Assessment of the Failed Acquisition of Skype by eBay - Research Paper Example

?ASSESSMENT OF THE FAILED ACQUISITION OF SKYPE BY EBAY INTRODUCTION Businesses in the contemporary business world are striving for growth and success in the deeply challenging environment. In such competitive environment, acquisition strategy is most seductive when corporate aims to boost the performance of the organization in the long term and at an inched pace. Additionally, the mergers and acquisitions are taking place all across the world. For instance, KPMG reports that mergers and acquisitions deals in Nigeria have noted steep increase of 379 percent in value in a single year from 2011 to 2012. Nigeria concluded 37 deals of USD 7.415 billion in 2012 as compared to 29 deals with USD 1.548 billion of value in 2011 (Nwannekanma, 2013). According to the Harvard Business review, the yearly expenditure incurred by the companies on the acquisitions is more than two trillion (Christensen, Alton, Rising, & Waldeck, 2011). Bitter truth of the story lies in the fact that organizations seduced to acquisition for the fast paced growth fail with a great number. Nearly 70 to 90 percent of the acquisitions fail to achieve the objectives set forth as the ground for the acquisition (Christensen, Alton, Rising, & Waldeck, 2011). The percentage of failure self evidences the fact that organizations adopting acquisition strategy have failed to learn the lessons from failure examples. Examples of the failed acquisition include prominent names of the corporate world across the globe. Furthermore, the failure examples are spread across industries from media to technology, oil to banking and so on. Some of the big names that top the list of the failed acquisition strategies include Microsoft (Rosoff, 2011), Kmart, e-Bay, AOL, Daimler-Benz and Bank of America (Huffington Post, 2013) etc. In the similar context, the underlying report is aimed at assessing one of the biggest failed acquisitions from the successful technological companies. The case understudy is the e-Bay’s acquisition of the Skype in 2005 which ranks on the 4th among the top ten failed mergers and acquisitions list by The Huffington Post (2013). Section I of the report will provide theoretical review of mergers and acquisitions in a broader context Section II will discuss the case of e-Bay acquisition of Skype. The section will shed light on the different dimensions of the deal with a focus on the accounting treatment and consolidation of the financials. Furthermore, the discussion about the reason and evidence of failure will also be presented and assessed. 2. OVERVIEW OF THE ACQUISITION STRATEGIES AND THE REASONS BEHIND FAILURE Mergers and acquisitions hold a significant position in the management literature as it is one of the dominant strategies adopted for the growth. Mergers and acquisitions are strategies that result in the consolidation of the two companies. Merger results in the formation of the new company after the consolidation while acquisition is the purchase of one company by another and no new company comes into the establishment. Large number of objectives is defined in the management literature as well as practical examples; however, the most important and the primary motive behind every mergers and acquisitions is to gain the position where companies can create and exploit the potential synergies (Bohlin, Daley, & Thomson, 1998). With this primary motive, companies attempt to achieve any, few or all of the mentioned below motives (Bohlin, Daley, & Thomson, 1998): Expansion of the market share in terms of product, geography and customer base. Limitation of ground for the rivals Take-up of new products Expansion of the business competence (Bohlin, Daley, & Thomson, 1998) All mergers and acquisitions can be defined as the three staged process with each stage aimed at achieving the milestone towards synergy. The core of the process is depicted as follows: (Bohlin, Daley, & Thomson, 1998) Therefore, through these three stages the organizations’ achieve synergies. Example of synergy driving process from merging projects is depicted in the image graphical representation below: (Bohlin, Daley, & Thomson, 1998) Finally, different aspects of businesses merged or acquired undergo changed, and result in the collective results are observed in business’ growth driving ideas, processes, tools, systems, infrastructure etc. The synergized model of change is as follows: (Bohlin, Daley, & Thomson, 1998) Success of merger and acquisition is subject in achieving the primary objective of the deal. Bloomberg reports that the companies when abide by five principles in their merger and acquisition strategies are ones who are then able to outperform S&P 500 by nearly 12 percent in years