I. EXECUTIVE SUMMARY & RECOMME DATIO

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1 TO: THE MCINTIRE INVESTMENT INSTITUTE, MANAGERS FROM: Y. LAWRENCE LIM SUBJECT: VONAGE INC. SHORT MEMO DATE: APRIL 23, 2007 I. EXECUTIVE SUMMARY & RECOMME DATIO It is recommended that McIntire Investment Institute short shares of Vonage Holdings Corp (VG). Vonage shares are down 80% since its IPO, and a strategic entry point would be as soon as possible. Strategic exit points would be to buy to cover after the next earnings period or when Vonage is listed on the pink sheets (declare bankruptcy). Summary of Short Theses Rapidly Losing Market Share to Competitors VoIP Industry Weakness Costly Lawsuits Weak Research and Development Rapidly Losing Customer Confidence Buyout Possibility Extremely Low II. BUSI ESS A D I DUSTRY Vonage Holdings Corp. ( YSE: VG) Sector: Technology Vertical: Communications Services Industry 1

2 Business Summary Vonage Holdings allows customers to turn a high-speed Internet connection into a long-distance phone service. A leading provider of broadband Voice over Internet Protocol (VoIP), the company serves consumers and small business clients. It has more than 1.6 million subscriber lines in service, 95% of which are in the US with an expanding presence in Canada and the UK. The company is growing rapidly as consumers seek VoIP services as an alternative to traditional telecom carriers. Its services are marketed directly through an Internet web site and through retail partners that include Amazon.com, RadioShack, Best Buy, and Circuit City Stores. Chairman Jeffrey Citron owns a 33% stake in the company. Utilizing its voice over Internet protocol (VoIP) technology platform, the Company offers feature-rich, low-cost communications services with a call quality comparable to traditional telephone services. The Company offers its customers a variety of service plans. Each of its service plans includes a full suite of features, such as call waiting, caller ID and call forwarding. It offers several enhanced features at no additional charge, such as area code selection, Web- and -based voic and an account management Website that allows customers to add or change their features online. III. FI A CIAL A ALYSES Valuations and Ratios Because the earnings of Vonage are not available, the P/E and PEG ratios are unavailable and unsuitable to value the shares of Vonage. Vonage s Price to Book ratio is 2.532, which is in line with the industry median of

3 Profitability Ratios Losing money on an operating basis, VG appears to be an inefficient company. While it's profitability is above average on a gross margin basis, it's bottom line, the net margin, is below the Communications Services industry average. Short Interest & Option Market Inferences Short interest increased 32% to 7.4M in April from 5.6M a month ago. 134 institutions holding shares, 31.55% of shares held by institutions Option Market Calls Last Sale Net Bid Ask Vol Open Int Puts Last Sale Net Bid Ask Vol Open Int 07 Apr 2.50 (VG DZ-E) Apr 2.50 (VG PZ-E) Apr 5.00 (VG DA-E) Apr 5.00 (VG PA-E) Apr 7.50 (VG DU-E) Apr 7.50 (VG PU-E) May 2.50 (VG EZ-E) May 2.50 (VG QZ-E) May 5.00 (VG EA-E) May 5.00 (VG QA-E) May 7.50 (VG EU-E) May 7.50 (VG QU-E) Vonage s option quotes from CBOE indicate a lot of open interest in May 7 th Put Options at a strike price of $2.50. This reflects the bearish sentiment of investors. Vonage options are only available up to the month of May, a warning sign of a failing company. 3

4 IV. SHORT THESES a) Rapidly Losing Market Share to Competitors Vonage s business model is failing because more customers are taking advantage of tripleplay - discounted bundles of phone, Internet and TV service - that is being offered by bigger and better-capitalized rivals like phone and cable-television companies. Cable providers now account for 60% of the 10.6 million U.S. households with Internet phone hookups. Most corporations who are enticed by the cost-saving aspect of Internet telephony use Cisco systems known for their reliability. b) VoIP Industry Weakness In addition, the fees and regulation that the government has long imposed on traditional phone companies have also caught up with VoIP providers, and customers are now paying surcharges. Internet phone providers were required to upgrade their 911 emergency-dialing facilities and modify their equipment to handle law-enforcement wiretaps and pay subsidies into the nation's universal-service fund, which finances phone service in rural and high-cost areas. c) Costly Lawsuits Verizon Communications accused Vonage of violating an array of basic patents covering Internet calling back in June Vonage was ordered by a federal judge on April 6 th 2007 to stop signing up new customers unless it avoids infringing on patents held by Verizon. These include a variety of features crucial to Internet calling, including the ability to connect calls to ordinary phone networks and call forwarding. If Vonage s appeal is unsuccessful, it could face an overall service shutdown, potentially leading to bankruptcy. d) Weak Research and Development Vonage says it is developing technology that will work around Verizon's patents and enable it to continue marketing its service regardless of how the court fight turns out. But it is unclear whether the technology would work and stand up in court. In addition, Vonage says it would take months to develop such a system. 4

5 e) Rapidly Losing Customer Confidence Vonage customers are concerned that they will be forced to switch to a different phone services provider. Long-time customers are concerned that Vonage might not stay in business and they will be forced to switch to Verizon. The competition took its toll on Vonage's finances in While its revenue more than doubled to $607 million, its net loss widened to $286 million from $261 million the previous year, largely because of higher marketing expenses. f) Buyout Possibility Extremely Low Vonage does not have intellectual property to entice potential acquirers. Its research and department facilities are working to develop technologies that can already be licensed in the market. Furthermore, most cable companies have developed or are currently developing their triple-play services, making acquisition of a VoIP provider unnecessary. V. RISK SUMMARY a) Buyout Risk The risks of a buyout, however minimal, remain a possibility. However, most of the larger cable companies already have their own VoIP telephony services. b) Severe Economic Downturn A recession could force consumers into opting for Internet telephony services, and cutting down on entertainment costs that are included in triple-play packages. VI. VALUE ADDED RESEARCH a) Theresa F. Jackson Attorney, Shearman & Sterling LLP Comments: Lawsuits with Verizon (appeal stage) and Sprint (discovery stage) could be extended through various court procedures, delaying Vonage s plans to restructure and sign up new customers without violating Verizon s patents. 5

6 b) David Zimmerman Store Manager, Verizon Communications ew York Store Comments: Many small business Verizon customers have chosen Voice-Wing over Vonage because of its corporate image and the ease of convertibility. c) John Rajaratnam IP Telephony Division, Cisco Systems, Inc. Comments: Vonage s research and development division will not be able to produce technology to work around Verizon s patents, and Verizon will be unwilling to license patents to a competitor. In the mean time, competitors are also aggressively developing new technology for triple-play services to reduce costs. d) D. Lemelin Senior Analyst, In-Stat Advanced Communications Researchers Comments: Triple-play growth rate is exceeding that of the VoIP companies. More than 60% of the 11 million U.S. households with Internet phone hookups receive IP telephony services as part of triple play packages. The consolidation of different bills also add to the appeal of triple-play. e) John Berton Council Manager, Gerson Lehrman Group Vonage user at home, Cisco IP Phone user at office Comments: Vonage has a higher dropped calls rate than Verizon, which provides most of the Internet Telephony services to corporate offices using Cisco IP-PBX Phone systems. On-site services for Cisco systems are also much faster than that of Vonage s. 6