Rudy Burger
Posted on May 26th, 2011 · Posted in blog

May 26, 2011

Microsoft’s recent acquisition of Skype for $8.5 billion represented the largest buy to-date for the Redmond, Washington giant, and a number of observers have noted that Microsoft overpaid in an act of near-desperation.

Having been a leader in acquisitions over the last decade, Microsoft made no significant acquisitions last year, while Google acquired 25 companies in 2010. Feeling the squeeze between Apple on one side and Google on the other, Microsoft needed to start spending its mountain of cash (still almost $50B) on some game-changing acquisitions.

Skype, the recognized leader in voice and video over the Internet, has a user base of 663 million users around the world in an area that Microsoft has never quite gotten right. Outside of Xbox, the company has struggled in the consumer internet technology space. NetMeeting never caught on, and Microsoft’s Windows Phone 7 continues to trail in the rapidly growing smart phone market, well behind Apple’s iOS, Google’s Android and RIM’s Blackberry product lines.

But let’s not discount Bill Gates yet.

Reportedly, Gates championed the transaction at the board level, calling the purchase a “great deal” for Microsoft’s strategic visions. One of Skype’s key technical strengths is its ability to get through almost all corporate firewalls, which makes Skype and Outlook a nice pairing. Skype also fits well on Microsoft’s Xbox and Lync technology platforms where gaming and enterprise collaboration are converging, respectively. Integrating Skype into the Windows Phone 7 mobile operating system, however, may be the lynchpin of the deal. While Google Voice and Apple’s Facetime platform are emerging, Skype enables Microsoft to immediately deliver a more mature technology than its competitors.

On the sell side, Skype’s recent activity suggests that the transaction may have been necessary for long-term health. In an SEC file for 2010, Skype reported $860 million in revenue and a net loss of $7 million. From their 663 million users, the company took in $1.30 per user. For a company that size, those numbers are not viable over the long term. Some forecasts suggest that Skype’s revenues may have peaked.

Skype has been mulling an IPO for some time, and eBay, one of its previous owners, was reportedly anxious to cash out. Facebook and Google may have kicked the tires on Skype, but neither was considered a serious contender. Google Voice service is already deployed, and a pre-IPO Facebook simply did not have the resources to make a serious pitch.

Compared to Microsoft, neither company would have been appropriate. Skype’s struggle has been in building revenue outside of the corporate sector. While Google and Facebook have commanding positions in search and social networking, they don’t bring in revenue through subscriptions. Their ad-based revenue models may have reduced Skype to a widget. Winner: Microsoft, perhaps by default.

With a huge infusion of capital and a virtually bottomless well of resources now at its disposal, the sale to Microsoft serves Skype the strongest opportunity in the market to grow the company and brand.

In Microsoft, Skype has a partner with which they can face a mutual problem: how to gain share in the casual-use digital landscape. Having been passed through multiple owners before arriving at Microsoft, Skype failed to chart a clear growth path. Integration with eBay didn’t work. Video conferencing is compelling for business users, yet it seems less so for consumers; eBay users preferred the relative discretion of online transactions to seeing a stranger’s face in the computer. With this transaction, Skype may be acknowledging that in non-corporate segments, voice and video over the Internet is a technology component in a wider suite of services, instead of the primary offering.

Microsoft has served notice that, despite the costs, it will remain a leader among the software giants. Where Skype pops up in the Microsoft landscape won’t be known for some time, and how this great digital convergence finally takes shape remains to be seen. But Microsoft has indeed acquired a strategically and technically important piece.