By now I’m sure you have seen that earlier this week Microsoft bought Skype for $8.5bn, or 32x trailing EBITDA, a price tag that Business Insider described as “silly on a stand alone basis”. There must, therefore, be a strong strategic logic, and the best explanation that I have seen is the defensive logic as set out in the article below from the Financial Times:
Trying to justify Microsoft’s $8.5bn price for Skype by increasing growth estimates is impossible without entering stratospherically silly numbers. But what happens if the acquisition is considered a defensive move, rather than an offensive one?
Perhaps Microsoft was thinking only about protecting the current franchise. If Google or Facebook got hold of Skype, they would be closer to building a suite of products that could shake users loose from Office/Windows. To prevent that, Microsoft was prepared to pay an amount that, on traditional metrics, looks insane.
If investors follow this logic and view acquisitions like Skype, or the $6bn purchase of advertising firm aQuantive four years ago, as the price of maintaining Microsoft’s current business, such purchases suddenly look much more attractive. Microsoft exudes free cash: almost three dollars a share of it over the past 12 months, for a remarkable free cash flow yield of 11 per cent. (Which is why value investors like the stock.) And even if Microsoft periodically lays out massive sums to keep the old cash machine running it barely makes a difference. Assume that Microsoft has to make a Skype-sized deal every three years. Take that out of future free cash flow and the stock’s free cash flow yield only drops from 11 per cent to 10 per cent.
This makes much better sense to me than the more offensive rationales I’ve seen (e.g. to boost Windows Phone 7, or to get a presence in video ads), but it doesn’t bode well for the future of Skype as a service. Atlas, the key product line at aQuantive, hasn’t prospered since the Microsoft acquisition and if the logic for buying Skype is indeed defensive then it is hard to see Microsoft investing adequately to keep Skype at the forefront of its market.
Whatever the logic the deal was a good one for Silverlake and the other investors who bought Skype from eBay last year. They made a 3.3x return in just eighteen months.