following the deal. These five principles include creating value from integration, setting goals that are inspirational, under-promised and over-delivered, clearly estimating and preparing for the significant resource requirement, developing clear chain and system of communication and finally embracing change across the entire system of business with the big event of merger or acquisition (Herd, 2010). Survey of 600 C-suite executives stated that successful mergers and acquisitions are subject to mastering the three stages of the process; first, evaluating the opportunity in due diligence, understanding the potential issues across different dimensions such as culture and most importantly conducting the sound planning and execution of the entire process (Herd, 2010). Interesting fact as reported is that alongside the strategic guidance to ensure that acquisition and mergers are successful the literature is also constantly identifying failure causes. For example, The Huffington Post reports that one of the most valuable lessons learned from failure examples is that size of the corporation taking up strategy is not enough to ensure that the deal will be successful (Huffington Post, 2013). HBR has put forward the theory which entails that failure in understanding the strategic objective of the deal is cause of the failure of mergers and acquisitions. HBR explains that companies confuse the two potential objective of acquisitions; first, improving the current performance and second is to transforming the company's model in future (Christensen, Alton, Rising, & Waldeck, 2011). Confusion on these two aspects leads to failure in defining the right value and prices to the deal (Christensen, Alton, Rising, & Waldeck, 2011). Merger and acquisition also fail once its fails to leverage the desired value to any or all of the mentioned below business model (Johnson, Christensen, & Kagermann, 2008): Value to customer proposition. Value to financial performance Value to the resources base (in all forms such as products, technology and employees and others) Value to processes (such as R&D, manufacturing and servicing etc) Hence, understanding the nuts and bolts of the objectives, systems to achieve this objective and practicability of the objectives is critical to accomplish the winning deal of mergers and acquisitions. Furthermore, understating of the failure examples and causes is also crucial for mid-size organizations as contrary to the big organizations they have limited resources to patch up the failure daunt (Adams, 2012). Nevertheless, it is a hard toss of a coin and organizations that fail to complete the homework while entering the domain end up with a hard hit from the coin toss. 3. REVIEW OF THE E-BAY AND SKYPE AND THE DEAL Technological organizations are evolving at must fast pace than any other industry has witnessed. Technologies embrace openness, nonlinearity, and dynamic changes and all these characteristics are now proving as battle fronts for the technology based businesses (Rui, & Xiao-feng, 2009). Competitive advantage based on the technology often backfires when isolated organizations face increased failure rates (Barnett, & McKendrick, 2001). Within these challenges in environments, there are examples of successful business such as Amazon, e-Bay, facebook, LinkedIn, Instagram, twitter etc (Upbin, 2013). e-Bay was founded in 1995 as en e-commerce platform. eBay holds the pioneer position on ecommerce that has managed to sustain the trust of people in the online based business. eBay also holds considerable in the businesses that have developed business models in aspiration from the opportunities offered from changing business environment (eBay, 2005a). The business model of eBay is defined as C2C or consumer to consumer. In such marketplace, the consumer prepares the product for the market and places an offer on the auction site like eBay. eBay facilitates these consumers with the catalogue, ease accessibility on the search engine, services pertaining to the clearance of the transaction etc. Hence, services of eBay provides the value of ease in displaying and marketing, connecting buyer and seller of the product irrespective of their geographical distance and paying and receiving the transaction proceeds. To facilitate the array of services, eBay has a range of website including eBay market place, PayPal, Rent.com, Kijiji and Shopping.com etc (eBay, 2005a). Some important statistics of eBay group are presented as follows: (Chaffy, 2013) Furthermore, segregated statistics of the three most valuable services of eBay which includes eBay market place, Pay Pal and GSI are described in pictorial representation below: (Adapted from: Chaffy, 2013) Other statistics about the performance of the three sections is as