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Skype: $6 Billion in Two Years

skype

For a while, it looked like Skype, the popular video chat program, could go either way.

Chatting via webcam is no longer the novelty it once was. Most all laptops and many tablets and smartphones come equipped with a front-facing camera these days. Apple’s video chat platforms iChat and FaceTime are standard issue on new Macs and iOS devices. You can make video calls (and even call phones) for free with features built into Google’s web-based email service, Gmail. And Google’s new social network, Google+, allows multiple people to video-chat simultaneously with the “Hangouts” feature, which only requires a browser plug-in. Facebook can’t even do that. In fact, you couldn’t make any video calls with Facebook until earlier this month, when they started unrolling their long-anticipated Skype integration.

But yes, Skype could have easily gone the way of other extraneous facilitators of functionality that, though once novel, became common place. AOL Instant Messenger or TiVo,  anybody?

Today though, Skype hardly seems on its way to the tech start-up junkyard. Or if it is, Microsoft just made an $8.5 billion mistake.

When Skype was aquired by eBay in 2005 for $2.6 billion, it was seen as a hot commodity. By 2007, it seemed clear that the purchase had been unwise. Skype’s founders and eBay’s management had a falling out. On October 1st, 2007, eBay bought out Skype’s founders. According to VoIP News, the founders got “an earn-out of $530 million. That’s one-third of the $1.7 billion they would have made if they had stayed, and Skype’s performance had met targets, into mid-2009.”

In addition to that, eBay wrote down their initial investment in Skype “by nearly 50%,” according to Fast Company, “and conceded that they over-paid [for Skype].” More than overvaluing the company, they had overestimated their ability to integrate Skype’s services with their online auction platform.

All of this turmoil actually led to a two-year period of growth, or re-growth, as it were, under the direction of CEO Josh Silverman, who took over in early 2008, following a long line of executives that had been coming and going since eBay first bought the company. With Silverman in charge, Skype overhauled many of its features, completely removed others, and gained new notoriety through product placement and stints in film and TV programming, like Oprah Winfrey’s use of the video-service on her daytime talk show. When eBay sold 70% of their stake in Skype in 2009, the business was valued at $2.75 billion and was experiencing tremendous growth– adding about 380,000 new users every day.

But still, it had to go. Who stepped in to take Skype off eBay’s hands? That would be Silver Lake Partners and venture firm Andreessen-Horowitz. And in just two years, they managed to make Skype attractive enough that Microsoft is now willing to fork over $8.5 billion dollars for it. That’s a $6 billion bump in the company’s value in just two years. And, while all parties involved seem pretty happy with the deal, Marc Andreessen for one, is confident enough in the company’s future that he could do with or without the paycheck from Microsoft, which is currently awaiting regulatory approval. “We have occasional fantasies of calling up [Microsoft] and torpedoing the deal,” Andreessen, founder of Andreessen-Horowitz, says in this August’s issue of Fortune. “I’m thrilled with the deal but would be equally thrilled if it fell apart.”

So what happened to make Skype worth so much money in so little time? Equally important- is it really worth that much money?

According to Fortune:

“The key to fixing Skype… was to win over the company’s mercurial founders, Niklas Zennström and Janus Friis, who actually owned the rights to the software underlying the service — without that intellectual property, it would be impossible to unleash Skype’s potential. The problem: The two had been pushed aside after the eBay acquisition and had no intention of throwing a bone to the next guys who wanted to buy their invention. In fact, the moment Silver Lake floated a buyout offer, Zennström, a Swede, and Friis, a Dane, sued all the parties involved.”

But Egon Durban of Silver Lake Partners and Marc Andreessen managed to win the founders’ trust. Eventually, “Zennström and Friis accepted a 14% stake in the new ownership structure in exchange for giving all the IP back to Skype. With Skype’s software rights secured, the investors went into turnaround mode.”

“Turnaround mode” meant new management, new engineers, and new features. It also meant making Skype more than what it was- an arguably cumbersome desktop program. They began embedding Skype in new TVs, video game consoles, and made the service available as a smartphone app. The kicker was forging valuable alliances with other companies like Facebook and Verizon Wireless. “The Facebook partnership was critical,” Durban tells Fortune. “And the partnerships with carriers — they had thought of us as an enemy. Getting Verizon signed up signaled that one of the world’s largest carriers was not at war with us but was supportive.”

Though Microsoft made their offer for Skype before Facebook launched their new video-chat Skype integration,  the two deals coinciding was, well, no coincidence. As CNN Tech points out, although Skype has been in bed with Facebook for some time, so has Microsoft. In fact, the very same day that “Microsoft announced its intentions, Skype executives met with Zuckerberg and his team, [Skype CEO Tony Bates] said.”

But still- is Skype really worth $8.5 billion dollars? You’d be far-pressed to find coverage of the acquisition that doesn’t at least mention the phrase, “tech bubble.” Even the Fortune article on the acquisition appears in an issue with a cover story called, “Tech Bubble 2.0” Between sites like Groupon, Facebook, and Pandora, the hottest tech companies are being valued at exorbitant prices, with few of them making any profit at all, let alone enough to justify their current valuations. Financial Times reports that the $8.5 billion pricetag for Skype “is 32 times its adjusted earnings before interest, tax, depreciation and amortization.” Not only that, but Skype lost $7 million last year.

Even so, Microsoft needs something like Skype. Windows has no built-in video chatting capabilities to date, and Skype could easily be integrated, or further-integrated, in many of their products, from their upcoming Windows 8 tablets to their Xbox 360 video game console. Even some of their business software could benefit from Skype integration. As Business Insider argues, PowerPoint “was practically built for Skype. First and foremost, Microsoft could quickly link the two products together for seamless online presentations. Instead of having to use an inferior web tool, and instead of forcing your attendees to create another account for yet another service, you could simply use Skype to share your presentation in real-time. Since Skype already has a screen sharing feature, this shouldn’t be too difficult for Microsoft to implement.”

Still some will have trouble justifying Microsoft’s new purchase. An important thing to remember though, is that their bid wasn’t meant to match competing offers. They were competing with the valuation many expected if and when Skype filed for an IPO.

It’s possible that Microsoft may find themselves writing down this investment in a couple years, just as eBay did in 2007. But, as Fortune contributor Kevin Maney points out, “The devil is in how that asset is managed, and whether it can integrate with existing products and services.”

At the very least, most would agree that Microsoft is a better fit for Skype than eBay ever was.

So when the Microsoft-Skype deal finally gets approval, and it’s expected to by year’s end, Skype’s current leadership will be busy counting their money, Microsoft and Facebook will be busy integrating Skype into their existing tech-empires, and the rest of us can sit back and watch how it all plays out. Personally, I’m confident Microsoft’s investment will pay for itself in the long run. But beyond that, I’m not making any bets.

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