Is Skype for sale?

Experts say that Skype is a bright spot in eBay's portfolio, and it will take a hefty offer for the company to sell.

eBay/Skype

Comments from eBay's CEO have sparked speculation that the online marketplace may be looking to unload Skype. But any suitor that comes knocking on eBay's door will likely have to pay a hefty price tag for the Internet phone service.

The Times of London reported Monday that John Donahoe, chief executive of eBay, described Skype as a "great standalone business" on a conference call last week with investors after the company reported disappointing fourth-quarter results.

The news has left many in the industry wondering if eBay will put Skype, which it paid a hefty $2.6 billion to buy in 2005, on the auction block. Donahoe had said last year that eBay would consider selling the business unit if it couldn't be integrated with its auction or PayPal payment system.

And according to statements made during the conference call, it looks like Donahoe doesn't think there is much the Skype technology can do to help eBay's other businesses. When asked what eBay was doing to add shareholder value to Skype, Donahoe admitted that "the synergies between Skype and the other parts of our portfolio are minimal," the paper said.

So is eBay looking to unload Skype? The answer is probably yes and no. Because Skype isn't core to eBay's online auction business, experts believe that eBay would be happy to let Skype go, at the right price. But Skype, which just posted a 26 percent gain in revenue for the fourth quarter compared to a year ago, happens to be one of the only bright spots in eBay's overall business, which means that eBay isn't desperate to let it go.

"Skype is not a drag on eBay at all," said Jim Friedland, senior Internet equity analyst for Cowen and Company. "In fact, it's one of the fastest-growing assets the company has right now. But I'm sure the company would sell it if they could get a hefty premium for it."

Indeed, eBay reported that its overall net income for the fourth quarter fell more than 30 percent compared to the same period last year, marking the first time ever that the company has seen its year-over-year earnings drop. It was also the second quarter in a row that the company saw the total value of all goods sold on the site fall, suggesting that the company's core business is struggling.

Meanwhile, PayPal and Skype, eBay's other two main business units, grew during the fourth quarter. PayPal revenues were up 11 percent to $623 million. And Skype's revenue grew 26 percent to $145 million.

Skype has also been adding new subscribers at a rapid pace. Scott Durchslag, the company's chief operating officer, told reporters at the Consumer Electronics Show this month that it's been adding about 30 million subscribers a quarter. It now has 370 million registered users worldwide. And these users are making lots of phones calls. Today, about 8 percent of the world's voice minutes originate from a Skype call, he said.

All told, Durchslag said Skype has been growing about 50 percent compared to the previous year in almost every metric--from minutes used to new subscribers to revenues. He also said the company just had its seventh straight quarter of profitability.

Because of this growth in Skype, eBay has little reason to sell Skype at this point. It could hold onto the service and run it as a separate business and still generate revenue.

But, of course, any business or asset is for sale for the right price. But the price that a potential suitor would have to pay for Skype is probably too high.

Three years ago, eBay paid $2.6 billion for Skype. There's no question now that the price tag was too high. In 2007, eBay said it would take a $900 million so-called impairment write-down against the value of Skype. This means that eBay has been forced to reassess the value of the Internet telephony company relative to its overall business today. By recording a charge, the company is essentially saying that it has taken a loss on its original investment.

A "peak" in value?
Based on its current financials, the highest price that eBay could hope to get for Skype is about $1.6 billion, Friedland said. And he said that would be a generous offer. eBay itself has valued the Skype assets on its balance sheet at $2 billion, so it's unlikely the company would accept a lower figure, Friedland surmised.

Friedland also said the inflated price tag that eBay paid for Skype is already built into eBay's stock price, which means the company is under no pressure to sell off a bad asset.

"I'm sure eBay's shareholders probably think that money could have been better spent on something else, like paying them dividends," he said. "But that's water under the bridge at this point. Going forward, Skype doesn't really hurt the value of eBay."

In addition to the slumping economy, there are other reasons why potential suitors would likely not be willing to pay a premium for Skype.

For one, the strategic value of Skype today is not what it was three and a half years ago when eBay bought it. Today, the three major Internet and search companies that might be interested in Skype--Microsoft, Google, and Yahoo--already have comparable messaging services, including instant messaging and voice and video calling. So from a technology standpoint, Skype doesn't offer anything that the other companies don't already have. Even phone companies AT&T and Verizon Communications already have their own flavors of voice over IP technology.

So an acquirer would likely be buying Skype for its 370 million registered users, which is nothing to sneeze at. But the big question is how much money can be made from these users? Sure, people love using Skype's free services, but most of its revenue is made from a small portion of its users. Skype generates most of its revenue from its SkypeOut service, which charges users to make calls from the Skype service to regular landline phones and cell phones.

The SkypeOut revenue stream is sufficient to sustain Skype's business model today, but as IP networks are deployed throughout the world and all communications becomes IP-enabled, there will be fewer opportunities to make money from connecting Skype calls to the regular phone network. What's more, as Skype adds more subscribers, those users are more likely to talk to one another over the free Skype-to-Skype network rather than paying to call these friends and family on regular phones. Of course, it will likely take years for this scenario to play out, but this fact could color a potential acquirer's willingness to pay a premium for the service.

"As more people adopt Skype, there's potential for the asset to peak in value," Friedland said. "It won't likely happen for another five to eight years. And unless Skype comes up with a new meaningful revenue driver, it could start to decline."

Skype doesn't plan to sit around waiting for its business model to wither. The company sees mobile phone applications and video as big components of its future strategy. But again the question remains: How will Skype monetize these services?

Skype is also looking to make a push into the business market.

"We're seeing a whole new opportunity in the business market, as companies that I'd never have thought would be a target for Skype are proactively coming to us and asking for a solution," Durchslag said at CES earlier this month.

Most likely suitor: Microsoft
Despite all these factors, there is still a possibility that a company or two might be interested in buying Skype. Friedland said it wouldn't surprise him if Microsoft made a play for Skype.

"We view Microsoft as the most likely candidate to acquire the Skype assets," he said. "Microsoft would probably be doing this to strengthen its Internet position and to buy market share."

He pointed to other deals that Microsoft has done lately that are geared more at grabbing market share than scoring profits. He used the recent mobile search deal with Verizon Wireless as a prime example . Microsoft has signed a deal with Verizon to become the default search engine on all Verizon Wireless phones. As part of the deal, Verizon agreed to pay a minimum of $400 million. But Friedland said he doesn't think Microsoft will make much more than the minimum revenue on this deal.

"Microsoft has been very aggressive about making deals," he said. "So for them it might be all about buying market share."

One thing is clear: Skype has already won substantial name recognition. Even Oprah Winfrey is a fan of the technology and uses the video service often on her talk show to interact with guests who can't be in her studio. She also uses it to connect her book club members with authors and to facilitate chats. And as we've seen in the past, Winfrey's endorsements carry a lot of weight. Just ask Barack Obama.

 

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