been released. But according to a form that VoIP Inc. filed with the SEC on March 30, the duration of the Vonage contract is two years. After that time, the companies can continue their relationship on a month-to-month basis.

Vonage did not return phone calls seeking comment on the deal with VoIP Inc.

In March, a federal jury found that Vonage's IP telephony services infringed on three patents owned by Verizon. Two of the patents deal with how VoIP calls connect to the regular public switched telephone network, and the third one is about making VoIP calls via Wi-Fi phones.

While the jury found that Vonage did not willfully infringe on Verizon's patents, it did award Verizon $58 million in damages. On March 23, U.S. District Judge Claude Hilton said he would issue an injunction barring Vonage from using the technology included in the three patents. But he said he would not issue the injunction until April 6, which is this Friday.

Since the judge announced he would issue an injunction, the IP telephony service provider and its more than 2 million subscribers have been living under a cloud of uncertainty. On the one hand, the judge could issue a stay on the injunction that would last a couple of weeks or until Vonage has had time to appeal the court's decision. On the other hand, the judge could also require Vonage to stop service immediately to ensure it is not infringing on the Verizon patents. That would mean a catastrophe for Vonage and its customers, who would be without phone service.

Vonage's recent deal with VoIP Inc. could help convince the judge to give Vonage more time.

"I think it's very unlikely that Vonage's service will be cut off on Friday," said Joel Rosenblatt, a patent and intellectual attorney in private practice in Florida. "The judge will be fair. The court didn't find Vonage willfully abusing the patents, and now that it is looking for a work-around, it shows that Vonage is working in good faith to find a solution."

But even though Vonage avoids a complete network shutdown this week, the company's troubles have hardly evaporated. First, it's still unclear whether the deal with VoIP Inc. will offer an arrangement that does not infringe on the Verizon patents.

A spokesman for Verizon declined to comment on the implications of the VoIP Inc. deal with regard to the case. But legal experts, such as Rosenblatt, said it's likely that Verizon is already evaluating the VoIP Inc. network and technology.

"I'm sure Verizon's legal team is already looking into their own patents to see how they line up with VoIP Inc.'s network and technology," he said. "And if they infringe, Verizon will be ready to sue VoIP Inc. and Vonage for infringing on them."

'Crisis mode' for Vonage
The threat of a permanent injunction has already taken its toll on Vonage. The company, which has yet to turn a profit, has steadily been losing customers. And the recent uncertainty hasn't helped matters, as customers try to figure out if they will have service next week or even a few months from now.

"Vonage is in crisis mode," said Clayton Moran, a stock analyst with the Stanford Group. "The uncertainty is impacting operations. We expect many existing customers to cancel service. And it will also make it more difficult for Vonage to attract new customers."

Moran said he has lowered his expectations for Vonage for 2007. While he had earlier projected the company would end the year with more than 3 million subscribers, he's now predicting it will fall short of the 3 million mark. Previously he had forecast Vonage reaching profitability by the end of the first quarter of 2008. Now the best-case scenario is that Vonage could reach profitability in the second quarter of 2008, he said. But even that is uncertain, he added.

Meanwhile, Vonage is facing stiff competition from cable operators that are bundling voice services similar in price and functions to its own service. Competition is also increasing from Internet companies like Skype, Google and Yahoo that are offering IP telephony services. While Moran doesn't believe that Vonage is in danger of going out of business anytime soon, he said the continuing legal troubles coupled with the increased competition could make it difficult for the company to compete in the future.

"I don't see the company dissolving completely in the near term," Moran said. "But I can't rule it out for the future either."

Even with the VoIP Inc. deal, Moran said he is unconvinced that Vonage will be able to get around the Verizon patents so easily.

"The agreement with VoIP Inc. is still unclear," he said. "But at this point it doesn't change my view that a work-around will be challenging for Vonage."

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