Microsoft-Skype Deal – 7 Reasons The Sucker Did It

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May 11 2011
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Microsoft, the world’s largest software company, agreed to pay $8.5 billion cash for Luxembourg-based Skype. That was cool because both Google and Facebook were trying to acquire Skype as well. But Google doesn’t really need Skype because it has its own Google Voice. As much as Facebook would like to add Skype into its inventory, it doesn’t have the financial muscle to do so. It would be a different story if Facebook is listed.

The question everybody is asking – did Microsoft pay too much for Skype? Was Steve Ballmer thinking straight in this deal, the biggest acquisition since Microsoft was founded in 1975? Heck, why pay such a giant amount for a company that is struggling making money? The $8.5 billion is about 32 times Skype’s adjusted earnings before interest, taxes, depreciation and amortization of $264 million – which means Microsoft is paying 39% more than the multiple Skype used to value its own equity in its recent April regulatory filing.

Skype had about $725 million in borrowings and a revolving credit line of $30 million. While Skype had a total of 663 million users, it has only converted 8.8 million users of its free PC-to-PC phone services into paying customers. Skype reported a net loss of $6.9 million on $860 million in revenue last year, its fourth money-losing year since 2006. Judging from Microsoft’s stock reaction after the official announcement of the acquisition, there’s little to cheer.

Skype's CEO Tony Bates and Microsoft's Steve Ballmer announcing the deal

Skype's CEO Tony Bates and Microsoft's Steve Ballmer announcing the deal

Sure, it was as if Microsoft had just paid for a hamburger considering it has a whopping $50.2 billion cash pile but shareholders and analysts would think it’s more worthwhile to it on dividends or buybacks. People are also wondering if this deal will be another flop, just like how eBay made the same mistake. In 2005, eBay agrees to by Skype for $2.6 billion in stock and cash with another $500 million in debts. Then the CEO Meg Whitman admitted the acquistion was a flop.

eBay then tried to float Skype but it seemed not only Meg Whitman made a bad decision in acquiring Skype but also a laughing stock when it was revealed that somehow eBay only purchased a license on the Skype technology. eBay did not or failed to buy all of the IP (intellectual property) in particular the underlying peer-to-peer technology that as well as driving Skype had powered KaZaA. Niklas Zennström and Janus Friis, the co-founders of Skype, still own some of the key technologies which Skype is built on.

eBay abandoned the planned IPO and instead sold a 65% stake in Skype to a group of investors for $1.9 billion – led by Silver Lake, Andreessen Horowitz and Canada Pension Plan investment board. But Zennström through its new P2P video company called Joltid launched fresh legal action against both eBay and Skype claiming copyright violation. In return for dropping its lawsuits, Joltid ended up with 14% stake in Skype. In the end, the Skype’s new investors hold 56% while eBay still own 30% stake.

Now, with the latest $8.5 billion acquisition by Microsoft, everyone in Skype is laughing their way to the bank.

1)   eBay with its 30% stake in Skype will actually (OMG!!!) make money from its’ initial bad investment of Skype as it set to get $2.55 billion.

2)   Niklas Zennström and Janus Friis, the co-founders of Skype, take home $1.19 billion from its 14% stake. How many would be able to sell the second time because the first buyer was a sucker who didn’t purchase the right thing?

3)   Silver Lake, Andreessen Horowitz and the Canada Pension Plan Investment Board (CPPIB) which own 56% stake in Skype is worth $4.76 billion.

 Skype Suckers Chain from eBay to Microsoft

As much as Ballmer justifies the rationals in paying the exorbitant amount for the deal, not everybody is impress and some said it’s a matter of time before Microsoft would be laughed at as the sucker of the year. Still, there’re some reasons why Microsoft is buying Skype.

1)   To inject excitement into existing Microsoft’s products

Microsoft is buying Skype, which has 170 million active users, to connect the service to its Outlook e-mail, Xbox game console, Windows mobile phone and corporate-phone software. Somehow it thought it was a freaking cool idea in allowing users to easily call their friends and colleagues with Skype integrated into the products.

2)   To rejuvenate Microsoft’s advertising revenue

Ballmer is aiming to revive Microsoft’s Internet advertising revenue. The company’s online services division had an operating loss of almost $2.6 billion in the 12 months ended March. Microsoft has been trying but is still eating dust behind Google in web search and related advertising. Ballmer is hoping Skype which would start showcasing advertising could help Microsoft’s Bing search engine in the online-search market – hope to narrow the huge gap between it’s Bing’s 14% versus Google’s 66%.

3)   To lure more users to its Windows Phone 7

Microsoft plans to add Skype to its Windows-based mobile phones to lure more customers after losing ground to Apple’s iPhone and Google’s Android devices. It was also hoped that Skype can help boost the popularity of Windows-powered devices such as tablet computers. It’s all about competition and Microsoft hates Apple and Google very much.

4)   To prevent rival Google from buying Skype

As much as Google likes to tell everyone that it has Google Voice so it doesn’t really need Skype, the fact remains that Google Voice is nowhere near Skype. It would be nice to add Skype into Google’s portfolios but not at crazy-price. But Microsoft simply cannot afford to sleep only to wake up one fine day that Google has bought over Skype. That would be disastrous and with deep pockets, it would be better to buy Skype and let it rot even if the deal is proven to be a flop.

5)   To diversify Microsoft’s traditional business

For as long as you can remember, Microsoft’s business has relied heavily on sales of its Windows and Microsoft Office programs, which runs on hundreds of millions of computers. Its venture into other business such as search engine and Microsoft’s Windows smartphones are nowhere near Google and Apple. Skype is a bet that may eventually turn into a gold mine, hopefully.

6)   Microsoft is simply jealous of Apple and Google

Microsoft is desperate to become relevant. They’ve tried everything on their own from Bing search engine to Windows Phone 7 but nothing seems to work and can put them as the leader on the latest technology map. Luckily they didn’t manage to buy Yahoo – the value of Yahoo has halved since then. Apple has just overtaken Google to become the most valuble brand and Microsoft brand ranking will only drifts further away if it doesn’t do anything now. Of the top-10 valuable brands, Microsoft improves the least. Now Microsoft can claim it has a new sexy product on par with Google and Apple.

7)   To have a stronger bargain power with carriers

At the moment, carriers don’t really care if Microsoft wants to work with them or not. Google’s Android and Apple’s iPhone are sufficient in generating tons of money for the carriers. Now with Nokia behind Microsoft, Skype will be a must-have service/application that Windows Phone 7 can uniquely offers to the carriers. Surely Microsoft will still make Skype free of charge but you’ll never know. Maybe Skype can be tweaked to compete with Apple’s Facetime.

 Microsoft Skype Facebook $8.5 billion

Regardless of the winners who walk away with billions of dollars from the deal or the sucker (Microsoft) who paid crazy money for it, there’s one hidden winner who’s smiling on the deal. Microsoft owns 1.6% stake in Facebook and both don’t like Google. Facebook actually needs Skype especially its peer-to-peer technology to offer video and voice services to Facebook Chat’s users. Facebook’s powerful 600 million users can now leverage on Microsoft’s Skype, if Ballmer decides to plug his new toy onto Facebook, with not a single penny of investment from Facebook.

Of course Microsoft stands to make truckloads of money if Facebook can also help Skype get more customers for its SkypeOut service, not to mention that existing Facebook Credits can be used to pay Skype minutes. Maybe Steve Ballmer is not a sucker after all.

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