NQ Logic

Technology | Strategy | Consulting

Microsoft Acquires Skype

Late Monday night (May 10), Skype Global s.à r.l and Microsoft Corp. came to a final agreement under which Microsoft would acquire Skype for $8.5 billion in cash. The deal, approved by the boards of directors of both companies, is the biggest acquisition in Microsoft’s 36-year history topping the acquisition of the digital advertising company aQuantive on Aug 13, 2007 for U$6.33 billion. Skype will become a new business division within Microsoft, and Skype CEO Tony Bates (ex-Cisco executive) will report directly to Steve Ballmer as president of the Microsoft Skype Division. Microsoft decided against hiring investment bankers to help them with the deal, thus saving around U$30 million in fees.

Founded in 2003, Skype was most recently owned by a consortium of investors led by the private investment firm Silver Lake Partners (39.8%). Other members of the investor group include eBay International AG (30%), Canada Pension Plan Investment Board (15%), Joltid Limited in partnership with private equity investment firm Europlay Capital Advisors (14%), and Andreessen Horowitz (1.8%).

This acquisition is the second time another technology company has acquired Skype. On Sep 12, 2005, eBay bought Skype for U$2.6 billion but never really managed to take advantage of its potential and merely sold 70% of its shares to an investor group in Nov 19, 2009 for U$1.9 billion in cash and a note from the buyer in the principal amount of U$125 million.

Since then, Skype was rumored to be approached by major technology companies (Facebook, Google and Cisco) but managed to stay focused on its IPO, which was finally filed for last August. The unsolicited offer by Microsoft was in fact a quick (less than 6 weeks) and personal effort by Steve Ballmer himself, who insisted that Skype sign a “no-shop” clause to keep it from soliciting other bids.

Source: comScore, Microsoft & Skype [May 10, 2011]

A large majority of analysts, observers and investors over the past days have commented that U$8.5 billion is too high of a price for a company that still has yet to convert its more than 600 million users into a profitable cash cow. Microsoft is paying 40% more than Skype itself states the business is worth, according to its most updated IPO filing with 2010 data. In reality the price reflects the premium on current valuations (i.e., Groupon, Facebook, Twitter), past successful IPOs (Amazon, eBay, Yahoo! or most recently Google), and an optimistic starting base price of U$7 billion, what Skype's owners expected to generate from the planned IPO.

The upside is spectacular given the short amount of time, mere 18 months, the investors have owned the internet phone service since buying a majority stake from eBay. The internal rate of return was as high as 70% to 80%, unheard of in a private equity business where investments are held and evaluated typically for three to five years.

Skype Today

NQ Logic previously discussed Skype and its strategy in March 2010. Since then the company has managed to move fast on multiple fronts. Skype launched new products for mobile devices, including an iPhone app that has been downloaded over 50 million times, and another for Android; doubled its workforce; signed strategic partnerships with Avaya, Verizon, TV makers Panasonic and Samsung; and appointed Cisco Systems' seasoned executive Tony Bates as CEO.

Source: Skype.com [May 2011]

According to its latest IPO filing with 2010 data, Skype had a total of 663 million users (mostly non-paying), who made 207 billion minutes of voice and video calls, and sent over 176 million SMSs in 2010. The Luxemburg-based company grew its registered user base in 2010 by 39%, and its paid customers by 20%, now at 8.8 million users (1.3% of its total user base). Just in the fourth quarter of 2010, video calls accounted for approximately 42% of all Skype-to-Skype minutes. Skype is the leader in internet voice and video communications, with 107 million users per month connected for more than 100 minutes a month on average.

Source: WSJ [May 11, 2011]

In terms of revenue, in 2010 Skype generated U$860 million of net revenue, and its adjusted EBITDA was U$264 million. After paying its debt interests the company's net loss amounted to U$7 million (Skype has about U$725 million in borrowings and a revolving credit line of U$30 million).

If Skype was a Telecommunications company, it would be the number one in terms of user base, ahead of China Mobile and its 600 million users.

And Skype is a verb, as they say.” — Steven A. Ballmer, Microsoft's Chief Executive [May 10, 2011]

The software company is the market leader in the multi-platform VoIP application, instant messaging, file transfer, and video conferencing markets over the internet.

