Analysts React to Microsoft's Skype Acquisition

| About: Microsoft Corporation (MSFT)

By David Zeiler

In a bid to energize its online communication services, Microsoft Corporation (NASDAQ:MSFT) announced yesterday (Tuesday) that it has agreed to buy Web phone company Skype Technologies SA for $8.5 billion.

Microsoft said it intends to integrate Skype's technology into several products, including its Xbox game console, its Outlook e-mail program, and its Windows mobile phones. Microsoft will also gain Skype's active user base of 170 million people.

"This could give Microsoft a much-needed kick-start" in telecommunications, Paolo Pescatore, an analyst at CCS Insight inLondon, told Bloomberg News. In voice services, "Skype has certainly set the benchmark and gained a lot of traction."

The deal is the most expensive in Microsoft's 36-year history, easily beating its $6 billion purchase of adverting firm aQuantive Inc. in 2007. With $50.2 billion in cash, the Redmond, WA, company can afford such pricey acquisitions.

Microsoft said Luxembourg-based Skype will become its own division within the company, with Skype Chief Executive Officer Tony Bates reporting directly to Microsoft CEO Steve Ballmer.

Analyst reaction was mixed.

Some see it as a strategic win for Microsoft in its Internet communication battles with Google Inc. (NASDAQ:GOOG) and Apple Inc. (NASDAQ:AAPL), both of which offer Web phone services.

"Apple's got their Face Time video chat. Android has video chat," Colin Gillis, an analyst at BGC Partners LP, told Bloomberg. "Now Microsoft is in the game."

Skype uses a technology called Voice over Internet Protocol (OTCPK:VOIP) that allows people to use an ordinary Internet connection, rather than a more expensive cellular network, to make a voice or video call.

Microsoft does offer some Web phone services through its corporate Lync product, but could use Skype to expand to consumers, particularly in the mobile segment of smartphones and tablets.

"It's a strategic asset and a defensive move," Gillis said. "If [Microsoft] can put it on Windows 8, it gives them an advantage. It helps them in the tablet market."

Other analysts doubt the deal will reap sufficient dividends, and have expressed concern that Microsoft paid a steep premium for a company that has shown little ability to turn a profit.

"It doesn't make sense at all as a financial investment," Forrester Research analyst Andrew Bartels told Reuters. "There's no way Microsoft is going to generate enough revenue and profit from Skype to compensate."

Wall Street reflected the negative view, taking a 1.5% bite out of the stock in mid-day trading Tuesday.

Investors have good reason to believe Microsoft may have overpaid. Skype was valued at just $2.5 billion 18 months ago, when eBay Inc. (NASDAQ:EBAY) sold most of its stake in the company to private investors. eBay had bought Skype in 2005 for $2.6 billion.

As recently as last week, it was reported that Google and Facebook were separately looking at buying Skype for between $3 billion and $4 billion, less than half of what Microsoft has agreed to pay.

Skype also has struggled to make money throughout its eight-year existence. According to papers filed for a planned initial public offering this year, Skype took a net loss of $7 million last year on revenue of $860 million. The company carries $544 million in long-term debt, net of cash.

Skype's business model of offering its most common Web phone services for free has made turning a profit difficult. Although Skype has 663 million registered users, only about a bit more than a quarter of them use the service regularly and only 8.8 million subscribe to paid services.

Microsoft may be hoping it can convert a bigger chunk of the user base to paying customers.

"Microsoft undoubtedly has overpaid for Skype in the short term but potentially not in the long term," Giles Cottle, senior analyst at Informa Telecoms & Media, told The Guardian. "Buying Skype gives Microsoft the ability to do whatever it wants with voice to an audience of 700 million users. This kind of scale does not come cheap."

Disclosure: None

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