Skype Pre-IPO Preview

Oct. 6.10 | About: eBay Inc. (EBAY)

The preliminary prospectus still has quite a few blanks in it, but after a basic review Skype looks like a company that might be better off acquired than public. Based on our valuation work the market clearing price should be around $4.8B.

The Wrapper: Skype is the leading Internet-based communication company with 560 million registered users completing about 200 billion minutes of calls annually. Skype has over 8 million paying customers with an ARPU of about $100. For 2010, we expect the company to report close to $900M in revenue with operating margins near 20%.

Recipe History: Skype was started back in 2003 and baffled many at the beginning – “Why on earth would anyone want to use their PC to make a phone call?” Even after Skype caught on the questions continued – “How are these guys going to make any money if the calls are free?” Years later these answers are clear but still developing. Skype makes most of their money today on calls to non-Skype phones. They charge a few cents per minute versus the tens of cents or even dollars that phone companies charge for the same call. New features like video calls and desktop sharing are broadening the appeal of the service and the way people use it. Additional features will roll out soon, like click-to-call, which will be integrated with services like Google (NASDAQ:GOOG) Search, Maps, and Facebook.

Yummy Ingredients:

  • Skype works at scale and their infrastructure is software-based. That means they have built a technology platform onto which many more features, and much more revenue, can be layered with low incremental costs.
  • Using an equivalent notion of “same store sales” shows that Skype provides a positive customer experience which is a key driver to their continued growth.
  • Skype fits into both our RealVR and Cloud Computing themes – a powerful combination of innovation and new market growth.
  • The company has a large market opportunity, a strong position and a profitable business model that doesn’t rely on advertising (yet.)

Sour Tastes:

  • The company has a solid management team; however, we get a sense that it may not be all that is needed to exploit the massive opportunity before them. It’s the “next billion dollars” that we’re not so sure about. [UPDATE: The company just announced that Tony Bates is leaving Cisco (NASDAQ:CSCO) to take over as the Skype CEO in October. This is certainly big news and will be factored in to our full preview as we get closer to the offering.]
  • Competition is likely to stiffen considerably as Skype’s success is starting to put it in “the red zone” of larger industry players like Apple (NASDAQ:AAPL), Google, Cisco, and Verizon (NYSE:VZ). At first they may be willing to “partner” with Skype but the stakes are probably too high for these companies to let Skype succeed as a separate entitity.
  • The Luxembourg-based structure of the company could be a little off-putting to some investors.

Valuation: The company has not filed a price range or many of the details we need to compute a per-share Intrinsic Valuation. We can, however, estimate that the IV is likely to be about $4.8B. Once the final prospectus is filed we can update our valuation analysis and include per-share IV estimates.

Candy Verdict: Skype is a leading player in an important area of the Internet and cloud computing. As such, we expect most investors will want to own it as long as the price doesn’t get too high. Skype is operating in a space that is of great interest to most of the major players and it’s been suggested that the company may be acquired before the IPO. Even if they do become a public company they will remain tempting.

Beyond simple continued execution, we expect the spread of Internet-enabled TV and video-capable communication devices to open up important new markets for Skype. The success of the management team will hinge on how well they take advantage of these.

In summation, Skype is a deal we expect most to want to own, which suggests it’s going to do well at almost any price. Once we see the filing range and how pricing goes we’ll have a clearer idea on what to do with the shares post-IPO.

[Disclosures: None]