Microsoft's Acquisition of Skype

1. Group 9
Soumyajit Sengupta 12P171
Aneesha Chandra 12P186
Arunabh Thakur 12P190
Karthik Kollipalli 12P204
Mergers & Acquisitions, Section B
A POSSIBLE SUCCESS STORY IN THE MAKING
Microsoft‟s Acquisition of Skype

2. CASE BACKGROUND

3. Technology Industry Scenario
2010-11 : The Recovery Era
 Period of Recovery - Renewed
Optimism and Strengthening balance
sheets
 Increasing spending on IT products and
services
 Consumers expected to spend $2.1
trillion on technology products and
services worldwide
Key Trends
 Consolidation ( Expansion into new
technology, Industry and Geographies)
 Licensed Software(SaaS)
 Virtualisation (VoIP)
Top 13 deals ($1 billion +) of the top 100
global technology companies, full-year 2010
Opportunities
 Cloud Services
 Security products and services
 Healthcare IT markets
 Virtualization products and services
 Mobile services (expected to generate
37% of total worldwide consumer
technology spending in 2012)
 Entertainment Services
Tech Market Factors: Economic Growth Versus
New Tech Adoption By Country

4. VoIP Industry Scenario
2010-11 : Fastest growing Industry in U.S
 Growth of 12.6% in 2010
 Industry expected to grow by 16-17% in
the next 5 years
Key Drivers
 Cost Savings and Greater efficiencies
 Increasing Global Network and Wireless
bandwidth capabilities (3G)
 Increased adoption by China, Japan,
South Korea
 VoIP aligning with cost cutting strategy of
firms post recession
 Expanding SMB and enterprise offerings.
VoIP, video conferencing and real-time
communication capabilities
Key Trends
Strategic Collaboration & Integration
 Hardware Providers (Avaya , Verizon
with Skype)
 Technology (Facebook with Skype)
 Mobile Operators (KDDI Japan with
Skype)
 Technology Compatibility (Ex: Skype
for Android)
 M&A on the rise
Challenges
 Regulatory Compliance (Open Internet
Access)
 Quality and Reliability of VoIP services
 Free Business Models
Announcement Date Acquirer Target Company
Feb-10 Comcast New Global Telecom
May-10 Google, Inc. Global IP Solutions, Inc.
Oct-10 ShoreTel Agito Networks
Nov-10 M5 Networks Geckotech
Nov-10 Cbeyond, Inc. Aretta Communications
Apr-11 M5 Networks Callfinity
Apr-11 West Corporation Smoothstone IP
May-11 Microsoft Skype
Jun-11 USAN, Inc. Interactive Softworks, Inc.
Jul-11 Interactive Intelligence CallTime Solutions
Sep-11 8x8 Inc. Contactual Inc.
Sep-11 Broadsoft iLinc Communications
Oct-11 Avaya, Inc. Sipera Systems, Inc
Dec-11 Stage 2 Networks hosted division of CTI
Dec-11 Warwick Valley Telephone Alteva

