MSFT

[S2S]

Investmentacc,

 

The keyword in your post, from where I sit, is "free". No doubt Skype would love to charge a pretty penny, but that's unlikely as long as MSN/Yahoo/AIM/Gchat etc etc offer (almost) the same capabilities for free for the foreseeable future.

 

As given2invest already said, the 30 something EBIT multiple is reminiscent of the dot-com bubble...

For all its promise, Skype has had a mixed history as an operating business. It has produced little net profit in the eight years since it was founded. Profits continue to remain elusive as the company expands its business world-wide. Last year the company posted revenue of $860 million and $264 million in operating profits, but still had a loss of $7 million. The company had $686 million in long-term debt as of Dec. 31.

 

Read more: http://online.wsj.com/article/SB10001424052748703730804576313932659388852.html#ixzz1Lv5NF2uX

 

... yet some folks still criticize MSFT for buying back shares  ::)

[ragnarisapirate]

VAL9000,

 

Yes, there's a good chance much of my knee jerk reaction would be proven wrong as we learn more about the deal (which value, btw, DealBook put at $8.5B, so debt assumption is likely involved), but here're a few quick thoughts:

 

- MSN already features a robust voice/video calling platform, hence I'm guessing MSFT is mostly paying for the membership base and talent. Feel free to do the math (which, btw, I rather enjoy in our previous debate) on the former, but it seems like a rich price no matter you cut it. The latter factor is far harder to measure; I imagine though, facing a choice between (a) cashing out after their lockout periods and possibly joining other hot startups and (b) working their way through the massive corporate structure at MSFT, many wouldn't think twice.

 

- Again, the same deal could have been done two years ago for less than 30% of the new sticker. MSFT was just as flushed with cash, and eBay was a (almost too) willing and motivated seller. Why now? Is the economics of consumer* voice/video calling 3 times better than it was back in '09?

 

* I think it's important to make this distinction. MSFT/Skype might pose a threat to commercial players like Polycom or Cisco over the long term, but it'd be another uphill battle facing the Tech giant.

 

To be fair, many deals could have been done for less than 30% of sticker... Look at Dollar Thrifty Auto! Not saying that these 2 are good deals, but, everything looks like a good deal 2 years ago, when compared to now.

[Liberty]

I just hope they won't screw skype up.. I use it everyday (and I pay yearly for SkypeOut).

[Guest VAL9000]

Some quick thoughts to ruminate over:

 

- Brand - "Skype me" is a popular term.  Nobody says "MSN IM Video Chat me" or whatever the term is.  So there's definitely value there.  How much?  Less than 8.5 bills for sure.  More than zero.  How do people value brand anyway?

- User base - I think the facebook:skype user base comparison is somewhat valuable but the value of a user in skype is much lower than a value of a user in facebook.  1/10th the value would put these companies in line, but that's probably still a dear valuation for these users.

- As an LD operator...  skype is the biggest LD operator in the world.  They connect something like 10% of the world's LD calls.  Not sure how valuable that fact is, but it's interesting.

- I doubt the talent here exceeds the average.  All the brains behind Skype left ages ago.  This isn't a hot start-up.  This company has been put through the wringer.

 

I'm chewing on a thesis but it's not ready for prime-time public skepticism... yet.

 

[Guest VAL9000]

Brilliant decision to allocate capital and compete with Google.

Do I detect a hint of sarcasm?  I don't think this has that much to do with Google directly.  Google's participation in voice barely registers.  It's related to something else...

 

8.5 is super pricey, though.

 

Here's a great way to monetize skype, though.  Contextual on-screen advertising based on what people are talking about.  Kinda like those ads next to gmail.  The tech is there and people will accept the intrusion *if* the free service is good enough..  interesting idea anyway.

[alwaysinvert]

- I doubt the talent here exceeds the average.  All the brains behind Skype left ages ago.  This isn't a hot start-up.  This company has been put through the wringer.

Well, the founders (Friis and Zennström) still have part ownership. And from what I hear, a job at Skype is really attractive and they have a rigor in their hiring process almost approaching that of Google, which would suggest high supply of labour... I think you are wrong here.

