The Skype's the Limit

eBay’s acquisition of Skype in 2005 has been one of the many controversial moves eBay been recently making. The purchase was originally marketed as the missing piece to create the holy trinity in eBay’s hallowed e-commerce halls (along with eBay’s auction sites and PayPal.) The thinking was that Skype would accelerate transactions among strangers as they communicated to each other more efficiently. eBay later found out that people are more interested in buying/selling quickly then chatting it up about those transactions. Consequently, Skype did not live up to all the hype, and eBay has been paying for the acquisition ever since. So the question remains, eBay goofed – but how bad? How bad really is Skype? I think if you look at their performance; you’ll find surprisingly that Skype is not bad at all…

What did eBay pay for Skype?

First things first, how much did eBay exactly pay for Skype? I’ve noticed a lot of numbers floating around the web anywhere between 2.6 to 4.1 Billion. The variance stems from the tiered payment structure that was negotiated to be based on Skype’s future performance. EBay had agreed to initially acquire Skype for $1.3 billion in cash and $1.3 billion in stock and would pay up to $1.5 billion more if Skype met financial targets by 2008 and 2009. eBay ended up paying 530 million out of the 1.5 billion performance portion to settle the transaction. So the grand total paid was 3.13 Billion dollars. If that wasn’t complicated enough, eBay at the same time took a 900 Million dollar charge basically valuing Skype at 2.23 B (out of the 3.13 B they paid)

How is Skype doing anyway?

So investors agree eBay overpaid and eBay agrees with them. So, just how bad is Skype? Well, let me breakdown revenue numbers and current growth rates and you be judge.

Revenue in the past 4 quarters came in at 521 million vs. 332 million for the previous 4 quarters giving us a growth rate of 56.9 % Y/Y, a growth rate that currently eclipses Amazon, Yahoo and yes…even Google.
But what good is growth if that growth is drastically slowing down? - Amazingly, growth is not slowing down – in fact it’s accelerating! Just this week Skype logged its fastest growth rate of user activity in its history – Skype logged an additional one million more concurrent users (a good measure of usage) in just 35 days.

So here we are; we have a company growing 50+ percent year over year, is currently accelerating growth and most importantly profitable. It sounds to me like we got the bases loaded for investors.

What’s Skype worth?

Skype had Q3 2008 revenue of $143 million and is on track to reach 2008 revenue of $570 million. Let’s be conservative and assume the current economic crisis hits revenue growth and causes it decelerate almost half to 30% next year, we can still expect somewhere around $741 million in 2009 revenue.
Skype's operating margin (excluding options) is expected to come closer to 16% in 2009. This would yield 2009 pro-forma operating income of $119 million and tax-adjusted pro-forma earnings of approximately $107 million. Again, just being very conservative and a forward P/E multiple of 30x (again restricting PEG to 1.0x) we get a current valuation of roughly $3.2 billion. 3.2 Billion Is more than the 3.13 Billion dollars that eBay paid and definitely more then what eBay has valued Skype at 2.23 B

Sometimes it’s okay to be a third wheel.

I understand Skype does not have any of the promised synergies with eBay. As a standalone company however – it would definitely be valued much more then the unloved step child it is now. Skype should be a net positive toward eBay, and at worse have a neutral effect on investor sentiment. Being a third wheel can be okay as long as that wheel is carrying its own weight…say like on a tricycle.