5. Microsoft – Company Profile
Company Overview
 Incorporated on September 22, 1993
 Involved in developing, supporting and
licensing an array of software products and
services
 Also works to design and sell hardware, and it
delivers online ads to the customers
 Number of employees: 90000 Full Time
 54000 US and 36000 International
 35000 Product research, 250000 Sales and
Marketing, 16000 product support, 5000
manufacturing
VISION
To help people and
businesses throughout
the world to realize
their full potential
Key Divisions
Windows and Windows Live
 Develops and markets PC
operating systems, PC
hardware products and
related software and
online services
 Products – Windows 7,
Windows Live, hardware
 Competitors – Apple,
Google, Yahoo!
Server and Tools
 Develops and markets
server software, services,
software developer tools,
and solutions
 Products – SQL server,
Intune, Visual Studio,
Silverlight
 Competitors – HP, Oracle,
IBM, Adobe, Intel, Google,
SAP
Microsoft Business Division
 Develops products that
are designed for
increasing personal,
organizational and team
productivity
 Products – Office, Lync,
SharePoint and Exchange
 Competitors – Adobe,
Apple, Corel, Google,
IBM, Oracle
Entertainment and Devices
 Develops and markets
products and services
designed to entertain and
connect people
 Products – Xbox, Kinect,
Mediaroom, Windows
Phone
 Competitors – Nintendo,
Sony, Apple, Google
Online Services
 Develops and markets
information and
content designed to
help people simplify
tasks online, and help
advertisers to connect
with audience
 Products – Bing, Atlas,
MSN and ad Centre
 Competitors – Google,
Yahoo
Acquisition History
 Microsoft acquires an average of 6
companies per year
 Acquired 18 companies in 2006
 Some notable acquisitions are:
 Forethought – Created Microsoft
PowerPoint
 Hotmail – Free webmail service
 Navision – Developed technology for
ERP software
 aQuantive – advertising company

6. Skype – Company Profile
Company Overview
 Global technology leader that enables real-
time communication over the Internet
 The software-based communications platform
offers high-quality, easy-to-use tools for
consumers and businesses to communicate
and collaborate globally through voice, video
and text conversations
 663 million registered users, out of which 8.8
million are paying users
 During 2010, Skype‟s users
 made 207 billion minutes of voice and
video calls using Skype
 Sent over 176 million SMS text messages
through Skype
 Video calls accounted for approximately 42%
of all Skype-to-Skype minutes
 Strategic Relationships with leading mobile
operators (Verizon Wireless in USA, KDDI in
Japan)
 Uses peer-tp-peer architecture which gives
them a significant cost advantage as no
physical communications network required
Products and Features
 Mobiles – Skype‟s products are on
multiple platforms including iOS,
Blackberry, Linux, Android and Symbian
 Integrated Features – Integrated with
Facebook
 Premium Products – Additional features
like group video calling, live chat
customer support, discount on HD
webcams, etc.
 Marketing Services, including Advertising
- Allows businesses to market their
products or services selectively to
Skype‟s user base, including Click & Call,
which enables users to initiate a Skype
call from a website to participating
businesses
 Skype Enterprise- Skype Manager allows
businesses to manage Skype accounts
for their employees; Skype Connect
allows businesses to connect their
private telephone branch exchange
(PBX) over the Internet to the peer-to-
peer network of Skype users to achieve
low-cost calling
Competitive Strengths
 Large, highly engaged, growing and
diverse global user base
 Strong network effects
 String communications brand
 Low cost and highly scalable peer-to-
peer architecture
 High-quality, multi-feature voice and
video product suite
 Payment infrastructure
 Software platform that is device and
network agnostic
 Attractive financial structure
Key Shareholders
 Silver Lake
 eBay International AG
 Joltid
 Canada Pension Plan Investment Board
 Andreessen Horowitz

7. DEAL DETAILS

8. Deal Rationale
 Enhances Microsoft‟s portfolio of real-time communications products and services
 Microsoft had a long-standing focus on real-time communications across its various
platforms including Lync, Outlook, Messenger, Hotmail and Xbox Live
 “Increases the accessibility of real-time video and voice communications, bringing benefits
to both consumers and enterprise users and generating significant new business and
revenue opportunities”
 Cross-selling the vast array of Microsoft family products to Skype users
 The key opportunities would be core communications service,, new premium subscription
packages (monetization), in-app advertising and mobile space
 Allows integration of Skype with Windows Phone, Nokia and Windows Office making it a
competitive offering to Google Voice and Apple‟s emerging communication platform,
Facetime
 Skype‟s peer-to-peer video chat adds another potentially more efficient and easier way
to place video calls
 Microsoft lags in new fields like smart-phone software
 Microsoft‟s current platforms are client-server systems
 Peer-to-peer technology is better suited to the cloud computing era

