There has been chatter in popular media about the possibility of Microsoft buying Skype (30% owned by eBay) for $8.5bn. While this has not been confirmed by either company, there have been multiple chatters of possible bids for Skype from Google, Facebook, etc. over the past two weeks. Equally important, during the March quarter there was a noticeable decline in Microsoft's repurchase program (only $827mm was spent on buy-backs vs. $5bn in Dec-10 and $4bn in Sep-10 quarters) and the company has been increasing its long-term debt position. In our view, an acquisition of Skype by Microsoft makes sense, given how important "communication" and "mobile" are for Microsoft. As far as valuation is concerned, our estimates imply 25x forward EV/EBITDA for Skype, which is somewhat rich. As far as eBay is concerned, the $8.5bn valuation for Skype implies $2 per share for eBay or $0.50 per share higher than our estimates.

Key Points

How does Skype fit with Microsoft? In our view, Microsoft can leverage Skype in many ways. First, Microsoft can enhance its Communications/Lync Server 2010 for its enterprise-class customers. Second, Microsoft can also beef up its offerings for Live Meeting with Skype and further integrate Skype into Office. Third, as far as consumers are concerned, Microsoft can bring product integration and create lots of cross-selling and up-selling opportunities for Windows Live users and Skype users. Finally, Microsoft can use Skype to enhance the value pillars of its Windows Phone 7 offerings.

âOur assessment of valuation. The chatter is that Microsoft would be paying close to $8.5bn for Skype (including assumption of $865mm in debt). The $8.5bn implies a 32.0x multiple on 2010 adjusted EBITDA and perhaps 25.0x 2011 EBITDA assuming 30% increase in adjusted EBITDA from 2010 to 2011. While this seems like a rich multiple, Skype grew its user base by 40%, revenue by 20%, and adjusted EBITDA by 40% from 2009 to 2010.

âAbout Skype. Skype is the global leader in Internet telephony with close to 700mm users and 207bn in global calling minutes. The company generated $860mm in revenue and $264mm in adjusted EBITDA in 2010. Skype was founded in 2003 and is owned by eBay (30%) and a group of investors (remaining 70%) including Silver Lake Partners, Canada Pension Plan Investment Board (CPPIB), Andreesse Horowitz, and Joltid.

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