[prunes]

The press release this morning specifically talks about the potential of porting skype to Windows phones. This idea I love. The notion the telcos promulgate that voice and data service are different is so false. It's all data! It's inevitable IMO that eventually they will be treated equally.

[DCG]

yeah...building into Windows phones is where the potential is. Otherwise, Skype has built a good brand, but not really one people want to pay for.

[Guest VAL9000]

Well, the founders (Friis and Zennström) still have part ownership. And from what I hear, a job at Skype is really attractive and they have a rigor in their hiring process almost approaching that of Google, which would suggest high supply of labour... I think you are wrong here.

I definitely could be.  My talent model is that once you get beyond 50-100 people in your tech company, you start to approximate a normal distribution of talent.  There are hot startups who defy this rule, but if they are taking only top 10%, the bottom 10% need to end up somewhere.

 

Are you saying that Friis and Zennström are part of the deal? (Kudos on the use of a umlaut, btw..)

 

WP7 integration is a great idea, but it seems like a partial answer.  I'm wandering off into thoughts on mobile, data vs. voice, and cloud services. 

[S2S]

The folks at GigaOM have done a great job of covering this story since the start:

http://gigaom.com/2011/05/09/why-microsoft-is-buying-skype-for-8-billion/

 

If Google's best bid was indeed $4B as rumored, well, you can draw your own conclusion on the purchase price...

[DCG]

-Seems like there are a ton of better companies out there that they could've bought for $8 Billion.

 

-Microsoft probably could've just replicated Skype's technology in a couple months using a few of their developers.

 

Yes, they are gaining Skype's users, but those users are people who except the service to be free.

 

As a shareholder of both Apple and Google however, I greatly appreciate everything Steve Balmer has done to run Microsoft into the ground.

[txlaw]

This was not an unexpected deal. 

 

MSFT knows that in order to compete with Apple and Google to be the platform layer for our Internet-connected devices, it must integrate over-the-top audio/video conferencing into its offerings.  It already has such software, but this will give MSFT increased traction.

 

For those of you who insist that MSFT has an enterprise moat (I believe that they will/are facing strong attacks on both the business software and business OS moats from GOOG and AAPL, which at the very least is decreasing margins), this acquisition likely bolsters that assertion.  Skype will be incorporated into Microsoft Lync and will be included in all MSFT OS's (including Win Phone).  I wouldn't be surprised if MSFT communications services are consolidated into the Skype brand.

 

As to the high price, that simply reflects the fact that MSFT is a slow moving, bureaucratic behemoth that often must buy great ideas/technologies/people at high prices.

 

Facetime and Google Voice, meet your new competitor: MSFT Skype!

[StubbleJumper]

Hmmm...  MSFT share price is down ~2% over the past day or so, which would equate to ~$4B of market cap.  IMO, that's a pretty harsh message from the market when you announce a $8B acquisition that your market cap drops $4B.

 

SJ

[cashisking]

I think the fact that skype is based overseas had something to do with it. Isnt a significant portion of MSFT cash outside of US (and hence cant be efficiently paid out)?

[DCG]

Hmmm...  MSFT share price is down ~2% over the past day or so, which would equate to ~$4B of market cap.  IMO, that's a pretty harsh message from the market when you announce a $8B acquisition that your market cap drops $4B.

 

SJ

 

yeah...even down $4 Billion, it's going to take a long time for Skype to earn $4 Billion in revenue. That $8 Billion was arguably more valuable as cash.

[rjstc]

  As to one possible thought of what to do with this investment. What if You put an ad which shows up when you first log into Skype. How much revenue could be generated with that? The infrastructure is already in place. Anything else could be extra. Newspapers ran losses on operations for years and made money on advertising. Microsoft looks to have overpaid but with this many Skype subscribers it seems possible there are a lot of potential synergys.