9. Deal Rationale (contd.)
 Skype‟s video, voice and sharing capabilities would give Microsoft a boost in
enterprise collaboration market
 Allows Microsoft to compete against Cisco and Google
 Creation of Microsoft-Skype World
 Skype will support Microsoft devices like Xbox, Kinect, Windows Phone etc.
 Microsoft will connect Skype users with Lync, Outlook, Xbox Live and other
communities
 Microsoft will continue to invest in and support Skype clients on non-Microsoft platforms
 Microsoft saves time and effort in building out its own VoIP infrastructure
 Gives Microsoft a working relationship with carriers who are looking to partner
with Skype as they start to transition to LTE-based networks
 Skype is a must-have application and service which will help in the adoption of
the future versions of Windows Mobile operating system

10. Deal Rationale (contd.)
 Skype is a great brand, especially for customers
 Allows Microsoft to revive its internet advertising revenue
 Prevents Google and Facebook from acquiring Skype (There were rumours that
these companies were interested in Skype)
 Allows Microsoft to hold onto SOHO/SMB market
 Skype had a huge user base of more than 660 million users, including more than
120 million active or “connected” users
 Rate of growth of users is 40% per annum
 Microsoft had huge cash balances of around USD 50 billion
 As an economic transaction, Microsoft was able to acquire Skype on a tax
efficient basis using offshore cash
 As Skype is based in Luxembuorg, the corporate tax rate applicable is 25.2% (US
corporate tax rate is 39%!)
 80% of Microsoft‟s cash balances are abroad

11. Deal Modalities
 On 10 May, 2011, Microsoft announced that it would be acquiring Skype
 Total consideration would be $8.5 billion in cash
 Skype will become a new division of Microsoft with the Skype CEO, Tony
Bates heading the newly created division.
 Microsoft‟s largest acquisition till date, surpassing the $6 billion paid for
aQuantive
 The division of the consideration between Skype‟s shareholders –
 Silver Lake and other investors – $4.76 billion for 56% stake which they
purchased from eBay for $1.9 billion in 2009
 eBay – $2.55 billion for 30% stake (they had acquired Skype in 2005 for $2.6
billion and sold it for 1.9+2.55 = $4.45 billion)
 Skype‟s founders - $1.19 billion for 14% stake

12. Key Risks for Microsoft
 The rates of net revenue growth may decline
 The rate at which registered, connected and paying users are added may
decline
 Failure in converting registered users in paying users
 Number of registered and connected users may be overstated
 Most of the products of Skype are free and a small proportion of the users are
paying users. Thus, even a small decline in the paying users has a major impact
on the revenue generated
 Highly competitive industry characterized by rapid technological changes
 Emergence of new competitors/technologies may make Skype obsolete
 Regulation of Internet communications products
 Possibility of Skype getting banned in countries (e.g. Already banned in UAE,
Egypt)
 Brand value can be affected if users concerns about the use and protection of
personal data and privacy of their communications

13. Reaction to Acquisition Announcement
Microsoft’s share price declined by 0.5% to $25.68
on the day of announcement
eBay’s share price increased by 2.5%

14. Reasons Behind Negative Reaction
 Skype did not seem to improve Microsoft‟s revenues and profitability majorly
 The valuation of Skype was very high (10x revenues and 34x EBITDA v/s the industry average of 7x-8x EBITDA), given the Y-
o-Y revenue growth of just 20%
 Given that there was no actual bidding war and that Microsoft‟s bid was launched to pre-empt Skype‟s investors from an
IPO, offering USD 8.5 billion was too high
 Skype itself had insisted USD 7 billion as the starting point of negotiations
 Success of this acquisition depends on whether Microsoft can convert the thrifty Skype users into future Microsoft
revenues
 Skype‟s revenue per user is low
 Only 8.8 million Skype users out of 663 million users were paying customers (a meagre 1.3% of total users)
 There can be several integration issues
 Microsoft‟s acquisitions have generally led to entry into new businesses with minimal overlap with the existing
business
 In case of Skype, Microsoft would have to integrate several technologies and products for this acquisition to work
 Microsoft‟s bureaucratic structure may create hurdles in the path of successful integration
 The timing of the purchase was not right as the stock market had fully rebounded in 2011
 As Microsoft had its large cash balances in 2009 and 2010, it would have been a better time for the same deal
 Peer-to-peer technology takes up a lot of bandwidth and was considered inefficient

