Column: Is it Skype or hype?

by Mathew on September 8, 2005

Here’s a column I posted to globeandmail.com about the speculation that Skype will be bought:

“First it was Yahoo. Then it was Microsoft. Then it was Rupert Murdoch’s media conglomerate News Corp. Now eBay is supposedly in talks to take over Skype, the voice-over-Internet company started by Swedish entrpeneur Niklas Zennstrom. According to a recent report in the Wall Street Journal, the on-line auction site is considering paying between $2-billion (U.S.) and $3-billion for the VOIP provider, while a report in the New York Post says the deal is worth $5-billion. Oh yes, and Skype has also reportedly hired an investment bank to look into an initial public offering, which sources say could raise billions.

Is it a coincidence that the name of this voice-over-Internet company rhymes with “hype?” Perhaps. It’s certainly possible that eBay is having takeover talks with Skype, just as it’s possible that Yahoo, Microsoft and News Corp. had talks — or even Google, Amazon or Time Warner, for that matter. Talking doesn’t cost anything. But does it make any sense for eBay to pay $2-billion, $3-billion or $5-billion for the company at this point in its development? Not in any universe that obeys the laws of financial reality.

That doesn’t mean it won’t happen, of course. With eBay and other maturing tech companies looking for sources of growth wherever they can find them, almost any combination you can think of has probably been considered by someone, somewhere. But that doesn’t mean such a deal would make any sense.

When eBay acquired PayPal in 2002 for $1.3-billion, the on-line payment company had a little over 15 million subscribers and annual revenue of about $100-million. It had just gone public earlier that year, and had a market value of about $1.3-billion at the time the offer was made. The deal made eminent sense for eBay because a large proportion of the transactions on its site already used PayPal, giving it a greater share of the market on eBay than eBay’s own on-line payment service, BillPoint. And an acquisition made sense for PayPal because eBay auctions accounted for more than 60 per cent of the company’s revenue.

Skype has about 50 million subscribers, but most of them pay nothing, since they use the company’s free Internet calling services (which allow users with Skype software to call other users with Skype software). Only about 2 million of those subscribers actually pay the company, for services such as SkypeOut, which allows users with Skype software to receive calls from anyone using a regular telephone. According to a recent interview Mr. Zennstrom gave to a Swedish newspaper, Skype brings in “a few dollars a month” from each paying customer, which would give the company revenue of about $70-million.

If you assume that Skype might fetch the same multiple of about 10 times revenue that PayPal got from eBay — and it requires a certain leap of faith even to get to that point — the Swedish company might be worth about $700-million or maybe $1-billion on the high side. It’s difficult to see how anyone could come up with $2-billion or $5-billion, however, unless it was a venture capitalist who was hoping to get a percentage fee of some kind from the deal. The point isn’t whether eBay has that kind of money or not; with cash on hand of about $3-billion and a market value of $52-billion, it could definitely afford it. But why?

Some observers and analysts argue that combining eBay and Skype would be a good fit, since eBay has been looking for ways of building its business — which has been slowing down of late — and it would be able to offer Internet phone calling services not only to its 155-million or so registered users, but also pay-per-call services to advertisers on its auction site. That’s all well and good, of course, but it doesn’t answer the question of why eBay would have to spend $3-billion in order to do that. Why not just sign a deal with Skype or some other VOIP provider?

When it gets right down to it, the main question is this: What does Skype have that is worth $3-billion? It doesn’t have any patents on voice-over-Internet calling (as PayPal did with on-line transactions), and it doesn’t really offer any services that any other company couldn’t offer. In other words, the business has virtually no barrier to entry. Google’s new Talk service, which combines “instant messaging” with voice over the Internet, could kill Skype just as easily as Google crippled AltaVista and others.

Voice-over-Internet provider Vonage makes substantially more money than Skype, because all of its million or so subscribers pay for its services (which allow calls to or from any phone and don’t require a computer). The company makes about $30 a month per subscriber — in other words, $30-million a month, or $360-million a year. That’s about five times as much as Skype makes. Does that mean Vonage should be worth $15-billion or $20-billion? Hardly.”

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