Acquisition of Skype - Essay Example

Acquisition of Skype Table of Contents Introduction 2 Strategy 3 Regulatory 5 Valuation 5 Financing 6 Defense Tactics 7 Implementation 7 Risk 9 Conclusion 9 References 11 Introduction In simple words mergers and acquisitions refer to the process in which two organisations are combined together in order to achieve certain business and strategic objectives. Such transactions are of great significance to both the companies as well as to several other constituencies including the managers, workers, communities, competitors and the overall economy. Success or failure of mergers and acquisitions greatly influence the lenders, shareholders and the above mentioned constituencies (Sudarsanam, 2003). Billions of money is invested in acquiring a company or merging two companies. In case of a merger, firms come together for combining and sharing their resources with the purpose of attaining the common objectives. On the other side, in an acquisition one corporation purchases the shares or assets of another corporation. Shareholders of the acquired firm lose their ownership (Sudarsanam, 2003). They have been taking place in the business world over the past century. It is one of the most effective strategies in the present intensely competitive business scenario. This paper provides an in-depth overview of e-Bay’s acquisition of Skype. It includes the discussion regarding how Skype fits into the long-term strategy of e-Bay. Furthermore, the paper also contains the regulatory and valuation aspects regarding this acquisition. Details related to the source of finance, risk related to this acquisition and various tactics regarding defense are also provided in this paper. Strategy EBay is one of the most successful companies in the world of e-commerce. It has changed the definition of e-commerce business with its popular websites like eBay Marketplace, Kijiji, Paypal, Shopping.com and Rent.com. Everyday these websites bring millions of sellers and buyers together. The company was founded in 1995. It is a company that is inspired by opportunity and sustained by trust (eBay, 2005). Skype, on the other hand, is renowned as a leading name in arena of global internet communications. With its high end peer-to-peer innovative software, Skype allows people to make unlimited, superior quality, free voice calls. Its award winning software can be used in different platforms like Windows, Linux, Pocket PC platforms and Mac OSX. It was launched in 2003 and within two years it was downloaded over 182 million times throughout world. There are 27 languages in which Skype is available (eBay, 2005). In September, 2005, eBay decided to acquire Skype Technologies SA at the cost of almost $2.6 billion. It was one of boldest bid that is ever placed in the history of e-commerce industry. In 2005, eBay, the leading e-commerce service provider, had only two online business platforms – eBay and Paypal. The company had clear understanding regarding potential of e-commerce industry. It knew that there would be numerous opportunities for business over the net in the coming years and with its two franchises, the company would not be able to capitalise on these in the best possible way. Furthermore, eBay also realized that communication is the key in e-commerce. EBay’s long-term objective was to dominate the online business environment and that is why it wanted to bring the internet communication service providing sector under its control. While talking regarding this acquisition, Meg Whitman who was the president and CEO of eBay during 1998-08 said that “by combining the two leading ecommerce franchises, eBay and PayPal, with the leader in Internet voice communications; we will create an extraordinarily powerful environment for business on the Net” (eBay, 2005). During 2004-05, eBay was suffering from slow growth rate especially in US which is the core market of the company. The company acquired Luxemburg based internet phone service provider with the hope that it would recharge the existing as well as new businesses that are controlled by eBay. Furthermore, eBay with the help of high end technologies of Skype wanted to start an entirely new business on online communications. Theoretically, there are two main reasons behind an acquisition – ‘economy of scale’ and ‘entry into a new market’. As far as eBay’s acquisition is concerned, both these motives are found to be relevant. According to Whitman, acquisition of Skype is a part of eBay’s long term strategy of becoming an ‘unparalleled e-commerce engine’ (Hof, 2005). Prior to purchasing of Skype, eBay acquired only those firms that were directly associated with e-commerce. However, in order to compete with more diversified rivals like Google, Yahoo, Amazon.com and many other start-ups, eBay had to look for a new business that is a ‘potential blockbuster’ (Hof, 2005). In very simple words, Skype was viewed as an opportunity that would take eBay in a whole new market. As far as economy of scale is concerned, Skype, with its remarkable business growth was expected to assist in increasing the margin in eBay’s business. Furthermore, eBay, when purchased Skype, had plans of using it in new industries like automobile, real estate and travel. So, overall it can be said that Skype was well-suited in the long strategy of eBay (Hof, 2005). Regulatory The deal between eBay and Skype is perhaps the most significant one in the world of online communications. As a result, it was expected that there would be certain regulatory issues in this acquisition. First of all Skype operates as a VoIP service provider, hence it has been greatly influencing the telecommunication sector as well. After buying Skype, eBay’s main challenge was