follows: (Chaffy, 2013) Hence, eBay has been constantly expanding its customer base. The growth driving strategy of ebay is based on the acquisition of customers to the ebay platforms, activation of the users on ebay and other platforms and activity of the users in forms of increased value of bids (Chaffy, 2013). Also, evident that ebay has been acquiring business units for the expanding its base. Among successful acquisitions, ebay also intended to expand its customer base towards the internet telephony but had hard hit from the acquisition of the Skype (Chaffy, 2013). Skype is the global internet Communication Company that offer a range of software such as Linux, Mac OS X and pocket PC platforms. The named software have won awards for facilitating the customer to conduct peer to peer calls for free while servicing superior quality voices. The fasted growing voice communication services offering Skype was launched in 2003 August and it is now being used in more than 225 countries. The software makes revenue from the superior quality services (eBay, 2005a). The growth on the customer of Skype has shown following trend: (Mercier, 2013) The software serves millions of the customer to be online concurrently. Other statistics of the Skype are as follows: (Statistics Brain, 2012) The recent statistics have revealed that nearly 145 million new users have activated Skype only in the year 2011 (Wilhelm, 2012). In the year 2011, Skype was bought by the Microsoft for USD $8.5bn. Within two years, the analysts have developed the view that deal is paying off. For the strategic objective of the increasing ways of communication, Skype has reported 45.5 million concurrent users in 2012 (Arthur, 2013). Contrary to the success from the deal with Microsoft, the acquisition of the Skype by ebay failed. In the year 2005, ebay announced to expand to the communication side of the business with the acquisition of Skype (eBay, 2005b). The objective of the Skpe’s acquisition is to add VOIP communication line between the buyer and sellers. ebay has been adding to its portfolio the units that can play a critical role in achieving the mission the of its corporate group. This communication between buyers and sellers was anticipated to add value to trust that is regarded as an important dimension of the mission statement. ebay viewed this strategic imperative to reduce the potential resistance and friction between the buyer and seller due to the traditional methods of communication. Therefore, ebay acquired Skype to inculcate the element of ease by reducing the response time between the buyer and seller. Also to facilitate the detailed consideration about the product at sell (eBay, 2005b). The deal aimed to test the synergies in different times of online connectivity serving platforms (Bylund, 2008). The collective power of three will be as follows: (Emory, n.d.) Hence, from the theoretical perspectives as developed above, the deal was aimed at adding value to the processes element of business model as defined by HBR as well as adding product and customer base to its portfolio (Christensen, Alton, Rising, & Waldeck, 2011). As the deal was announced, many analysts were skeptical about it. For example, for the strategic objective for enabling the dealing between buyers and selling with higher convenience, it was critical matter to understand that sellers do not want constant calls from anxious buyers. Another failure note referred that ebay like any other business is concerned for focus while Skype has only concerned for integrating ease in communication without any focus of dimension. The comments on the merger went to an inch and described it as the dumb merger (Whatron, 2005). Moreover, it was more regarded as the failure of ebay as it failed develop the integration between the processes (Malik, 2011). While other challenge arose as ebay was pressured with thin down of resources and management in managing and driving the synergy value from the deal (Whatron, 2005). In addition to these challenges, the most important challenge arose from the fact of steep payment for the deal for which the analysts were skeptical. Skype was acquired for nearly USD 2.6 billion deal with other payments in addition to the performance based consideration which steeped the total amount to USD 4.1 billion. The investors were concerned for the steep payment for the deal that was still not clear of the value it intends to pay (Whatron, 2005). 