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Microsoft to buy Skype for $8.5 billion

Microsoft's acquisition of the Internet phone service Skype is the software giant's latest bid to diversify, but some analysts predict it will be a multibillion-dollar dud.

May 11, 2011|By David Sarno, Los Angeles Times

It could be the most expensive call Microsoft Corp. has ever made.

In acquiring Internet phone service Skype for $8.5 billion, the technology giant is seeking new ways to make money as its core computer software business faces a growing threat from a new generation of powerful mobile devices.

But some analysts believe the Skype deal, Microsoft's largest ever, could become a multibillion-dollar dud, as it once was for EBay Inc. The online auction site acquired Skype for $3.1 billion in 2005 but then sold most of its stake in the phone service after failing to wring a profit from it.

"The question is, what's the point here?" said James E. Schrager, a professor of entrepreneurship at the University of Chicago Booth School of Business. "They seem to be buying an interesting company to which Microsoft doesn't really add anything."

In explaining the purchase, Microsoft said it would weave Skype's Internet and video calling services into its Windows smartphone, Xbox gaming console, and Office e-mail and document software, allowing users to more easily call their friends and colleagues. Microsoft said it hopes to extract more revenue from Skype by showing users colorful advertising as they make calls.

Wall Street investors were not convinced, however, and Microsoft's stock lost about 1% in regular trading, falling to $25.67. The stock is down 8% so far this year, while the technology market overall is sharply higher.

If there was any obvious upside to the Skype deal, analyst said, it was that Microsoft prevented archrival Google from buying Skype. Although the search giant has for years allowed users to make Internet calls using its Google Voice service, it too was rumored to be interested in Skype.

"Did they pay a premium to keep it out of Google's hands? I'm sure they did," said Colin Gillis, an analyst at BGC Financial. But from Microsoft's perspective, he said, "imagine what would happen if this landed in the hands of Google. That'd be brutal."

One clear winner emerged from the deal. It was a big payday for the private investors who sold Skype to Microsoft after buying it from EBay 18 months ago. In November 2009, investment firms led by Silver Lake and Andreessen Horowitz bought a majority stake in Skype in a deal that valued it at $2.8 billion, about one third of what Microsoft will pay for it. Andreesen Horowitz is run by Marc Andreesen, who founded Netscape, a popular Web browser in the 1990s that was eventually eclipsed by Microsoft's Internet Explorer.

Skype was formed in 2003 by Swedish entrepreneurs Niklas Zennström and Janus Friis, who were also behind the Napster-like file-sharing network Kazaa. The service has grown to nearly 170 million users each month, making it one of the world's largest phone companies. Skype had planned an initial public offering that would have valued the company at $1 billion, according to Reuters.

But since Skype's founding and during the years it was owned by EBay, the company has had trouble making a profit despite its popularity and widely recognized name. In 2010, the largely free calling service recorded a net loss of $7 million on $860 million in revenue.

Skype is Microsoft's latest bid to diversify its business. For decades, the company has relied largely on sales of its Windows and Microsoft Office programs, which run on hundreds of millions of home and business computers around the world.

So far, Microsoft has had trouble breaking into other kinds of markets. Its Bing search engine accounts for about 13.4% of online searches, far behind Google's 65%, and Microsoft's Windows smartphones have not made a significant dent in the market now dominated by phones powered by Apple Inc. and Google.

Microsoft has also been criticized for its past acquisition efforts, including its high-profile 2008 bid for Internet giant Yahoo Inc. for $45 billion. That sale fell through, and three years later Yahoo is worth about half of what Microsoft was willing to pay. Analysts said Microsoft may have also overpaid in its 2007 purchase of online ad firm AQuantive for $6.33 billion.

"Unfortunately their acquisition track record has been spotty at best," said Brad Reback, an analyst at Oppenheimer & Co.

The success of the Skype deal may ultimately hinge on Microsoft's ability to keep Skype's most talented employees, he said. "I think it'll definitely be a challenge to retain the best and brightest. Microsoft is not the most exciting place to work at."

david.sarno@latimes.com

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