Skype + eBay = Deal! $1.3B cash + $1.3 stock + $1.5 earn-out = $4.1B!

Reuters’ Eric Auchard has just reported that eBay has made a run after Skype after all, and has put a consideration that would total $4.1B if earn-out conditions are met.

This is a massive deal: eBay is spending about half of its cash reserve to acquire the VoIP company, at a stratospheric multiple (based on Skype’s rumored revenue levels).

The story is obviously going to develop during the day, but dam’n, I just did not see it happening – especially at that price. According to Rob Hof, eBay will host an analyst call in a couple of hours.

This is an awesome payday for Skype’s investors: Draper Fisher Jurvetson, Mandrove, Index Ventures, Bessemer and others. We know that the company raised a maximum of $21M (?) but what is yet to be disclosed – and that we should know because this is not a non material acquisition – is Skype’s cap table and who is going to make big $$$$$$.

Congratulations to Tim Draper, Danny Rimer and other VCs involved. That is a hell of a deal, and I suppose, a monstrous IRR. And remember that DFJ already had a great exit a few weeks ago on Baidu.

And even bigger congratulations to Skype employees, who in 2.5 years have disrupted an established market, and are getting an handsome payout. Scoble’s former boss, Lenn Pryor, must be happy to have relocated to Tallinn.

Update: here is the official press release. A few notable data points regarding the terms and the rationale of the acquisition:

• Improved communication: “Online shopping depends on a number of factors to function well. Communications, like payments and shipping, is a critical part of this process. Skype will streamline and improve communications between buyers and sellers as it is integrated into the eBay marketplace. Buyers will gain an easy way to talk to sellers quickly and get the information they need to buy, and sellers can more easily build relationships with customers and close sales. As a result, Skype can increase the velocity of trade on eBay, especially in categories that require more involved communications such as used cars, business and industrial equipment, and high-end collectibles.“
• New seller capabilities like Pay per Call: “The acquisition also enables eBay and Skype to pursue entirely new lines of business. For example, in addition to eBay’s current transaction-based fees, ecommerce communications could be monetized on a pay-per-call basis through Skype. Pay-per-call communications opens up new categories of ecommerce, especially for those sectors that depend on a lead-generation model such as personal and business services, travel, new cars, and real estate. eBay’s other shopping websites — Shopping.com, Rent.com, Marktplaats.nl and Kijiji – can also benefit from the integration of Skype.”

• On the earn-out: “The maximum amount potentially payable under the performance-based earn-out is approximately €1.2 billion, or approximately $1.5 billion, and would be payable in cash or eBay stock, at eBay’s discretion, with an expected payment date in 2008 or 2009. Skype shareholders were offered the choice between several consideration options for their shares. Shareholders representing approximately 40% of the Skype shares chose to receive a single payment in cash and eBay stock at the close of the transaction. Shareholders representing the remaining 60% of the Skype shares chose to receive a reduced up-front payment in cash and eBay stock at the close plus potential future earn-out payments which are based on performance-based goals for active users, gross profit and revenue. “

• On revenues and multiples: “ Skype generated approximately $7 million in revenues in 2004, and the company anticipates that it will generate an estimated $60 million in revenues in 2005 and more than $200 million in 2006. For Q4-05, eBay expects the acquisition to be dilutive to pro forma and GAAP earnings per share by $0.01 and $0.04 respectively. For the full year 2006, eBayexpects the transaction to be dilutive to pro forma and GAAP earnings per share by $0.04 and $0.12 respectively, with breakeven on a pro forma basis expected in the fourth quarter of 2006. On a long-term basis, eBay expects Skype operating margins could be in the range of 20% to 25%.” So the forward revenue multiple is 40X (!!!), and the price paid per client is $45 (against $20 per MySpace users paid by NewsCorp).

I am sure that we’ll learn more in the coming days, but I don’t (yet) see why eBay needed to buy Skype at such a price to get the product/distribution leverage that is mentioned in the release. Skype is a great service, but it is not the only one available offering a VoIP conduit or a potential Pay per Call solution. And I thought that previous attempts to get buyers and sellers to communicate “in realtime” had failed because sellers don’t want to get stuck being a buyer “support desk”. I welcome contrarian views, especially as I have seen my eBay stocks losing 30% over the past few months.

The information about the earn-out is interesting as well: some investors have decided to cash-out and run, others to hang in there, and potentially profit from Skype’s  future performance. Can’t wait to see the SEC disclosure.

A key learning: after this one, no deal is impossible or unthinkable.