 

  Also it's not like they have permanently harmed the company. It's like what 2/3 yearly cash flow which is a one time event. If they gave Skype away for free they still have the cash flow coming in like they did before if they do nothing else. Skype isn't making money yet but it isn't losing hugely either. Many companies have one time events that temporarily hurt profits but are one time events like this. Maybe a dumb waste of money but only time will tell about that. One of those cup half full versus cup half empty situations. 

[Myth465]

http://www.gurufocus.com/news/132189/microsoft-buys-skype-for-85-billion

 

My thoughts expressed far more clearly.

 

With the Skype deal, I'm left to value eyeballs, synergies and future expectations – three things I'm decidedly poor at deciphering or putting a number on. In the end, management better present a pretty convincing argument for why Skype, and why now.

 

Not in the comments area an update relating to the conference call.

[txlaw]

In my view, it is best to view this deal as a "maintenance acquisition."  It is simply something MSFT had to do in order to ensure that it doesn't get destroyed or substantially weakened by GOOG, AAPL, and others going forward. 

 

Investors who simply back out the entire net cash + investments position in order to calculate earnings yield are being imprudent.

[Guest VAL9000]

I spent a lot of time on the subway today (Myth - that was for you) and I spent most of that time thinking about what Microsoft is doing buying Skype.  Before I get into my thoughts on where I think Microsoft and the world are headed, I want to sum up some thoughts on the purchase price.  This is an expensive asset and not addressing that would make for some irresponsible analysis.

 

First off, I think they overpaid.  Not because they're unsophisticated investors, but because there's a slew of asymmetric information that favours the seller.  Usually, acquisitions occur after an IPO (market sets the price) or well before an IPO (illiquid market sets the price).  In this case, Skype had already prepared for an IPO, has been sold a number of times, and is owned by some pretty damn sophisticated sellers.  Not only are they more experienced (having sold the company three times), they also knew what the bankers involved would set the price at, plus the prices they had shopping the deal to Google, Facebook and possibly others.  Skype reportedly rejected a deal with Google at $4bn, which I heard was their preferred landing place.  Based on that information and the stock dropping by about 1% today, I'll guess that Skype's market price should be somewhere between $4.5bn and $6.5bn.  If we settle on $5.5bn then MSFT overpaid by $3bn.  This isn't chump change, even to Microsoft, and therefore I believe that these guys see value beyond what the market and what other players see.  It just has to be that way.  Right or wrong, they see it and the market doesn't.  Who is right, we'll have to wait and see.  (But I'll note that on the subject of losses, if they were projected to continue then Skype's $100mm initial ask seems undersized.  Just some food for thought.)

 

Some credit to some good ideas on this thread regarding what MSFT Skype is going to be about:

- txlaw hit pretty close to home on my initial thoughts by mentioning Lync, which would benefit from integration to Skype.  Lync = server for email, chat, video conferencing, etc. all rolled into one package.  It's Microsoft's "unified communications" offering.

- prunes - introducing the windows phone port was a great contribution.

- Investmentacct - the facebook users comparison is really useful, too.  Skype and Facebook were both started within a six month period, so Skype's user growth has somewhat lagged Facebook's, but is impressive no less.

 

Ok, so those thoughts and a bunch more have given me some interesting ideas on how the world could shape up.  And as Smazz mentioned, some of us are thesis writers, so I'd hate to disappoint...  Here's a few axioms that are required for this thesis to be even close to right:

1. Voice as we know it is going away.  We've seen the death of the land line, but my view is that we're also going to see the death of the voice plan, too.  As wireless networks get faster, the relevance of voice as a carrier feature will continue to diminish.  Voice as a carrier value-add will be supplanted by network speed because network speed is what will let you stream movies and video calls to your device.  In other words, voice is so last century, data is where it's at.

2. The highlander principle applies to all closed networks.  I mentioned in previous posts that when it comes to platforms (and networks, usually), there can only be one.  Essentially, the biggest network wins.  Facebook is like this - it destroyed myspace.  Myspace destroyed friendster.  Something could destroy Facebook, but they only have one more order of magnitude to grow before they've reached 100% of their potential market penetration, so not likely.