15. ACQUISITION TRACK RECORD OF MICROSOFT

16. Previous Acquisitions by Microsoft
Landmark Acquisitions
Company Deal Value Deal Rationale Success factors Failure Factors
Success
Rate
Forethought $ 14 Mn
 To add presentation program to
portfolio of Ms Office
 To give the company presence in
Silicon Valley
 Creation of PowerPoint
 Gave Microsoft a Silicon
Valley presence
 Acquired a talented
pool
Hotmail $500 Mn
 To have a complete portfolio of free
email and search engine
 To drive traffic to its revenue-
generating sites by keeping users within
the Microsoft circle
 Increased scalability of
service
 Increase in number of
members
 Higher traffic on other
Microsoft sites like
Expedia
 Growth of Gmail
 Hotmail lacked the
unlimited storage and
clean and professional
interface of Gmail
Navision $1.3 Bn
 To provide the strongest .NET
applications and development
platforms, including extensible
accounting solutions based on the .NET
platform
 Microsoft Dynamics NAV
became a successfully
recognized global
solution
 Change of name was
detrimental

17. Company Deal Value Deal Rationale Success factors Failure Factors
Failure/
Success
Aquantive $6 Bn
 To compete with Google and other
rising computer companies by giving
it exposure to search-based
advertising
 Focus was made on search
advertising whereas aquantive
specialized in display advertising;
Aquantive started lagging behind
rivals
Danger $500 Mn
 To get a perfect complement to
Microsoft‟s existing software and
services
 To improve mobile experiences
 Talented workforce with rich
experience in what customer
want from a mobile
 Another department set to build
Windows 7; Made danger useless;
Internal fighting
Fast Serve $1.2 Bn
 To gain proficiency in enterprise
search which was becoming an
indispensable tool to businesses of all
sizes, helping people find, use and
share critical business information
quickly
 Deep talent pool expertise in
high-end search solutions
 Increased Microsoft‟s
research and development
presence in Europe
 Lack of due diligence – the
company was charged with
accounting fraud and raided by
police few months later
Greenfield
Online
$486 Mn
 To extend Microsoft's search and e-
commerce services in Europe
 Gain in market share in
Europe
3DV $35 Mn
 To gain a stronger foothold in the
video game console market by use
of 3D animatronics.
 Xbox Connect uses 3D
sensors for its operation
 Allowed it to compete with
Nintendo Wi
Previous Acquisitions by Microsoft
Recent Acquisitions

18. Previous Acquisitions by Microsoft
Minority Stake Acquisition
Company
Deal
Value
Stake Size Deal Rationale For Microsoft Deal Rationale For Company Success Factors
Overall
Success
Facebook $240 Mn 1.60%
 Keeping Google at bay
 Gain cachet in the
burgeoning internet
economy
 Facebook can hire more
employees, build its
website and handle more
traffic
 Microsoft will get exclusive
rights to sell advertising on
Facebook, which presently
has little revenue-raising
content
Apple $150 Mn
150,000
shares
 Patent and technology
cross-licensing agreements
between Apple and
Microsoft
 Apple agreeing to install
Internet Explorer as the
default Web browser on all
Macs,
 Bail out for Apple which
would have otherwise
gone bankrupt leaving
Microsoft to have a
monopoly
 Turnaround of Apple meant
high growth in stock prices
which would have allowed
Microsoft to earn
considerably higher profits
when compared to the $8
at which Microsoft bought it