4. ACCOUNTING METHODS The deal details of the Skype being acquired by the ebay entails that ebay paid for the deal based on the performance assessment. According to the press release for investors, the Skype generated nearly USD seven million in the year 2004. Considering its performance, the Skype was expected to generate nearly 60 million in the year 2005 while there was as an expectation of the steep rise in revenue from Skype to the 200 million in the year 2006. Therefore, after considering the dilutions the Skype was estimated to generate margin of nearly 20 to 25 percent for ebay in the long term (eBay, 2005b). The summary of financial transaction is as follows: (Emory, n.d.) Ebay determined following standards pertaining to the financing, cash flow, achieving breakeven and long term revenue from the transaction as follows: (Emory, n.d.) The price paid for the acquisition is determined by the considering the large number of factors as referred in the literature review section. Furthermore, various settings and systems are determined for the valuation of the entity to be acquired. Three main methods include pricing on the basis of the market value, on the basis of the value of the assets and the valuation on the basis of income. In addition to this valuation on the basis of the basis of comparable market prices, replacement cost, discounted cash flows of future earning, book value based valuation etc. It is based on the discretion of the buyer, seller, other representatives and analysts about which system to be used that best addresses their concerns about the acquisition. There can be many explanations for the adoption of income based approach by ebay for Skype. One potential explanation for the adoption of income based approach can be the attractive revenue stream of Skype. Skype cannot be defined only as a VOIP standalone business instead its strength was attributed to following features: Leadership position in the market: (Emory, n.d.) Cross border business through Skype users: (Emory, n.d.) Steeply rising number of users of the Skype provided an attraction for the revenue growth for ebay: (Emory, n.d.) Hence, usage of income based approach provided an opportunity to provide a clear rationale for acquisition of Skype. The other standard employed in the acquisition deal was earn-out performance payment of nearly USD 1.5 billion. Majority of the employees opted for an earn-out option that was tied to performance targets (Emory, n.d.). 5. CONSOLIDATION OF FINANCIAL STATEMENTS The revenue segment added 24,809, 000 to the total revenue of ebay on consolidation as presented as follows:  Net Revenue Summary by segment Year Ended, December 31, 2003  % Ch Year Ended December 31, 2004   % Ch Year Ended, December 31, 2005  % Ch Year Ended, December 31, 2005    (In thousands, except percent changes)   Net Revenues by Segment:           U.S. Marketplaces $ 1,062,834 32% $ 1,399,848 29% $ 1,804,092 24% $ 4,334,290 International Marketplaces 664,640 77% 1,173,759 44% 1,695,045 Payments 437,622 59% 697,702 47% 1,028,455 40% 1,440,530 Communications - - - - 24,809 686% 194,921             Total net revenues $ 2,165,096 51% $ 3,271,309 39% $ 4,552,401 31% 5,969,741 (eBay, 2005b) Acquisition combination of asset and liabilities added to the balance sheet of ebay on addition of Skype is as follows: (eBay, 2005b) Furthermore, the details of intangible assets from Skype to ebay are as follows: (eBay, 2005b) Similarly, the goodwill added to the balance sheet of the ebay accounted as follows: (eBay, 2005b) The consideration paid to the Skype initially amounting to USD 2.6 billion was paid in the form of cash and stock. Nearly USD 1.3 billion was paid in cash while 32.8 million shares comprised for the remaining balance. The stock number was defined on the basis of the average price of stocks in the market during the announcement of the acquisition. TH earn-out payment of the performance bonus was to be paid in terms of cash or stock based on the decision of ebay management (eBay, 2005a). Annual report of 2007 reports a significant increase in revenue from communication segment. The major contribution in the communications segment was due to the additions in revenue from Skype. Additionally, the cost attributed to Skype also increased by USD 105.5 million (2006). The cost of the net revenue in the year 2006 increased with 21.1 percent in contrast to the traditional trend of ebay of around 18 percent. The annual report of 2007 attributes this cost to the Skype telecommunication (eBay, 2006). The annual report published on Feb , 2008 states referred to the growth of nearly 96% in the in the communication segment as compared to 2006 and attributed the major portion of growth to Skype. Year 2007 reported a negative impact to the ebay due to the goodwill impairment of skype of amount USD 1.4 billion. This reduced the operation margin of ebay to seven percent and also reduced the diluted earning per share by USD 1.01. The rise in the telecommunication cost attributed to Skype was 64% as compared to 2006 and amounted to USD 86.2 million (eBay, 2006). . Also for the year 2007, the earned out settlement amount was paid as defined in the deal which amounted to USD 530,334, 000. The y-o-y changes in goodwill and earned out payment of ebay is detailed as follows: (eBay, 2007) Hence, Skype despite an increase in the customer base could not generate the desired synergies with the ebay and ebay sold Skype. Skype was sold back to investors while retaining nearly 35 percent of the stake (Afarian, 2011). It is important to mention that many analysts comment that though ebay could not generate synergies and claimed benefit from Skype it has made some financials benefit from buying and selling of the business unit (Afarian, 2011). 