3. Closed networks will never be interoperable (without a charge).  e.g. I can't Skype your Google Voice account.  I can Skype out to your phone network but I have to pay.

 

Now on to the show.

 

Today's trend in cellphone telephony is away from voice calls and towards cheaper / free methods of communication.  Users in the business and consumer worlds are rapidly changing their behaviour to take advantage of offerings such as Skype and FaceTime.  Personally, my 200min phone plan gets about 15 minutes of use per month.  All of my friends and family calls are made using Skype.  Currently, I don't use Skype outside of a WiFi zone because the data aspect is cost prohibitive.  Given that data plan prices are rapidly decreasing as the supply of wireless bandwidth rapidly increases, I see this as a short-term reality.  If voice doesn't budge on cost but data becomes much cheaper, all of my calls will be made through the Skype network or through Skype-out to a regular phone network.  I believe that I am a rational person, and that other rational people will act similarly.  Verify it for yourself - ask around to see who uses Skype more now and voice less.  A negative proof of this is that my fiancée, who I believe to be irrational at times, wants us to shell out for a land-line.  Fat chance.

 

Anyway, Skype, as you can probably guess, is the biggest closed network provider of voice / video communications services on the internet.  600mm+ users is nothing to sneeze at.  And the growth is blazing fast, too.  Skype has no free interoperability capabilities, and I don't think that it ever will.  I believe the thesis for Microsoft's investment is to own the biggest and potentially only provider of P2P voice / video services.  Assuming Skype can capture something like 1bn users, it will be very difficult to dethrone.  Why would I use service X, when Skype already has free connectivity to everybody else I know and talk to?

 

Skype is on one hell of a trajectory.  The client is available on every smart phone platform.  It's available on every operating system except QNX :).  It's reliable, it's useful..  there's really not much to complain about it, except that it cost $8.5bn. :P

 

The main idea I'm working towards is that Skype as a voice/video network could handily become the only voice/video network (incl. traditional voice) that anybody uses.  Penetration into the consumer market is proven.  Penetration into the business market is imminent under Microsoft and it will be _extremely_ valuable to businesses and to Microsoft.  i.e. Microsoft does Google Apps, but offers Skype as part of this.

 

Anyway, there's a lot more to say, but I end with stating that this is just one step further in the direction of Microsoft moving everything they possibly can to cloud delivery and services.  Paired with mobile, this is the biggest shift in computing we've witnessed* in decades.  I'm happy to see Microsoft moving on it in a big way and I don't see a $3bn overpay as a major concern given what's really at stake.

 

S2S and Shalab - I eagerly await your responses :P

 

*Excluding those of us who are too young to have witnessed the last one.

 

[farnamstreet]

Sergey Brin commenting on Google possibly buying Skype when it was a fraction of the price Microsoft is paying "This is the dumbest shit I’ve ever seen." This is out of the book that Charlie Munger recommended, by Steven Levy, In the Plex: How Google Thinks, Works, and Shapes our Lives. A great read.

 

Levy's post on the subject is here.

[S2S]

As the discussion shifts away from software and into TMT, where the duty with my current employer creates a possible conflict of interest, I won't delve into details. There are a few things your thesis (and quite a few others I've seen today that also hint at MSFT's bypassing the traditional carriers) do not address:

 

1. It's a mistake to believe cellular bandwidth is or will become inexpensive to deploy. Every time the government put up a dozen MHz or so of spectrum on the block, bidding ends at $1B+. AT&T's shelling out $35B+ for T-Mobile US and in the process taking on significant regulatory risk of ramming the deal through the DoJ and the FCC, Clearwire and Lightsquare's having any value at all despite being massive capital sinkhole; it all goes back to the spectrum landgrab. Ask yourself why Sprint's CapEx is going up 50+% year over year. All that while over the air Netflix, video calling etc etc are still far from mainstream.

 

Remember the good old days of across the board unlimited data plan? I'm 99% sure that'll go away once LTE deployment finishes.

 

2. Wired data can also get expensive, quickly. Ask yourself why Comcast, TWC, AT&T, Verizon et al argue so strongly against net neutrality?

