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Microsoft Buys Skype for $8.5Bn…? But Wait, There’s More!


by Russell Bennett, UC Insights

May, 2011

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Introduction

I admit that I was taken by surprise by this morning’s news that Microsoft had acquired Skype for $8.5 billion (yes, I wasn’t paying attention on Sunday when GigaOm got the scoop).  After the Skype IPO was put on hold there had been lots of rumors of Cisco / Facebook / Google being in discussions to buy Skype but I never heard that Microsoft was interested (and that was part of their plan, since they agreed the purchase price over 3 weeks ago).  However, now that I have woken up to this news, I think I have a perspective that most of the baffled financial/trade press have yet to latch on to.

The more I think about it, the more the voice of the late infomercial king, Billy Mays, keeps ringing in my head: “But wait, there’s more!”

So this deal makes perfect sense to me: let’s see if it makes sense to you.  From Microsoft’s perspective, Skype has a number of interesting attributes:

  • Brand

  • Network - 170m users

  • Technology: Voice, video, IM; all running in ‘the cloud’

  • Synergies

  • Worldwide PSTN origination and termination deals

  • Competitive strategy benefits

  • Intellectual Property portfolio

  • Luxembourg domicile

Brand and Network

In the modern vernacular, Skype is a verb: that is evidence alone of the value of the brand.  (I know that the marketing professionals are divided on whether this is a good thing for the brand or a bad thing for the trademark, but I will let them continue to battle that one out.)  Skype also has 170m registered users; although claims of registration for a ‘free’ service don’t directly translate to revenue, this is not a small number.  However, if you add in the following statistics you start to get a sense that the service is compelling:

final infographic image.jpg

Infographic by Skype

These statistics (which will have been audited by Microsoft, knowing what I do about their ‘CorpDev’ group) mean that the business has face value, but is there hidden value?  I think so, and here is why.

Technology

I said in my UC Cloud Implications paper that scale is going to become a problem with UC in the cloud; particularly the issue of latency and local network bandwidth at the data center.  Skype’s peer-to-peer technology for voice, video and IM&P neatly addresses this by distributing the load to the clients (even better than SIP does), theoretically making consumer/SMB cloud UC infinitely scalable.  If you combine Skype’s emerging SMB product (which was being developed by 3 former Microsoft executives and Jonathan Rosenberg) with the emerging Microsoft 365 cloud service, then you have a winner with cloud based UC.  Since both Skype and Lync use wide-band and internet-glitch-resilient codecs, the call/video quality will be much better than you will be able to get on any other service.

Synergies

There are clearly synergies between the Skype consumer service and existing Microsoft offers: Lync, Outlook, Xbox Live, Windows phone, Windows Live, Bing/search, the list goes on.  Lync, which already has multi-modal federation with the Windows Live community will get a massive lift by being able to offer UC connections between its enterprise customers directly with their value chain partners: this is huge in and of itself – I commented on this in my Federation paper last month.  Clearly Avaya had this idea first in announcing its partnership with Skype last year while both companies were owned by Silver Lake.  Since that service has not yet shipped, it will be interesting to see if it will ever ship (see 'Competitive Strategy' below).

A counter-intuitive synergy (for conventional thinkers), is the ability for Skype to ship on non-Microsoft platforms (Mac, Linux, Android, etc. even the ubiquitous home TV!….).  In the press conference this morning, Steve Ballmer stated that Skype would continue to support non-Microsoft platforms (they would be silly not to, IMHO) but in the Q&A session he was challenged on this again.  The ability for Microsoft to ship UC and other clients on popular platforms has always been a goal for Microsoft, but it was something that it a) wasn’t very good at and b) never got much help on from the platform owners (for obvious reasons).  Buying the technology expertise and the business relationships to enable cross-platform support is critical for Microsoft’s future success.  Furthermore, Microsoft’s dependence on Windows is something that draws heavy fire from industry analysts; so I am not sure why anyone would be incredulous about this part of the acquisition strategy.

PSTN Termination and Origination

Clearly, Skype has built an extensive list of PSTN origination and termination deals to support their Skype In/Skype Out service.  As I said in the Cloud UC and Federation papers, Microsoft is arguably building an alternative (UC) communications network with Lync and Microsoft 365 and needs to build those service provider relationships itself while rapidly being perceived as a competitor by those same service providers.  So gaining access to the Skype PSTN connectivity neatly solves both problems for Microsoft and is a major advancement of their cloud UC strategy.

