It looks like the initial wave of Vonage Holdings (NYSE:VG) euphoria has worn off, judging by the way the stock has retreated from its recent peak of $2.63. For those of you who were planning on getting into the second wave of buying, consider this a warning - there may not be a second wave of buying anytime soon. The market's had time to crunch the numbers, and frankly, the numbers just aren't that promising.

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Back to the Beginning
The rally for Vonage was made on a bit of a delayed basis. The VoIP service provider announced its newest service - Vonage World - on August 20. Vonage World in many ways is the current Vonage service most of us are familiar with in terms of pricing; a flat $25 per month gives the subscriber unlimited calls around the world - to a network of more than 60 countries.

Better still, mobile phone users knew an application for Apple's (Nasdaq:AAPL) iPhone was on the way, turning the device not just into a cell phone, but a phone that could potentially tap into wi-fi hot spots and give users a couple of options about how to connect with other Vonage users.

A game changer? On the surface it seems like the market would have - perhaps should have - gone immediately nuts on the news. The stock didn't really budge until the August 25 though - three trading days later - when VG jumped from 60 cents to $1.59. Shares hit $2.63 the next day.

Just a delayed reaction? I think this was more of a case where the market managed to make a mountain out of a molehill. There's a problem with investor-induced run-ups, they tend not to last, as more of those euphoric investors start to actually crunch the numbers.

Reality Check
Yes, the new Vonage offer should help draw new business. And yes, the Vonage iPhone application may sweeten the pot even further (even though it's not been unveiled). However, with the surge to a peak of $2.63 back on August 26, VG's market cap briefly topped $412 million. No problem, except that's a tad expensive for a company that posted a $2.3 million profit last quarter - its first ever profit.

One could argue that the swing to profit was a step towards progress, and it was. The profit came on the heels of diminished revenue, slashed expenses, and lost (net) subscribers though, not exactly a trifecta of success.

However, the problem isn't even really a $412 million market cap versus $2.3 million (let's just say an annualized $9.2 million) in earnings. That's a P/E of 44.8, which is expensive, but not ludicrous.

No, the problems are: net losses in subscribers, slashed expenses early in the year, and new calling territories that need set up and service.

To stop the bleeding of subscribers, and to service new ones, it's not like expenses can be cut indefinitely. Earnings were already paper thin to begin with, and the new geographical ventures and capturing new users is likely to necessitate more spending. Hence, profits are still at risk.

Even at the current market cap of $215 million, the annualization of last quarter's earnings leads to a P/E of 24, which isn't dirt cheap considering the risk involved.

The other argument in favor of Vonage's future is built on Google's (Nasdaq:GOOG) entry into the VoIP fray with Google Voice, another competitor. The assumption is if Google's getting into the business, then the opportunity must be for real.

It's not a bad assumption really, but there's a flaw to it. See, Google can afford to lose money on Google Voice indefinitely, and has a massive web platform and user base already in place. Vonage hasn't got either of these things.

If anything, potential Vonage investors may want to look at eBay's (Nasdaq:EBAY) recent decision to sell Skype - at a $1 billion loss - as a clue that the VoIP business isn't a cakewalk. eBay put quite the positive spin on the sale, but the fact remains that it chose to sell the unit at a loss.

The biggest assumed flaw with Skype (which greatly mirrors Vonage) was that it didn't fit with any of eBay's other web properties, so there's not enough synergy. The same can be said of Vonage; it's not strong enough to stand on its own.

Google doesn't have that problem though. So, rather than Google Voice generating interest in VoIP, it may be time to acknowledge that Google could just simply dominate VoIP, hurting Vonage more than helping it. (For more, see Is Your CEO Street Savvy?)

Bottom Line
A lot of investors have already taken note that Vonage might not be sustainable. It might be best to give it a bit of time and see if VoIP is all that it's made out to be.

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