 

3. Last but certainly not least, regulation, regulation, regulation. Since cable companies recently moved voice calls over to VoIP for the most part, regulation (google "USF/ICC reform") that would govern, among other things, some of Skype operations, is being written. And that's only a small small part of the whole regulatory picture.

 

Back to MSFT, a topic which I have more leeway to discuss, I do find the valuation tempting, even if my attempts to poke holes in others' bull thesis might suggest otherwise. However, at this juncture there're too many moving parts for my taste and MSFT's track record at execution doesn't necessarily inspire confidence. It seems like a "show me" story at least for the near term.

[Guest VAL9000]

S2S,

 

Absolutely the main argument hinges on the idea that wireless data pricing will drop over time.  I wouldn't argue with your points 1&3 because the subject matter is totally out of my realm, but it seems to me that the trend has been increasingly more data for less, regardless of hardware configuration.  Five years ago my BB data plan cost me something like $.01 per kb downloaded.  Now my monthly plan is rated at $.000004 per kb.  But for point 2 I'd say outsize profit motive more than anything - if data is so pricey, raise prices.

 

You're right, we'll have to wait and see where the cost of data lands for both wireless and wired hardware configurations.

 

Poking holes is the reason why I spend significant time developing ideas and posting them here.  I know I have blind spots in my analyses - I just hope that they don't overlap with everyone else's.  MSFT is at the top of my buy list, but I haven't pulled the trigger yet.  I was hoping for a significant drop in the price today, but that didn't materialize so I'm playing the waiting game for now.

[shalab]

One has to congratulate the Skype investors who made a good chunk of money. There was an article about Marc Andressen in WSJ today on how his venture company has changed the landscape in silicon valley - he invested in skype.

 

I have used Skype on iPhone and it is nifty. Having such an app on windows phone would be advantageous - my guess is that Skype would have done the app for a token amount. I have used other IM clients from the desktop and I dont see a huge advantage for skype in comparison to others.

 

Then the next thing is the number of users. Skype has the mind share which is a plus. How it pans out is anyone's guess.

[goldfinger]

I have used Skype on iPhone and it is nifty. Having such an app on windows phone would be advantageous - my guess is that Skype would have done the app for a token amount. I have used other IM clients from the desktop and I dont see a huge advantage for skype in comparison to others.

 

Then the next thing is the number of users. Skype has the mind share which is a plus. How it pans out is anyone's guess.

 

I think they are trying to shoot multiple stones at once:

- getting critical mass in the phone business with Nokia + Skype. This is cheaper than acquiring RIMM and they failed doing it on their own.

- becoming a major player in VOIP + Video over network. Remember one of the new corner stones of Cisco's strategy is video. Cisco wants to go to more software and applications. This is where margins are now.

- integrate unified communication technologies across their products (Office, Lync, CE, cloud, etc...). Skype's technology can be upgraded in the future to meet new challenges or just to fit in the evolving technology landscape.

- increase the value of other investments like Facebook and fend off some competitive pressures from Google and the like.

They probably have plans for cost cutting, monetization and market expansion. They are less dumb than everyone says they are but it still is an expensive acquisition. However they are spending money they cannot bring back advantageously. Some of the cost has to be understood as a capex necessary to maintain business. Some of it could be used to adjust free cash flow figures. The current stock price would still look cheap however.

[Guest VAL9000]

Office, Lync, CE, cloud etc. span different spectrums from the enterprise to the consumer. Microsoft's greatest strength is in the business space. Skype has mindshare in the consumer space.

 

The span is a good thing.  If they make these networks of users interoperable with each other and with Skype, then the value of the Skype network will increase by a greater-than-linear amount.  Assuming (1) $8.5bn is the correct price for Skype and (2) that price is based on the value of users, if Microsoft can make the user base 1bn just by connecting ~340mm users from its other services, then it follows that Skype would be worth well north of $8.5bn * 1000mm / 663mm = $12.75bn.

 

The nice thing about Skype's architecture is that the cost of operating the network vs. its size and activity levels have a very low positive correlation.