Microsoft Nears $7 Billion-Plus Deal for Skype

MAY 9, 2011 THE WALL STREET JOURNAL

By ANUPREETA DAS And NICK WINGFIELD
Microsoft Corp. is close to a deal to buy Internet phone company Skype Technologies SA for more than $7 billion, and a deal could be announced as early as Tuesday, people familiar with the matter said.
Negotiations were wrapping up Monday evening, and a deal could still fall apart, the people cautioned. Representatives for Microsoft and Skype declined to comment.

A deal represents Microsoft's most aggressive move yet to play in the increasingly-converged worlds of communication, information and entertainment. Skype connects more than 663 million users around the world via Internet-based telephony and video, making it a key technology platform for a new generation of Web-savvy consumers. During 2010, those users made 207 billion minutes of voice and voice video calls over Skype.

Buying Skype would give Microsoft a recognized brand name on the Internet at a time when it is struggling to get more traction in the consumer market. The company has invested heavily in marketing and improving the technology of its Bing search engine. While it has made some market share gains over the past year, Google Inc. still dominates the search market with more than 65% of U.S. searches going through its site.

At a value over $7 billion, the Skype deal would rank at or near the top of the biggest acquisitions in the 36-year history of Microsoft, a company that traditionally has shied away from large deals. In 2007, Microsoft paid approximately $6 billion to acquire online advertising firm aQuantive Inc. Many current and former Microsoft executives believe Microsoft significantly overpaid for that deal. But they are also relieved that Microsoft gave up on an unsolicited $48 billion offer for Yahoo Inc. nearly three years ago. Yahoo is valued at half that sum today.

Microsoft Chief Executive Steve Ballmer, though, sees the Internet as an essential battleground for Microsoft, a company that still makes the vast bulk of its profits from Windows and Office software systems. Investors have become increasingly concerned about Microsoft's ability to squeeze continued growth out of those businesses, as rival technologies from Apple, Google and others put more pressure on profits.

The Microsoft division behind the company's hugely lucrative Office suite of applications also makes a product, known as Lync, which ties together email, instant messaging and voice communications into a single application. Skype could strengthen that offering.

The deal shows how far Skype has come since it was launched in 2003 by Niklas Zennstrom and Janus Friis, two men who had created a file-sharing technology called Kazaa that became widely associated with music piracy. While Skype was initially popular with techies, it increasingly worked its way into the mainstream by offering free or cheap phone calls which were especially appealing to international callers.

When EBay purchased the company in 2005 for $2.6 billion in cash and stock, Skype was regarded as something of an experiment, in which EBay's buyers and sellers would use the service to communicate about potential transactions.

The experiment faltered, and EBay gave up on Skype in 2007, taking a $1.4 billion charge on the investment. It sold a 70% stake to a group of technology investors including Silver Lake Partners, venture capital firms Index Ventures and Andreessen Horowitz, and the Canada Pension Plan Investment Board, who will make a handomse return on the Microsoft transaction.

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 worldwide. Last year the company posted revenue of $860 million and $264 million in operating profits, but still lost $7 million. The company had $686 million in long-term debt as of Dec. 31.

Skype uses a technology called voice over Internet protocol, which treats calls as data like email messages and routes them over the Internet, rather than a traditional phone network. Skype's software, which can be downloaded free, allows users to call other Skype users on computers or certain cellphones for free. Skype users can also call land lines for a fee and conduct video calls.

Skype could play a role in Microsoft's effort to turnaround its fortunes in the mobile phone market, an area where it has lagged badly behind rivals Apple Inc. and Google. The company last year launched a new operating system for mobile phones known as Windows Phone 7 that has been well reviewed by technology critics but hasn't yet meaningfully improved Microsoft's market share.

Microsoft will likely need to tread carefully, though, in integrating Skype into its mobile software because of the potential for pushback from wireless carriers, whose support Microsoft badly needs. Skype could give consumers a way to make cheap phone calls over the Internet from mobile phones, without paying higher rates to the carriers.

Last August, Skype filed documents to go public but put its IPO plans on hold after bringing in a new chief executive, Tony Bates. Skype had expected to raise close to $1 billion through its IPO, people familiar with the matter said at the time. At the same time, the Luxembourg-based company entertained conversations in the past with potential buyers and joint-venture partners, including Facebook Inc., Google and Cisco, according to other people familiar with the matter. Skype had sought between $5 billion and $6 billion to sell itself, they added. The blog GigaOm earlier reported news of Microsoft's interest in Skype.

—Spencer E. Ante contributed to this article.