More:

• Pierre Chappaz, the Founder of Kelkoo (sold to Yahoo! for over $500M), writes (in French) that Yahoo on the case but was not ready to pay the price that eBay agreed to ultimately. He sees the reasons I mentioned: adding a communication mechanism to eBay’s marketplace, expansion of Paypal beyond eBay to be used as “the” payment infrastructure for Skype, and maybe – leveraging eBay’s resources to become a much bigger player in telecommunications.
  Sort of bringing together markets AND conversations.
• Rich Therani comments on his VoIP blog:

Right now, Skype gets just over a dollar per active user. I am sure eBay thinks – and they are likely right , that Skype will grow its active user base and also grow its revenue per user. So in another 18 months or less we can expect Skype to have 100 million active users and perhaps each will pay an average of $3. This gets us to $300 million.
Of course Skype has its potential problems to deal with. Port blocking in some countries and the declaration that Skype is illegal and a fining offense are obviously not too good for your business model. Still, this is exactly what happened last week in China. Will China become a model for the rest of the world or an isolated incident?”

• Rob Hof posted a long analysis of the deal and its business fundamentals. Interviews of small merchants has led to what I hinted regarding their relative lack of interest on interactive communication feautures.  I’ll also point to his conclusion:

The big question remains whether eBay has overpaid for a business that’s unprofitable, beset by lots of competition, and unrelated to its core business. Whitman noted in the conference call that “our overarching goal is to grow faster than e-commerce” overall. Investors will have to decide in coming months and years whether she overreached in the pursuit of growth.

• Paul Kedrosky is “seeing the glass half-full”, i.e he is midly positive on the deal. I would actually have expected Paul on the “half-empty” side as I am still for the moment. See Skype Dices! It Minces! It Chops!.
• Staci from PaidContent does a thorough job summarizing the investor pitch (here is the presentation and the press pack) and some key numbers and providing PC’s analysis on the deal.
• David Cowan discloses (in the comments) that Bessemer made about 150X on their Series A investment. Not too shaby (far from it), though the actual amount is not mentioned ($1–2M ?).
• Steve Jurvetson, in his usual self, just posted a picture and a “congrats” comment. DFJ is going to make several hundred millions on this deal (if not in the $B if Draper Luxembourg is an affiliate of DFJ as opposed to a private investment vehicle of Tim Draper), so we could have understood a bit more exhuberance.
• Ross Mayfield reports from Skype Estonia that it is business as usual. Yeah right, they’ll keep on wearing T-Shirts in the office – from now on, they’ll just be Lacoste originals.
• Chris Carfi sees 3 fundamentals in the acquisition: an opportunity to extend eBay communities to the desktop, a highly strategic move into emerging markets, and an integration of PayPal into the Skype interface.
  "One" and "three" make sense, and are sort of two different angles of the same always on presence. "Two" is much more challenging IMHO, owning the conversation conduit is not enough to generate the market.

Comments

[Rahmin Sarabi]

What are the barriers to entry in the VOIP market? Why didn't eBay attempt to develop the technology internally instead of shelling out all the $$$? Even if the technology made sense for eBay, which is questionable, why buy it for $4.1B? Either eBay has just made a huge mistake or we're all missing something here... I'd start selling my shares.

[DaveMc500Hats]

there are cheaper per-user VOIP solutions i'm sure, but i think the real reasons as carfi noted are greater desktop presence and paypal integration.

i would offer a more basic reason, which is simply a large & viral userbase (recent info on growth metrics aside) which eBay can cross-market features & services to.

one of the areas eBay hasn't really pushed hard is to increase page views / time on site among less active users, and (like google uses free gmail to further monetize adwords) use the increased minutes/eyeballs to further monetize eBay and PayPal transactions.

while i can't comment on the relative cost vs value of the deal, i would say it's a reasonable way to use the cash (other than issuing a huge-ass dividend, that is)... there may have been other less expensive deals they could have done, but it's not a bad choice for logical fit or good reason in my book.

while i might have suggested a dividend is the best solution for shareholders, for an activist management team this is not a bad way to go. that said, the other area i don't see eBay doing much with that could be energized is by doing a number of early-stage investments that would be relevant to the eBay ecosystem. they appear to have left that to local VCs, but i think abdication there is a poor choice (again, from a shareholder perspective).

full disclosure: i used to work at PayPal, and i'm pretty with the conservative approach eBay generally has taken to non-geographic acquisitions. altho the Shopping.com deal was a step towards more active M&A, this is a much more anxious and/or aggressive move -- depending upon your perspective.

[meenfes]

Another Skype threat after Gizmo, VoipBuster, Yahoo Messenger and the mighty Google Talk, OpenWengo is an open source alternative for Skype which includes features such as sip calls, SMS, video conference, and automatic NAT configuration. Currently under heavy development, you can download the stable Windows 2000/XP client and the beta versions for the Linux and Apple variants. The project is calling for developers too.

http://www.openwengo.com/index.php

[Jeremy Fain]

Jeff, your analysis of Skype´s acquisition is one of the best I´ve read on the topic. I tried on my behalf to elaborate a little bit on how Skype is being eventually integrated to eBay. Here´s the link:
http://itaddict.blogspot.com/2006/06/ebay-eventually-integrates-with-skype.html

I have to say that I´m pretty skeptical about the real added value Skype is providing (at least Skype´s voIP component since instant messaging allows for asynchronous answers).