Microsoft’s Call on Skype: Profits, $0; Value, $8.5 billion

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A million years ago, Microsoft was a late arrival to this thing called the Internet. And it seems that the company has never ceased trying to play catch up in the various business segments the web has spawned. Search, games, email, commerce, news, advertising, social networks—you name it and the warriors of Redmond have been chasing it, aping it or buying it in their effort to close the gap with sector leaders such as Google, Apple or Facebook, or eBay. Microsoft’s announcement that it is buying Skype, the voice over internet protocol (VOiP) provider for $8.5 billion in cash is its most expensive effort to reduce that gap and get closer to consumers. “Skype is a phenomenal service that is loved by millions of people around the world,” said Microsoft CEO Steve Ballmer in a statement. “Together we will create the future of real-time communications so people can easily stay connected to family, friends, clients and colleagues anywhere in the world.”

Microsoft is certainly not a company that is loved by people around the world, so in buying a popular outfit such as Skype, Microsoft will be able to have a bigger part in the multichannel, multiplatform world in which we live.  Skype brings 170 million users to the party, and they are a chatty bunch: they racked up 207 billion minutes of voice and video traffic last year. Think of Skype as a giant switchboard for Microsoft, which will now be able to plug in users into all kinds of Microsoft devices.  The company says Skype will support Xbox, Kinect, Windows Phone and will connect Skype users with Lync, Outlook, and Xbox Live.

Microsoft will also be trying to do what one of Skype’s former owners, eBay, could not: earn a profit. Skype has never made a dollar. One of the reasons people won’t shut up on Skype is that most of them pay nothing, since computer to computer communications costs zilch. Skype was founded in 2003 by the guys who created the file sharing system Kazaa—you know, the one you used to pirate music. It was a disruptive technology to say the least, but a business model based on charging zero is always going to pose some difficulties. Skype was acquired by eBay for $2.6 billion in September 2005, which figured it could take this rogue company and reform it for better use by eBay customers, who obviously were exchanging tons of pictures and other data as they bought and sold goods. But eBay boss Meg Whitman admitted defeat in 2009, unloaded the outfit on Silver Lake and took a big write-off.

The lesson here is about timing: get into an emerging technology too early and you might not be able figure it out before the shareholders start to get restless. eBay’s parting gift is that it retained 30% of Skype, a holding worth about $2.5 billion based on the purchase price. So it is roughly breaking even on the deal, but that’s not accounting for the vast amount of opportunity cost and management time that Skype absorbed.

The reason Microsoft is still in the hunt, of course, is about timing, too.  Windows and Office, products whose development coincided brilliantly with the PC boom of the 20th century, are still spinning money. So while Microsoft is paying a premium for a business that still has no earnings, it has about $50 billion in cash on hand, meaning the purchase shouldn’t be too difficult to absorb.