Tuesday, May 10, 2011

Microsoft buys Skype [HOT REPORT]

May 10, 2011
Microsoft buys Skype: A good move for Ballmer?
10:51 AM

Paul Sakuma,


By Tim Mullaney, Special for USA TODAY

Microsoft is buying Skype in a $8.5 billion deal for cash and assumed debt. The world's largest software company is paying a fairly rich price for Skype, at 32 times last year's profit before interest, taxes and non-cash charges, especially considering that Skype's operating cash flow had been almost flat since 2008.

Microsoft hopes to use the Internet calling service to beef up its Windows 7 mobile-phone operating system and its enterprise software business by adding Skype's voice capabilities, tech blogger Om Malik reports. The logic is that Microsoft can cut marketing and overhead costs for Skype, boosting profit enough to make the deal a moneymaker if it can sell Skype's voice-over-the-Web services to corporations. Malik calls the deal "a bet worth taking, especially for a company that has been left in the cold for so long."

Or was Microsoft CEO Steve Ballmer simply left to be the dumb money in Microsoft's biggest-ever deal, a role he played in the 2007 deal to buy aQuantive, the online ad agency and services company for which he paid $6 billion shortly after Google laid out half that much for online ad rival DoubleClick? It's a role he almost played, again, in the failed effort to acquire #2 search engine Yahoo for nearly twice its current market value.

The problem is a combination of Microsoft's storied bureaucracy and its persistent inability to create a money-making Internet division in more than a decade of trying. Last fiscal year, its online services division (including the Bing search engine, aQuantive, and the MSN portal) lost $2.36 billion on sales of $2.2 billion, a performance few companies would tolerate, especially in the relatively high-margin online advertising business. It's not as if these businesses are start-ups, either. Instead, they have limped along unable to thrive, with flat revenue and persistent losses, while entrepreneurial executives leave.

One glaring example is aQuantive, where sales grew 51% the year before Microsoft bought it. Three years later, in fiscal 2010, Microsoft's annual report blandly notes that advertiser and publisher tools revenue, aQuantive's core business, fell from 2009 even as the rest of the industry bounced back from the recession.

aQuantive's Razorfish ad agency was sold for $530 million in 2009 -- less than half what the same buyer, French ad-agency holding company Publicis Groupe, had paid for rival Digitas in 2006. Contrast that with what happened when Microsoft spun off Expedia in the late 1990s, a prelude to the one-time piece of MSN becoming the world's biggest travel agency.

Since Skype is a private equity-owned company packed with hired guns -- as Malik notes -- it's hard to expect them to stick around and build the business for the long term. And Microsoft's track record of replacing online entrepreneurs with top-flight managers is thin.

It's not clear who else would have paid the price Ballmer did for Skype. The private-equity firm that bought control of Skype from online auction leader eBay in 2009 helped boost sales 20% last year, but was just getting started on its strategy of focusing on corporate customers to build a second large business.

Not Facebook, which was reportedly interested but didn't have enough money. Probably not the initial public offering market: Skype had filed to go public last August, and even in a reasonably warm market the deal hadn't yet moved for reasons Skype hasn't publicly explained.

Google sniffed around but has its own Google Voice product. "How could you turn $8.5 billion away?" said Paul

Bard, an IPO market analyst at Renaissance Capital in Greenwich, Conn. "We thought it would come out at a $5 billion or $6 billion valuation."

We'll have more later on who wins and who loses in this deal, but Microsoft shareholders should be worried. Their stock is worth about what it was in late 2001, adjusted for splits, thanks to Microsoft's inability to use dealmaking to adapt to how the Web has remade the tech industry's power grid. Paying up, or maybe overpaying, for Skype isn't much of an answer.