Tuesday, May 10, 2011

How to value Skype (hint: it's not worth $8.5bn)

Maybe it's because I've been looking at Greece's sovereign debt nightmare so much in the past few days that the $8.5 billion that Microsoft agreed to pay for Skype didn't seem like such a big number at first, but it is. Not only is it 32 times EBITDA for a company that has yet to make a profit, it's more than three times the $2.75 billion that it was valued when eBay sold the majority of its shares in 2009 to a group of private investors who are currently laughing all the way to the bank. Remember that eBay had paid $3.1 billion to buy Skype from its founders in 2005. Ouch.

So what happened in the last two years to take Skype from a $2.75 billion valuation to a $8.5 billion valuation? OK, Skype has 145 million active users but most of these people don't actually pay for anything nor do they view any ads. On the other hand, they don't cost much either. Comparisons with Facebook and its half-a-billion-plus users are tempting but Facebook needs some really beefy server infrastructure to serve up its rich interconnected data set. Skype calls need none of this; Skype just gets you and the person you're calling together, after which you just communicate with each other and provide little to no additional load on Skype's infrastructure.

Then there's the 10 million paying customers who pay Skype to make calls from their client to traditional phone numbers or to rent a phone number that is reachable from those traditional phone numbers. This looks like a business model at first, but there are huge problems with this approach: First, it puts Skype in direct competition with both traditional telcos and cheap VoIP calling-card peddlers that are scrambling to offer and market the cheapest calls per minute to anyone who's interested. Second, it rather awkwardly diminishes its revenue stream as Skype's user base grows. The more people who are on Skype, the fewer calls they will make to traditional phones and the less they will pay. Granted, this is a very long-term thinking, but if you're paying eight and a half billion dollars you'd better be thinking long-term.

The fact that we can't make free calls to anyone anywhere from any device connected to a network these days (free as long as you've paid for the network, of course, but that's usually a flat monthly fee) is down to some technological inertia but mostly due to the way telecoms companies are protecting their current business model by charging termination fees to anyone who wants to call their users. If your phone company decided to offer all its users unlimited calling for a flat monthly fee, every time they called a number in a different network that network would demand payment by the minute which could be just about anything. It's a perfectly viable business model for the industry, but nobody wants to move first, so we're still stuck paying something like 50 cents for a 140-byte text message between two phones in different countries when a 5,000,000-byte email with photos, sent between those same two phones, is free. The problem with Skype in this brave new world that is going to roll around sooner or later is that Skype already uses other people's networks for its calls. When you Skype your friends the call goes over your ISP's network. If the phone service is free then Skype adds no value.

The reason we don't have a good, open, standard way to do voice, text messaging and video chat over the Internet is because everyone's trying to own this somehow. In the long run it's as futile as trying to own e-mail. E-mail wouldn't be e-mail if one company owned the service, or the client software, or the network infrastructure. Similarly, VoIP and IM won't be ubiquitous unless they're open services. Microsoft has lost that game once already with Hotmail versus G-Mail: Even if you manage to have such a huge user base that you're the de facto owner of VoIP, someone's just going to offer a better, cheaper alternative because the barriers to entry are so low.

In the end, Microsoft is buying 145 million active accounts: People who have a username, a password, a public Skype address and use them regularly. Can they turn them into Live accounts and merge them their other online services? Probably, though many of these people will already have Live accounts and many more won't bother. Can they convince them to turn into profitable paying users or advertising eyeballs? Probably that too.

Will this stop tomorrow's unspecified free-or-thereabouts, open, commoditised VoIP behemoth? Not a chance in hell.

And in the end, what's $8.5 billion divided by 145 million?

$58.62 per user.

And that, dear readers, is over the odds.

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