The hammer falls on eBay's $4bn leap into the unknown

Swoop for Skype revives memories of the dot-com bubble
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The Independent Online

"Loss-making internet firm bought in $4.1bn deal": it sounds like a headline from the heady days of the dot-com bubble five years ago.

But the deal - online auctioneer eBay buying the voiceover internet protocol (VoIP) firm Skype - is a reality. And, as if to underline that there is a whiff of tech madness in the air, the acquisition was announced last week just as computer software company Oracle was also unveiling its latest multi-billion-dollar purchase, that of smaller rival Siebel for $5.9bn (£3.3bn).

To conform still further to the dot-com boom stereotype, Skype's co-founders Niklas Zennström and Janus Friis are young, exotic (well, Swedish at least) and will become fabulously rich overnight. They must be very pleased with the price tag, not least because Skype, which allows customers to make free phone calls over the internet, made an operating loss of $400,000 last year on revenues of $7m.

Yet analysts at Goldman Sachs estimate it will make profits of $1.2m this year on the back of revenues of $60m (that's an increase of 757 per cent). Mind-bogglingly, they forecast that revenue will go on to hit $826.8m in 2010, on the basis that take-up will rise and more people use Skype's additional, paid-for services.

But Leo Hindery, managing partner of investment manager InterMedia Advisors, reckons that's a big ask. "The price is breathtaking," he says. "It's those artificial internet values revisited." So what exactly is Skype, and why has eBay spent so much on it?

Downloading Skype's software lets users talk to each other over the internet. The technology has been around for a decade but needs broadband to work, which is why it has only recently become more widespread. Skype has the largest subscriber base among VoIP companies, with 54 million users, but the vast majority don't pay a penny. It makes its money from the two million customers who use extra services like voicemail, or who call landlines or mobile phones from their computers; unlike internet-to-internet callers, they are charged.

Analysts estimate that Skype receives around $30 a year on average from paying subscribers. Getting more people to use these services, and pay more, will be a challenge. The brief history of the internet has shown that if users can get content or services for free, they will.

Katja Ruud, research director at technology consultancy Gartner, says that the expectations of analysts are ambitious. "I am not convinced about the revenue forecasts for Skype. Because it only generates revenue from a small proportion of users, it would need huge growth in user numbers to meet the forecasts."

Skype - and, more to the point, its new owner eBay - must also face up to a strong competitive challenge. Last month Google launched its own VoIP service, and Microsoft is gradually incorporating the technology in its Messenger service.

Next to these two giants, the company is an unknown quantity. "Skype lacks the brand name, scale and financial strategy to go it alone," says Lars Godell, telecoms analyst at consultant Forrester. "It has a headstart, but when big players get involved, this could change."

So why has eBay bought it? The online auctioneer wants to incorporate the Skype technology on to its site, in the same way it has managed with PayPal, the online credit card payment service it bought in 2002.

EBay is vague on the details, but the idea is that the Skype technology would allow buyers to call the vendor to request details about the item being sold. This, in turn, would enable eBay to sell higher-priced items such as property. More importantly for the company, it would also boost revenues. In the same way that PayPal takes a cut from the vendor's sale price, eBay could take a commission from sales generated via Skype calls.

Critics ask why, if eBay was set on using VoIP, it didn't develop a service of its own. The retailer replies that Skype is not just a piece of software but a "thriving ecosystem". In plain English, that means the software works, has a brand and comes with a subscriber base that can be encouraged to use eBay.

Yet the value of that brand is questionable. Given that VoIP is still in its infancy, not many people have heard of Skype. And compared to the universally recognised and respected brand of eBay, it pales into insignificance.

The reaction from Wall Street has been mixed. Merrill Lynch put out a research note encouraging investors to buy the stock, but warned that the volatility risk was high. A newspaper report gave shareholders advance warning of the deal earlier this month, which sent the stock sliding almost 4 per cent. So the surprise was muted when it was confirmed last week: shares briefly nudged higher but not enough to make up for previous falls.

If analysts' forecasts for Skype are right - and who knows what any of us will be doing in five, let alone 10, years from now - then eBay's high-stakes gamble will have paid off. But it is in unknown territory. Chief executive Meg Whitman will be crossing her fingers that she has not auctioned off eBay's future.