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Why Skype is perfect for Cisco

Skype and Cisco Systems could be a match made in heaven. Cisco is reportedly courting Skype, which plans to go public sometime this fall.

If I were a technology acquisition matchmaker, I'd definitely set tech giant Cisco Systems up with Skype.

The companies complement each other so well, it seems as though they'd be a match made in heaven. In fact, I'd argue they are much more compatible than Skype and eBay ever were. eBay acquired Skype in 2006 for $2.6 billion.

Apparently, I am not the only one who thinks that Cisco and Skype should get hitched. Cisco has reportedly already made a bid for the company, according to TechCrunch. The two companies are keeping mum on the rumors.

One of the biggest dilemmas the online auction site eBay had with Skype was figuring how to successful work the technology into its core business. At the same time, eBay also wasn't able to make Skype's own business model profitable enough to justify its huge expense.

eBay and Skype eventually broke up. eBay sold off its controlling stake in Skype in late 2009. And earlier this month, Skype filed for an initial public offering with the Securities and Exchange Commission.

By contrast, Skype's business and technology would fit nicely into Cisco's existing product line. In fact, Cisco wouldn't have to make Skype's traditional business model, which generates cash mainly from its Skype Out service, profitable to still make an acquisition of the Skype technology a huge success.

"Embedding the Skype technology into some of Cisco's existing products, like WebEx and Unified Communications, will only make those products more valuable," said Zeus Kerravala, a senior vice president with Yankee Group. "So they wouldn't necessarily have to make the traditional consumer Skype service hugely profitable."

Video is key
Cisco is all about video these days. In fact, that's all CEO John Chambers can talk about. At a recent event in New Jersey, Chambers said video is quickly becoming the killer app of all IP networks, including the Internet itself. With each new evolution of TV, the applications consume more network resources. And this feeds Cisco's business, as well as other businesses.

"Video is today's voice-on-an-IP network," he said.

So it makes sense that Cisco would want one of the largest online video conferencing applications on the planet as part of his empire. Skype claims that 40 percent of all its calls made through its software are for video chat.

The most natural and easiest place to integrate the Skype technology into Cisco is in Cisco's WebEx conferencing service. WebEx is a leading collaboration tool that allows businesses to share documents and communicate online with one another. Skype video and voice integrated into that service would take WebEx's service to a new level. Many businesses large and small are already using Skype video anyway.

Skype technology could also be a nice complement to other Cisco products. For example, Skype video would also fit nicely into Cisco's other corporate unified communications products providing a video element to the voice over IP calling and presence applications. It could also be used to bring Cisco's telepresence video conferencing service to the masses.

Cisco has been selling its high-end videoconferencing equipment to large companies for the past few years. And in January at the CES show in Las Vegas, the company said it would be testing a consumer version of the product that offers a similar video conferencing experience at home. The telepresence system will use consumers' existing high-definition TV sets and broadband Internet connections.

Adding Skype's video technology could help Cisco drive down the cost of the service. Skype would also give Cisco an instant user-base of at least 124 million active users.

"Even if Cisco could make comparable technology to Skype's video service, Cisco would still have to get millions of people to switch from Skype to the Cisco service," said Kerravala. "So it could be an uphill battle. Why not just acquire?"

Skype could also benefit by hooking up with Cisco, one of the most cash-rich and stable companies in the tech sector. Since separating from eBay last year, Skype has actually begun to turn a profit. In the first six months of 2010, Skype reported revenue of $406 million, and net income of $13.2 million, according to is SEC filing. Compare this to all of 2009. Then Skype had sales of $719 million and a loss of $99 million. Skype said in its SEC filing that it expects revenue to increase through new deals it has struck with Verizon Wireless and television makers, such as Samsung and LG.

But even with new deals in the works, Skype's revenue stream is still predominately tied to one service: SkypeOut. This is the Skype service that allows users to call regular phone numbers from their Skype account. Considering that only 8.1 of its 124 million active users are actually paying customers using this service, the company's revenue stream is somewhat precarious.

As a part of Cisco, Skype wouldn't have to worry if its traditional consumer business stumbled. Unlike eBay, which couldn't find a good fit for Skype's existing business, Cisco could still benefit from Skype's free consumer services even if it made little to no money. Skype has a total of 560 million registered users worldwide, with 124 million using the service every month. That is a lot of eyeballs throughout the world that could associate Cisco's brand with making Skype calls.

Cisco has been trying to break into the consumer market for years. It sells the Linksys brand of routers and last year it acquired Pure Digital, the maker of Flip video cameras, for $590 million.

At the end of the day, Cisco's main business is still selling switches and routers that shuttle traffic across corporate networks and around the world via the Internet. Video is the most bandwidth intensive application out there. And anything Cisco can do to drive more video usage is money in its pockets. That is why a Skype acquisition makes sense as did the Pure Digital acquisition.

A price to pay
The potential price tag of a Skype acquisition is nothing to sneeze at, but it shouldn't be a problem for Cisco. Some reports suggest that Skype is looking for a valuation of $5 billion, which means Cisco would at least have to match that for Skype to even consider accepting its acquisition proposal.

Cisco has spent that kind of money for other acquisitions. In 1999, it spent nearly $7 billion on optical networking start-up Cerent. In 2005, it bought TV set-top box maker Scientific Atlanta for $6.5 billion. And in 2006, it paid a cool $3.2 billion for WebEx.

In other words, Cisco has proven that it will pay top dollar for strategic assets. And Skype is at least as, if not more, strategic than many of Cisco's hefty acquisitions of the past.

The only potential snag is that if Cisco were to acquire Skype, it would then be in direct competition with some of its biggest customers, phone companies such as AT&T and Verizon Communications. But Kerravala doesn't think that is a big worry for Cisco.

"It definitely puts Cisco in a more competitive position with some of its customers," he said. "But the market is moving toward VoIP anyway. And there are just so many synergies between Skype and Cisco."