to make it a hugely profit making unit. However, it was not easy to make free service provider into a fee-based provider as eBay had to deal with several legal and regulatory issues (Bahlmann, 2005). In simple words, a fee-based VoIP service provider is equivalent to a legitimate telecommunication service provider which requires licenses. For instance, China Telecom which is one of the biggest telecommunications service providers in China identified those internet users who started making international phone calls using VoIP services as in this country, to provide such a service one need license which Skype did not have (Blau, 2005). Other regulatory issues that eBay faced were regarding imposing taxes on internet phone calls and providing 911 emergency services in US (Blau, 2005). In 2009, eBay faced another crucial regulatory issue as it was accused of using a ‘code’ that was owned by Joltid Ltd. which was the holding company of Skype. eBay did not possess any license for using the code (Williams, 2009). Valuation While acquiring Skype, eBay paid $2.6 billion in cash and stock. Moreover there was ‘potential performance-based consideration’ which took the deal up to $4.1 billion. In simple words Skype was valued as a company worth $4.1 billion. Given this huge value of the deal, investors were likely to be expecting a lot from this eBay-Skype deal. In fact analysts like Christa Sober Quarles said that “Skype would need $1 billion in revenue with 25% operating cash flow margins to justify the price eBay paid” (Wharton University, 2005). She also added that providing low-cost internet phone call service is not a sustainable strategy for generating revenue for long period of time. All these predictions started to become true gradually. After two years of acquisition it was quite clear that the valuation of Skype was much more than what it deserved. Skype had some successes during these two years, but it failed to make revenue of $1 billion. At the end of 2007, Skype had revenue of almost $300 million which was up from $60 million that was in 2005. In October, 2007 eBay declared that it has to pay charges worth $1.4 billion. Out of this $500 million was paid to some of the shareholders as well as management team that included the CEO of Skype, Niklas Zennstrom (Anthony, 2007). In 2008, eBay admitted that acquisition of Skype was financial as well as strategic failure (Williams, 2009). Even Zennstrom went on saying that eBay “overshot in terms of monetization” for Skype (Anthony, 2007). Financing In October, 2005 eBay completed the acquisition of Skype. At that time Skype was a privately held company. All the outstanding shares of Skype were acquired by eBay by paying $2.5 billion. Furthermore there was “potential performance-based consideration” that was comprised of cash worth $1.3 billion and the composite value of almost 32.8 million eBay shares (eBay, 2005). The maximum amount that can be paid under “potential performance-based consideration” was $1.4 billion (eBay, 2005). It could be paid as eBay stock or as cash. Among the shareholders of Skype almost 42% decided to receive eBay stock and cash in a single payment. The remaining 58% decided to receive eBay stock and cash in a ‘reduced up-front payment’ (eBay, 2005). Defense Tactics Skype did not try to defend itself from the aggressive acquisition of eBay. The most probable reason behind that was the overvaluation of the company. $2.6 billion excluding other charges was very lucrative for Skype. Furthermore, eBay has been a greater brand as compared to Skype. Coming under the roof of eBay was an exciting opportunity for Skype. With eBay’s excellent online presence Skype had the opportunity of expanding its reach. Hence, there were no such reasons for Skype to defend itself from eBay’s acquisition. Implementation eBay’s acquisition of Skype has been one of the most talked about deals in the online market place. The main objective of eBay behind this acquisition was to become a giant in the e-commerce business and stay ahead from the competitors like Google, Yahoo and many other small and medium companies. It wanted to integrate Skype with its two other main units of it – Paypal and eBay. It expected that the sellers and buyers who use eBay and Paypal would communicate among themselves through Skype. However, eBay users disappointed the company by relying more on e-mails. Moreover, success of such integration is nearly impossible to measure (Stone, 2007). In simple words eBay could not integrate Skype with its other business lines. Most of the analysts have seen this acquisition as a strategic failure of eBay as the company could not see the future. Aaron Kessler who is a renowned internet analyst said that most of the online companies “are buying users instead of revenue and profitability. That’s what eBay did for Skype. They saw a great asset with tons of users but no clear monetization path” (Stone, 2007). Soon after the completion of acquisition of Skype, eBay struggled to make profit out of the popularity of Skype. In 2007, when Skype was still a part of eBay, added a directory – ‘yellow pages’. Furthermore, new option was also provided for the users for rating the business. Unfortunately none of these were able to draw attention of the users (Stone, 2007). In the second quarter of the same year Skype managed to earn only $90 million, but this was far below the projections that were made by eBay. However, the number of members went up to 220 million during that period, but this was not enough as the eBay was looking for more profit (Stone, 2007). The company was very much concern about the situation. Gradually it realized that Skype in no way is helping the core businesses (online auction and payment) of it. Clearly, there was lack of synergies. In 2008 CEO of eBay John Donahoe was found to be saying that "If the synergies are strong, we'll keep it in our portfolio. If not, we'll reassess it" (Waters, 2008). Finally in 2009 eBay decided to sell off a major share of Skype to a group of private investors. 