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Weekly Column

It's Only $2.6 Billion: How eBay Was Able to Squint and Make Buying Skype Almost Look Like a Bargain

Status: [CLOSED]
By Robert X. Cringely
bob@cringely.com

It was just a lucky break that this week's NerdTV subject was Max Levchin, who co-founded PayPal and later helped sell it to eBay for $1.5 billion. Max -- quite without knowing it, given the interview was shot June 30 -- offers us some clues why eBay would pay at least $2.6 billion and perhaps as much as $4.1 billion this week for Skype, the Internet phone service. And we need the help, because on its face the acquisition appears to be right up there for wackiness with Yahoo's 1999 purchase of Broadcast.com -- the apex of 90s dot-com merger lunacy.

I could spend this space ridiculing eBay for overpaying for Skype, whose investors had put two years and $20 million into the company for a return of 12,899.88 percent. Nice work if you can get it. But let's instead make the assumption that Meg Whitman and her business development people have NOT been smoking Arkansas polio weed and instead know something the rest of us don't. What makes Skype worth that kind of money to eBay?

Here are the typical analyst questions:

1. Couldn't eBay have built a Skype equivalent of their own for a lot less money?

2. Couldn't eBay have found an equivalent service to Skype that came with a lower price tag?

3. What does eBay actually intend to DO with Skype, anyway?

Remember we are assuming here that eBay was making rational decisions, so here's how I would answer each of these questions in turn.

Yes, eBay could have built a Skype equivalent, but that would take the same two years or more than Skype took to do it. And unlike Skype, eBay would be building its VoIP division in an environment that still contained Skype as a competitor. But the simple fact is that the chances of eBay being able to repeat Skype's success at this time are pretty close to zero. Skype has too much of a head start in terms of members. It would be analogous to eBay starting a payment service in competition with PayPal, which they once did, and that, too, failed. Maybe eBay was trying to learn from the PayPal experience and simply cut to the chase, which is acquiring earlier and avoiding completely any expensive lessons.

Yes, eBay could have purchased another Internet phone service, but not one with as many members as Skype's claimed 52 million. They could have bought Michael Robertson's Gizmo, for example, which is technically just as clever as Skype because it was created specifically to compete with Skype. But for all its flash, Gizmo doesn't yet have Skype's installed base, so eBay must have been interested in not just buying a technology but customer eyeballs, 'er ears.

Only eBay knows its plans for Skype, but Max tells us what ultimately made the PayPal acquisition a success was the advanced level of integration achieved between the two companies. eBay doesn't just OWN PayPal, they are the same company. eBay has mentioned using Skype to help its auction business, and while that could mean voice auctions and buyer-seller VoIP communications, it probably has more to do with the eBay community and customer retention.

Let's be honest: eBay's sales growth is slowing as the market matures. Once they have sold all the garage sale merchandise built-up in American and the world, there isn't much left to do but re-sell that same stuff and there is a definite limit to how many times that can be done profitably. eBay's problem is structural -- good old market saturation -- not competitive pressure. eBay can continue to make tons of money, sure, but what Wall Street wants is GROWTH and ultimately that means new businesses -- NON-auction businesses.

There is another trend at work in eBay and that's the subsumation of member e-mail. More and more eBay communication with members takes place through webmail on the eBay site. This was originally intended to subvert spammers, which it does very well, but it has the secondary effect of drawing customers even tighter to the mother ship, giving them more reasons, more often, to log-in to eBay, where they just might buy or sell a bit more, too. Maybe (and this is just a guess) eBay hopes to subsume phone service, too.

Let's look at some numbers. eBay and PayPal together represent about 80 million members and 135 million customers, 430,000 of whom make their entire living on eBay. Skype claims 52 million customers for its free VoIP phone service, some percentage of which also pay for SkypeOut VoIP-to-POTS service.

While there is definite overlap between these customer bases, it is unlikely to be complete overlap. If we guess that half of all members on both sides are active, that there is a 50 percent overlap of Skype members with eBay/PayPal members, this suggests that Skype offers the POSSIBILITY of delivering some new members to eBay. This number could be as high as 13 million, but is probably 6.5 million or so, which would represent about a 16 percent increase in real eBay members.

But is the POSSIBILITY of a 16 percent active membership increase worth $2.6 billion to eBay? Based on the relationship between membership numbers and eBay's market capitalization of approximately $50 billion, the answer is "yes." But it depends on execution, which means you have to discount it in any calculation by, say, 50 percent.

eBay will be entering the VoIP phone business, of course. Adding the 430,000 eBay professional sellers to Skype's paid ranks is a no-brainer: all eBay has to do is say that's the only way it can be phoned. Figuring another 10 non-professional will sign-up for each eBay professional, that brings the total number number of Skype users up by about 10 percent, though it probably doubles the number of paying Skype customers.

It is very logical to assume that eBay will pursue its business customers with Vonage-like phone services, but is that enough to justify paying $2.6 billion for Skype? No, but it makes up somewhat for the uncertainties in the membership-increase calculation, above. In fact eBay's dream, according to the PowerPoint presentation to investors you'll find in this week's links, is to use Skype to create a supercharged e-commerce company that transcends auctions and more fully leverages PayPal's financial resources.

Looking at it this way, taking into account economies of scale, PayPal taking over SkypeOut account balances and such, eBay can BARELY justify paying $2.6 billion for Skype. But that makes perfect sense because this is the process by which prices are actually determined.

So if Skype is just barely worth $2.6 billion to eBay, why did they do the deal? There are two reasons. For one, eBay views itself as being out of ideas and mojo, so it felt the need to do something bold that would also bring new blood into the company. That new blood -- the current Skype management -- is the other reason why they did the deal. Look at those $1.5 billion in incentive payments that are part of the deal. Whatever the targets, if they are reached eBay will be happy to pay because they will have made that much and more. But even more importantly, the incentives indicate how vital eBay views retaining current Skype management -- something they didn't feel in the case of the PayPal acquisition where Peter Thiel left immediately and Max Levchin left a few months later.

I'm not trying to justify this acquisition, which I still think is likely to be a mistake in the long run, but now it at least makes some sense why they did it.

The other story on a similar note this week is Microsoft's possible acquisition of AOL. Well, that's one way to finally defeat Netscape, isn't it? And the fact that nobody has pointed to possible anti-trust issues shows just how insignificant Netscape is anymore, but more importantly it shows how dial-up services have lost their luster, too. Time-Warner, if the deal goes through, is effectively selling the AOL subscriber list to MSN and that's about it. In the magazine business that's the last asset left to sell before you turn out the lights. And by retaining some ownership, Time-Warner is not just showing its confidence in Microsoft (that's what they'll say), but effectively discounting the price and financing the deal, they are so eager to be out of the online business.

What's in it for Microsoft that nobody has mentioned are AOL's most dynamic and under-monetized businesses -- AOL Instant Messenger (AIM) and ICQ. These 84 million members are more important to Microsoft and MSN than the 22 million AOL customers. They are probably why Microsoft is doing the deal.

That and to unnerve Google (it won't work) and put a twist in Mozilla's knickers, which I don't think will happen, either. Once completely free of AOL, Mozilla and Firefox should thrive.

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