Skype Fit

In its press release, Microsoft mentioned that "Skype will support Microsoft devices like Xbox and Kinect, Windows Phone and a wide array of Windows devices, and Microsoft will connect Skype users with Lync, Outlook, Xbox Live and other communities. Microsoft will continue to invest in and support Skype clients on non-Microsoft platforms."

Source: Microsoft & Skype [May 10,2011]

Although private platforms using internet technology to communicate using video are becoming quite common (Google Talk, Apple’s FaceTime, AOL’s AIM, RIM’s QNX-based BlackBerry or Cisco’s Umi), Skype is the only large platform supported across different OS, and able to connect to regular PSTN lines (SkypeOut to regular phone lines).

Combining Windows Live Messenger and its 330 million monthly active users with 40 million concurrent users, with Skype's 170 million active users and 30 million concurrent users, Microsoft would be merging the two market leaders of internet communications on both private platform and cross-platforms.

By making Skype a separate business unit, Steve Ballmer is also acknowledging that the application is already an appealing proposition to the consumer market as it stands, and with more advertising revenue could turn the VoIP software into a large part of Microsoft’s new strategy of “three screens and the cloud”. Ballmer recently said that online advertising contributes U$3 billion in revenue per year to Microsoft, and is the fastest growing part of Microsoft’s business.

At the same time, Microsoft with its deep expertise in the SMB segment, knows that today's small and medium companies need to communicate and collaborate more on daily basis across different places and different time zones while balancing out their costs. Microsoft Lync and Microsoft Exchange are both lacking the Skype's capability to call out to regular phone lines, and the acquisition will enhance Microsoft's offering in the Unified Communication market to SMB customers (a U$2.5 billion business a year according to research firm Synergy Research Group).

What's Next

Microsoft’s competitors will try to size up Skype’s potential rivals (Jajah, Fring) or maybe promote new or copyleft software (GNU Free Call, Exiga, Empathy, Blink or Linphone) onto their platform.

Upon regulatory approval later this year, Skype will just be another brand in Microsoft’s basket. Skype name will stay as is (like “Hotmail”) and hopefully the business unit will continue to grow thanks to the Microsoft's marketing machine and infrastructure investment to scale and finally stabilize the platform.

Skype will still be supported across different OS and devices (TV, mobile, PC, and Tablet). Some recent deals will be revisited (e.g., Avaya) and some others will be expanded (e.g., Facebook, Citrix). A new client for Windows Phone 7 will be released contrary to the initial plan.

But it will be a couple of years before the Skype defensive buyout can reveal itself as a success or failure. It will be easy to imagine that in a later release of Windows OS across the multiple screens (TV, PC, Mobile, and Tablet) a Skype client could be integrated directly onto and would create de facto the biggest social network ever created on the planet. The next May 27 conference about the “next major release” of Windows Phone could be a major indicator of Microsoft strategy.

Apart from Skype integration execution, the most difficult part would be for Microsoft to explain to all its carriers and telecommunications company partners around the world, that Skype is not a competitor and that they still can decide what to do on their network.


After last month's deal with Nokia, and Skype’s acquisition, Microsoft has decided to move forward in the mobile-telecommunication arena. The Redmond-based company is finally putting to use the U$42 billion (out of U$50 billion) of cash it has overseas. In partnering or acquiring the best pieces of technology outside the US, it avoids the 30% repatriation tax rate.

We are in the middle of a transition in telecommunications from voice and video being a fixed hardware application to a software application sitting on top of the network.” — Marc Andreessen, Silicon Valley Tech Guru, [May 10, 2011].

By snatching Skype out of the hand of large technology companies (and especially Google and Cisco), Microsoft consolidates its leadership position in the Unified Communication in the business market, and peer-to-peer communication in the consumer market. This expensive acquisition (largest in Microsoft’s history) may seem too costly today, but if the Redmond company manages to create a new, seamless communication experience across multiple screens (TV, Mobile, and PC today; Tablet tomorrow), this deal could be seen in retrospect as the best move Microsoft could have made toward the lucrative global telecommunications industry with its trillion US dollar revenue a year.

<< Home