eBay takes USD900m hit for Skype buy

02-10-2007

by Silicon.com

Don't call it a bust just yet but it's fair to say eBay executives aren't thrilled with what they're getting out of Skype, which the auction king bought for USD2.6 billion two years ago.

eBay has now said it will take a USD900 million so-called impairment write-down against the value of Skype. This means eBay has been forced to reassess the value of the internet telephony company relative to its overall business today. By recording a charge, the company is essentially saying it has taken a loss on its original investment.

In what looks like an attempt to shake things up at Skype and move the division in a new direction, eBay also said Skype co-founder and chief executive Niklas Zennstrom has stepped down.

His departure was expected. Zennstrom, who helped start Skype in 2003, has joined forces with Skype co-founder Janus Friis to start an internet television service called Joost. And it has long been anticipated he would take more time to work on that endeavour.

From the time the Skype acquisition was announced in September 2005, analysts and investors on Wall Street shook their heads wondering how the company could pay such a hefty premium on a company that essentially provided free or low-cost voice minutes in a market that is dominated by large incumbent telephone companies.

When the merger was announced, eBay, which owns and operates the most well known online auction service, said it saw great potential in using Skype's peer-to-peer voice over IP technology to connect buyers and sellers in the eBay marketplace. There were grand plans to integrate eBay's PayPal payment system with Skype's VoIP network.

But nearly two years after the acquisition closed, there is little integration between eBay's auction website and the Skype voice service. Even though Skype has grown into the largest voice over IP provider on the planet, the bottom line is clear -- it still hasn't made enough money to justify the hefty USD2.6 billion price tag.

Jordan Rohan, managing director and internet analyst at RBC Capital Markets, said: "The Skype service has been tremendously popular as a free service. But at some point, free doesn't work anymore. It's not a management problem. It's a business model issue."

That said, Skype has been a success story of sorts in the VoIP arena. Its subscriber base has grown from 57 million registered users in 2005 to 220 million users at the end of June 2007. That's an increase of more than 160 million registered users in less than two years. The division also recorded its second quarterly profit in a row on July 18 on revenue of USD90 million.

But despite this success, eBay's CEO Meg Whitman said when the results were released, she was still not happy with Skype's usage levels.

The big question now is, what's next for Skype?

Clearly, the current business model is not enough to satisfy eBay in light of how much the company spent on Skype. And the reason is simple. Even though Skype has done a very good job of getting users to download its software client, most people who use the service do so to make free Skype-to-Skype phone calls.

The only way that Skype makes money from its subscribers is when people use its Skype-In or Skype-Out services. Skype-In allows users to pay to rent a phone number, which people on regular phones can call. Skype-Out allows users to call traditional phones or mobile phones for a fee.

Skype and eBay don't break out how many subscribers use Skype-In and Skype-Out but Rohan said there is evidence in Skype's numbers to suggest its Skype-Out usage is actually declining.

He said: "Skype-Out usage is way down. But regardless, Skype's core business isn't much different from a really cheap calling card business. The margins are really thin."

It's clear that the dream of massive integration between eBay's auction site and Skype won't happen anytime soon. But the company still sees big potential in Skype's voice services.

A spokesman for eBay said: "We feel like we can do a lot more with Skype as a standalone VoIP provider. Skype has been focused on user acquisition, and it's done a great job. But we also feel like we can find new ways to monetise those users."

For example, he said the company is looking at ways to integrate e-commerce into the Skype client itself. Exactly how this would work is still unknown but for the 220 million users who have Skype on their desktops, eBay could integrate tags to purchase goods and services.

Advertising is another avenue that eBay is exploring, according to the spokesman. With 220 million registered users, Skype has a big enough audience to attract large advertisers. Some analysts agree this would be a logical opportunity for Skype to explore. But supporting a service through online advertising isn't necessarily going to guarantee success.

Sally Cohen, an analyst with Forrester Research, said: "It could be as easy as showing Skype subscribers advertisements when they use the VoIP client. The challenge will be in making sure that eBay can match the advertisements with the subscriber base."

Adding advertisements to its service could also pit Skype against Google. The king of online advertising is also in the voice over IP market with its GoogleTalk application.

Some analysts speculate that Skype and eBay's biggest opportunity is in taking their applications to mobile devices. Specifically, this would mean embedding the Skype client on mobile phones. Today, the client is very processor intensive, so the Skype mobile client is only able to run on more expensive smartphones, such as devices running Windows Mobile.

Scott Devitt, a managing director at investment company Stifel Nicolaus, said he also sees Skype and eBay leveraging the mobile platform in the payment arena as well, combining eBay's PayPal service with the Skype client. "Wireless is the key to their future," he said. "In my eyes, that is the only future opportunity that justifies the price that eBay paid for Skype."

The eBay spokesman said the company is primarily focused on addressing desktop users but said it is committed to putting the Skype application in the hands of its users on whatever device they're using.

Marguerite Reardon writes for CNET News.com.

Reprinted with permission from Silicon.com