About the only thing more shocking about EBay's (Nasdaq: EBAY) $2.6 billion acquisition of Skype Technologies SA is the fact that so many people missed out on it (see EBay Buys Skype for $2.6B).
Sure, a handful of VCs, including Tim Draper, Bessemer Venture Partners, Draper Investment Co., Draper Fisher Jurvetson, Mangrove Capital Partners, and Index Ventures, made out like bandits. But most of Silicon Valley – as has happened often with the largest-ticket deals – shunned this deal as too eccentric and expensive.
Yes, Skype is one of the most interesting VOIP companies. That's because its technology works really well, and it's based on a pure Internet architecture. Skype truly works "over the Internet" and is packet-based, so it doesn't require piggybacking a partner's circuit-switched PSTN system, as is the case with something like Vonage Holdings Corp. (see Skype Rules North American VOIP).
Silicon Valley has been allergic to telecom for years. So the question is, how did Skype draw money from its own Silicon Valley investors? The answer is that these VCs saw Skype, not as a telecom services place, but as a consumer Internet marketing play, which is exactly how it was sold to EBay. And consumer Internet vehicles are still very much in play in Silicon Valley.
Well, congrats to the VCs who had the cojones to do this deal and the foresight to see the exit strategy. But let’s examine whether this deal actually works as a consumer Internet play – and why or why not (see Is Skype Worth $3B?).
EBay and Skype say that Skype will report less than $100 million in revenue for 2005. But the companies say that more revenue is coming – as much as $200 million in 2006. At $2.6 billion, that means this deal is still enormously expensive, at roughtly 12 times next year's expected revenue. But let's face it: EBay is in search of new users, and the metrics really expected to support the deal are its use as a vehicle for marketing and consumer acquisition, with EBay paying $48 per Skype user.
Those metrics just don’t work.
On the Internet, we learned long ago, valuing a company based on registered users, or even extrapolated revenues and non-existent profits, is a recipe for disaster. Take, for example, Time Warner buying AOL. In most cases, the user data is thin, and many of the users are, if anything, non-existent. They do not equate in any predictable way to a future stream of revenue.
Here’s an example: I am a Skype user. I like Skype. It’s a good product. I’ve registered two Skype handles. So, actually, EBay has just paid $96 to “acquire” me as a user (since I’m really two “virtual” users). But here’s the real catch: I’m also already registered on EBay, which I’ve used a grand total of twice during the past year. I also have a PayPal account (PayPal is owned by EBay). Now that EBay has acquired my two Skype accounts, after they’ve acquired my PayPal account, does that mean they have now acquired me four times? And through those acquisitions, have they generated four times as much revenue from me on EBay? I don’t think so. Will I use SkypeOut? Possibly, though I haven't yet.
The other question: How many of these Skype users are backpacking student types, drinking beer on an Adriatic beach and using Skype in Internet cafes to phone home for free? Are they the kinds of people who are ready to start generating all sorts of revenue on EBay? How many of them are criminals who like Skype because they can’t be wiretapped? How many terrorists use Skype? Do the terrorists using Skype buy things on EBay?
I would love to see the data on Skype users that was exchanged during the acquisition negotiations. I can’t imagine it matches up to even the weakest data from a monthly consumer magazine, a business that often depends on consumer acquisition. This is, after all, a product that is mostly free and even grants the user the benefit of anonymity, if he or she pleases.
And what about Google’s VOIP product? Or AOL’s? Or Microsoft's? Are they really that far behind Skype? (See Yahoo Enters VOIP Fray, Google Talks the Talk, Poll: Google Talk Heard Over Skype Hype, and Researchers Vet VOIP's Value.)
If there is one thing I learned during the bubble, it’s that common sense is common sense. And when it appears that folks have taken leave of their senses and overpaid for something... they have.
There are other risks associated with EBay's entrance into the telecom market, some of which I mentioned last week. The U.S. government will want wiretapping capabilities in place for Internet telephony. And Internet telephony is almost certain to encounter some sort of regulation in the future. Will this scare away some Skype users, and is EBay prepared to invest in a regulated Internet telecom business? (See China De-Skyping?)
The best Internet businesses in the past few years have been marked by a return to the fundamentals. Take Google, which waited many years before it had the business model and had billions of dollars in revenues and profits to back up its valuation in its spectacular IPO. Then there’s Yahoo’s acquisition of Overture: Again, there were revenues in the billions and profits in the hundreds of millions of dollars to back up the deal.
Skype is a great service and an excellent product, but it's a product in a market that will be plagued by thin margins and intense competition. We wish them well. But I would sell EBay stock if I had any. However you look at it, $2.6 billion for $100 million in revenue does not add up.
— R. Scott Raynovich, US Editor, Light Reading