David Prosser: Microsoft bets big on a gamble with long odds of coming off
Wednesday 11 May 2011
Outlook If one company is thinking about buying another, there are some basic questions to ask before signing on the dotted line. Shareholders in Microsoft will be wondering whether Steve Ballmer, their chief executive, did that before agreeing to pay $8.5m for Skype.
There are three of those basic questions. First, is this business a good strategic fit with the business we run already? Second, are we confident we can realise its potential? Third, are we being asked to pay a reasonable price?
Let's start with the first test, where Microsoft rates most highly. It is not difficult to see how Skype might enhance Microsoft's business model. It works on PCs where Microsoft is so dominant and it works on mobile phones using the Windows operating system. It could also be integrated into Microsoft's Xbox offering. Another plus is that it gives Microsoft much greater exposure to the consumer market, with which it has steadily been losing touch in recent years – but it has huge potential in the business sector too. Then there is the fact that Skype will give Microsoft's internet operations, where it is desperate to compete with Google, a shot in the arm.
That's the good news. From here the answers get more difficult. Can Microsoft execute the integration of Skype? There are two reasons to worry. The first is that building Skype into Microsoft's other products without inconveniencing its existing user base looks like a massive technical challenge. Second, a Microsoft-Skype tie-up represents a threat to the big phone carriers – the spread of Skype's free-call model to smartphones, for example – and they will do their best to be disruptive. Microsoft could do without that, particularly given its deals with handset makers, including Nokia.
So what about price? Well, in the middle of a valuation bubble for all things online, let's at least concede that Skype has some revenues – $860m last year, in fact. Maybe a price tag of 10 times sales is not so outlandish (though for a business that has now been trading for eight years, a multiple of profit would be better, but getting Skype into the black has proved difficult). Equally though, a chunk of Skype was bought 18 months ago in a deal that valued the company at just $2.5bn.
The conclusion? Microsoft has bought a business that looks to be an excellent strategic fit. Realising the potential of that fit, however, may well prove beyond it. And it has almost certainly overpaid.
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