6. EVIDENCE OF FAILURE OF THE ACQUISITION There are many evidences of failure in the acquisition of the Skype by the ebay. The most important evidence is reported from the statement of CEO of ebay. The CEO and president of ebay Inc then John Donahoe clearly declared that the synergies between the Skype and the ebay market place and pay pal are much limited. The CEO on separating Skype also stated that Skype is a standalone business, and it can maximize its potential while exploiting its potential with its unique and strong fundamentals and pacing up momentum. Other evidences include the declarations from strategic and financial analyst. For example, Malik (2011) declared it an ill-fated acquisition venture. Also, the acquisition of the Skype by Microsoft on 2008 from eBay at USD 8.5 billion was also referred to as an event of the breathtaking a moment from ebay. Along with the inability of the eBay to create synergy from Skype from its core operations, it is also debated that Skype as bought on steep prices. This increased demand from the investors of eBay to generate quick returns from the Skype in terms synergies. Analysts from WSJ on the in depth assessment of the deal stated that Skype need to generated nearly one billion in revenue as well as 25 percent margins in operating cash flows for justifying the price paid (Whatron, 2005). In addition to this, the share price movement of the ebay stock also reported the concerns of the investors as evident from the given trend of share prices: (Gu, & Lev, 2008) According to the study of Gun and Lev (2008) that stock price of eBay steeped nearly 100 percent which is attributed to the hindsight as the stock prices of eBay went significant correction in the 2006. Furthermore, the goodwill impairment of nearly USD 1.45 billion which accounts for around 55 percent of the original prices paid resulted in the worsening of the matter. According Gun and Lev (2008) this massive correction in the share price goes far beyond that price correction and indicate that the acquisition was ill-advised. An important interpretation of the high share prices that lead the adoption of acquisition is that swelled share prices generate attractive incentive for the manager at stake and at decision seat. These things often encourage managers to acquire an ill-suited target in order to maintain the growth facade. Also, this decline in the share prices also reflect about the increased social cost that affect business. 7. CONCLUSION Mergers and acquisitions are among the most important strategies employed by organizations in order to expand with limited resources deployment and generate synergies. Mergers and acquisition require considering a wide range of aspects that affect the business pre-acquisition, acquisition and post acquisition processes. The reported assessed the example of failed acquisition of Skype by eBay. The acquisition announcement since beginning could not win the support of analysts and was being questioned since initial stages. Ebay employed the income based approach and expected the synergies from both businesses to positively affect the auction trade between the buyer and seller. The overpriced acquisition (as commented by analysts and reflected from share price movements) followed by the impairment of goodwill and then sales of Skype by eBay asserted the view of analysts about the lack of potential synergy generation aspects between the two businesses. Hence, the example reveals that though acquisition comparatively requires fewer resources but the critical understanding of the system from which the benefit can generated by removing red tapes and exploiting growth avenues often fail if not adhered with excellence. References Adams, S. (2012). Why Half of All M&A Deals Fail, and What You Can Do About It. Forbes, Retrieved December 19, 2013 from http://www.forbes.com/sites/forbesleadershipforum/2012/03/19/why-half-of-all-ma-deals-fail-and-what-you-can-do-about-it/ Afarian, D. (2011). Skype Ping Pong, Microsoft Pays $8.5 Billion, Will Ebay Get Sued?. 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