Competitive Strategy

Clearly a big part of this deal for Microsoft was preventing Cisco / IBM / Avaya / Google / Facebook / whoever from acquiring Skype – the classic business school ‘double whammy’.  (Not to mention the threat of Skype for Enterprise becoming a UC cloud competitor.)  Of these competitors, only Google already has a credible consumer VoIP service; and Facebook now has to spend money and, more importantly, time in building a real-time communications service to support its truly enormous and vibrant social network.

As mentioned above, there is the possibility that this deal will allow Microsoft to kill the Avaya/Skype federation deal that was agreed late last year.  I am sure that Avaya had a contract for this and that Skype will be committed to deliver on it.  If for no other reason, both Avaya and Skype are owned by Silver Lake and they wouldn’t sell Skype to Microsoft without ensuring that Avaya wasn’t harmed in so doing.  Or would they?  Maybe this was part of the deal and was reflected into the sale price: only time will tell.  Without doubt, Microsoft will ensure that they delineate the Avaya federation to the Skype user community and will not allow Avaya users to federate with Xbox Live users, for example.

There is of course Skype as a stand-alone business and access to its user community is as coveted by other eCommerce ventures as it was by Microsoft; only now even more so.  I predict that many online businesses will be doing deals to use the Skype network in future and that the Skype business unit’s stand-alone P&L will start to grow quite handily.  Of course, this was the value that eBay saw in Skype in 2005, it’s just that they were not able to realize that value, for whatever reason.

[As a side note, the 35% that eBay retained in 2009 when they sold the majority stake to Silver Lake was then worth $1 billion: it is now worth $2.98 billion just 18 months later.  Although eBay took a $900 million write down on the Skype acquisition in 2007, that was just financial engineering.  eBay’s sale of Skype to Silver Lake in 2009 valued the company at $2.9 billion, which approximately what they paid for it.  So that makes the net profit for eBay on Skype, at today’s price, $2.18 billion ($2.98bn+$1.9bn-$2.7bn), excluding the tax benefit of the write down.  Meg Whitman took a lot of flak for the Skype purchase, but she has had the last laugh.]

Intellectual Property

Skype has 32 approved patents and 36 filed patents in the US on all manner of topics related to peer2peer and IP communications.  Given, as I said above, that peer2peer communications solves all kinds of UC scaling issues, and given that patent lawsuits against Microsoft are never less than $1 billion in damages, the price tag for this acquisition could be justified on the intellectual property inventory alone.

Luxembourg domicile

It has been commented in the financial press that Microsoft can unfairly use part of its $40 billion overseas cash pile to pay for Skype in Luxembourg while ‘avoiding’ paying US tax.  I think that this is a fatuous argument: all corporations use overseas money to pay overseas bills, it is just common sense.

However, the real pearl in the oyster with regard to the Luxembourg domicile is potentially the ability of Microsoft to side-step any future national regulation on IP communications (see my Cloud UC paper on this topic).  Clearly I am not professionally qualified to comment on international law or national regulatory jurisdiction, but it seems intuitive that regulation of a communications service that has an overseas corporate domicile (with a profoundly liberal business environment), not to mention a communications technology that doesn’t have any national physical premises, just got a lot more difficult.  Having said that, the Chinese government ‘switched off’ Skype in the PRC in January of this year; however, the Chinese are clearly willing to go that extra mile further than many other sovereign governments.

Summary

I think that there is a lot more to this deal than meets the eye and I give credit to the Microsoft leadership for pulling it off.  Of course, there is a gap between plan and execution so this deal may not yield the all of its intended benefits.  With only a few hours’ notice, the pundits can be forgiven for questioning the $8.5 billion price tag just because it represents a 350% profit for Silver Lake (and partners) in just 18 months.  However, Microsoft has had many months to consider all the angles and I suspect that they believe that they got a good deal.

According to the Gartner Magic Quadrant for UC for 2010, Microsoft was the leader in UC, followed closely by Cisco and Avaya.  The 2011 Magic Quadrant will make very interesting reading.


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