Signal Hill Blog: Analysis & Perspectives

Many opponents of Microsoft’s Skype acquisition see the deal as another waste of money and resources by a big out-dated firm looking to become relevant again. But there are quite a few important differences between eBay’s acquisition of the company in 2005 and Microsoft’s today.

1. Independence makes a world of difference. Just 18 months ago Skype was foundering – an orphan that never fit within eBay. The company was also drowning in an IP ownership lawsuit. When Skype spun-off from eBay, it gained an opportunity to clean up its act without a bureaucratic business to hold it down. Once independent, the IP lawsuit was settled for an equity ownership in the company, and the new owners were able to steer Skype to better ground. New leadership was sought out (CEO Tony Bates joined in October 2010) and a commitment was made to R&D that expressed a fully formed vision of a company. Without that turn around, Skype never could have put itself in the position to obtain such a staggering purchase price — more than three times what Silver Lake, Andreessen Horowitz and Index Ventures paid for it 18 months ago.
2. Engagement stats support a higher valuation. Skype’s latest valuation is publicly justified by a healthy increase in user engagement. Since eBay spun off Skype to Silver Lake et al in 2009, monthly calling minutes witnessed 150% growth. In 2010, registered users grew to 663 million users – an almost 40% increase over 2009 and a 104% increase since 2008. Of those users, more than 100 million are active every month, spending an average of 100 minutes each month talking on the service. These users are one asset that is extremely important to Microsoft as it shows the huge market opportunity. There is plenty of room for growth; at the beginning of 2010, Skype had only about 12% of the international calling market share. With Microsoft’s help, the service could easily reach billions of users within the next few years.
3. Synergy is not just a buzz-word. eBay’s vision of voice calling accompanying internet auctions was ill-conceived.  As a consequence, the acquisition destroyed equity value.  Microsoft, in contrast, offers multiple, realistic synergy opportunities that can be carried out immediately. Ultimately, it is not paying $8.5 billion for what Skype is today, but what it can be tomorrow. Currently, Skype is only growing revenue by 20% and is largely driven by individuals and small businesses willing to pay for VoIP. But teamed up with Microsoft, Skype has new credibility as a business tool and beyond. Microsoft plans to keep the company as a standalone unit and incorporate into its other products, such as the Office suite, collaboration tools, its Xbox consumer offering and everything else they do for businesses and consumers. This creates a huge market to sell to, and eventually a huge new source of revenue. With these new user avenues also comes new places for advertising – and yet another huge potential source of income.
4. VoIP is the new battleground. Microsoft is signaling a face off with Apple, Cisco and Google on VoIP platforms and bulking up its mobile strategy. Facebook, on the other hand, in which Microsoft is an investor and partner, and with which Skype is integrated, will most likely benefit. This deal (Microsoft’s biggest ever) has the potential to spawn acquisitions by other VoIP and video conferencing technologies. This week, VoIP iPhone app provider Bababoo announced it raised $1.5 million from Sierra Ventures. The service allows users the ability to make calls through WiFi, 3G, and the iPhone’s carrier networks, AT&T and Verizon, without having to change networks, phone numbers, or caller ID. Other providers such as Pinger and Talkatone could be in the M&A spotlight in the coming months.
5. Internet remains a bull market. Microsoft is paying a healthy premium to acquire Skype and keep it out of the hands of competitors, especially Google and Apple, who are clamoring to gain market share in every area possible. The Internet sector overall witnessed an explosion of deal volume during Q1 2011with median revenue multiples rising. Deal making is keeping pace in Q2 as well. On top of that, Internet sector stocks climbed 25% for the last 12-months as of Q1 and have continued to climb since then.