65% of Skype was sold to these investors at a price of $2.75 billion which was quite lower than the amount that eBay spent in buying the company. The group of investors includes Marc Andreessen who is the co-founder of Netscape (Gustin, 2009). Apart from him the group is composed of Canada Pension Plan Investment Board (CPPIB), Index Ventures and Silver Lake (Carew and Davies, 2009). According to Donahoe, the deal is appropriately valued and it will help both Skype and eBay in achieving their long term business goals. The top management of eBay believes that Skype can be a good stand alone business and it cannot be integrated with eBay’s core businesses. Risk When eBay acquired Skype it must have thought about the risk aspects of it. However, eBay might have read this aspect improperly; otherwise it would not have made such a strategic mistake. There was always risk regarding the possibilities of integrating an internet phone-call service provider with an online auction house (eBay) and an online bank (Paypal). eBay was planning to arrange an IPO of Skype before selling it off. Now, after it sold off Skype, the risk of IPO was significantly eliminated (Carew and Davies, 2009). However, there is still risk of lagging behind the competitors like Amazon.com. After selling off Skype, eBay is all about its auction site eBay.com and online payment site Paypal.com. Now, both these two business unites have been experiencing stiff competition from many global as well as domestic players. As a result there is always a risk of falling behind the rivals in the near future. Conclusion Decisions regarding any merger and acquisition are very crucial and success or failure of these decisions determines the success or failure of that merger or acquisition. Decision of acquiring Skype was a significant strategic failure for the e-commerce giant eBay. It could not read the future properly. An ambitious take over with the objective of integrating with two other core businesses did not work at all for the online auction house. Initially it seemed that Skype do fit in the long term strategy of eBay, but with the passage of time when Skype failed to earn enough revenue and eBay failed to use its technologies in its main business, it became quite clear that it is one of the biggest mistakes in the history of online industry. The factor that harmed eBay more was the overvaluation of Skype. $2.6 billion apart from other charges was too big for a company that works in an entirely different sector and that started up only two years before the acquisition. The decision of selling it off was perhaps a wise one as it allows eBay to focus more on its core businesses. However, now it is hugely dependent on its two main business lines that face intense competition from the rivals from local as well as international market. In fact, being a part of the online world the competition is actually boundary-less. This is a huge challenge and whether eBay can live up to this challenge or not that will be clear over the coming years. References Anthony, S. 2007, Skype Out?, Business Week, [Online] Available at: http://www.businessweek.com/innovate/content/dec2007/id2007123_541275.htm Accessed on April 25, 2011. Bahlmann, B. 2005, eBay, Skype, and the Terrorists, Birds-Eye, [Online] Available at: http://www.birds-eye.net/article_archive/ebay-skype-and_the_terrorists.htm Accessed on April 25, 2011. Blau, J. 2005, EBay Buys Skype for $2.6 Billion, PC World¸ [Online] Available at: http://www.pcworld.com/article/122516/ebay_buys_skype_for_26_billion.html Accessed on April 25, 2011. Carew S. and Davies, M. 2009, EBay to sell 65 percent of Skype for $1.9 billion, Reuters, [Online] Available at: http://www.reuters.com/article/2009/09/01/us-skype-ebay-idUSTRE58016S20090901 Accessed on April 25, 2011. eBay, 2005, eBay Completes Acquisition of Skype, eBay, [Online] Available at: http://investor.ebay.com/releasedetail.cfm?releaseid=176402 Accessed on April 25, 2011. eBay, 2005, eBay to Acquire Skype, eBay, [Online] Available at: http://about.skype.com/2005/09/ebay_to_acquire_skype.html Accessed on April 25, 2011. Gustin, S. 2009, eBay seals $1.9 billion Skype sale to former Netscape founder, partners, Daily Finance, [Online] Available at: http://www.dailyfinance.com/2009/09/01/ebay-nearing-skype-sale-deal-could-be-announced-today/ Accessed on April 25, 2011. Hof, R. 2005, Why eBay Is Buying Skype, Business Week¸ [Online] Available at: http://www.businessweek.com/the_thread/techbeat/archives/2005/09/why_ebay_is_buying_skype.html Accessed on April 25, 2011. Stone, B. 2007, EBay Revises Its Ambitions for Skype, New York Times, [Online] Available at: http://www.nytimes.com/2007/10/02/technology/02ebay.html Accessed on April 25, 2011. Sudarsanam, P.S. 2003.Creating Value from Mergers and Acquisitions, FT Prentice Hall Waters, R. 2008, Ebay considers sale of Skype subsidiary, Financial Times, [Online] Available at: http://us.ft.com/ftgateway/superpage.ft?news_id=fto041720081406499364&page=2 Accessed on April 25, 2011. Williams, C. 2009, eBay could ditch uncrackable Skype tech, The Register, [Online] Available at: http://www.theregister.co.uk/2009/07/31/skype_joltid/ Accessed on April 25, 2011. Wharton University, 2005, eBay Calling Skype: Is It a Good Connection?, Knowledge @ Wharton, [Online] Available at: http://knowledge.wharton.upenn.edu/article.cfm?articleid=1291 Accessed on April 25, 2011. Read More