19. Key Takeaways
 Microsoft has had a series of both successful and not so successful
acquisitions in the past
 A key point to note is that most of the recent acquisitions have not
performed that well
 Integration is not one of Microsoft‟s fortes and in case of Skype, the
pace and extent of cultural and technological integration can
make-or-break this deal

20. VALUATION OF SKYPE

21. Skype Valuation
Transaction Comparables
Acquirer Target
Paid User Base
(in '000s)
Deal Value
(In $ Millions)
Equity Value/
User Base
Telanetix AccessLine 100 34.9 0.35
Google Global IP Solutions 150 68.2 0.45
Google Gizmo5 6,000 30.0 0.01
Google On2 Technologies 100 106.0 1.06
ShoreTel Agito Networks 190 11.4 0.06
Intermedia Telanetix 290 42.0 0.14
Median 0.25
 Paid User Base of Skype (in „000s) = 8,800
 Estimated Equity Value = $2.173 billion
 Premium Paid by Microsoft = 291.2%

22. Skype’s revenues have been growing at a CAGR of 55% after
Microsoft’s acquisition. Thus, Microsoft actually just paid a
premium of 14%!
Skype Valuation
Discounted Cash Flow
 Historical financial data for 2009-2011
based on Skype‟s SEC filing on March 4,
2011
 Key assumptions:
 WACC for initial years = 12%
 Terminal WACC = 6%
 Revenue CAGR for next 5-years =
35%
 Terminal Growth Rate = 3%
 Equity Value = $2.27 billion
 Premium Paid by Microsoft = 274.4%
Terminal Period Growth
TerminalWACC
1% 2% 3% 4% 5%
2% 10526.0 NM NM NM NM
4% 2624.1 4285.0 9268.1 NM NM
6% 1089.8 1532.6 2270.6 3746.6 8174.7
8% 458.6 646.5 909.6 1304.1 1961.6
10% 124.4 222.4 348.4 516.3 751.3
Sensitivity Analysis
Equity Value (in $ million)
Estimates
Revenue
CAGR 2011-15
Equity Value
(in Mn)
Premium/
Discount
Industry Estimates 20% 544 1,462%
Analyst Estimates 35% 2,270 274%
Microsoft‟s Estimates 40% 3,174 168%
Actual 55% 7,438 14%

23. Post-Acquisition Results
 Currently, the acquisition has bore positive results –
 Skype has been integrated with Microsoft Lync and integration efforts are continuing
 Skype has reported strong revenue growth (CAGR) of 55% in the past two years

24. DEAL EXTERNALITIES

25. Facebook
The Clear Winner
 Microsoft had purchased 1.6% stake in Facebook for $240 million in 2007
 On its own, Facebook had no or very low chance of purchasing Skype
 However as Microsoft is an investor in Facebook, the latter would get access
to Skype‟s assets
 At the same time, Google would not have access to Skype
 Thus, even though Microsoft finally purchased Skype, Facebook came out
as a clear winner
 Why Microsoft gave this access to Facebook? – The Microsoft-Skype-
Facebook trio make a worthy competitor to Google

26. Developments in 2013
 Cisco challenged European Commission‟s approval of Microsoft‟s acquisition of
Skype
 The arguments are that the acquisition creates an unfair monopoly and that
there could be serious harm to consumers:
 Around one-third of world‟s voice communication is via Skype
 Microsoft would control 80-90% of the market for video calls on Windows-based
computers
 Microsoft was required to make no concessions in its purchase
 The counter argument given by EC is:
 There is no evidence of competitive harm
 Other emerging technologies can succeed making Skype obsolete
 Cisco‟s main demand is inter-operability – the capability of any device to
connect to any content that allows Internet to grow
 If Cisco wins this case, then Microsoft may have to annul its acquisition of Skype

27. THANK YOU