The Economist doesn’t really like some of the recent Internet acquisitions (sub required). The core of their concern is grounded on what you’d expect: some of these valuations seem completely out of whack. Their view of Ebay’s purchase of Skype is surprisingly harsh:
A Microsoft stake in AOL—which it would merge with its MSN portal—would come hot on the heels of last week’s purchase of Skype, an internet-phone company, by eBay, an internet-auction site. There is no doubt that there is huge commercial potential in internet telephony. But how that potential will come to fruition—and whether Skype will be the company that benefits—are very much open questions. Look at the raw numbers, and this seems like a deal with strikingly bubble-era economics: a price of at least $2.6 billion for a loss-making firm with unlimited ambition but expected revenues this year of only $60m.
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Valuing a firm is tricky at the best of times (as is making a success of a merger), but it is especially hard for a young firm. The rationale of Rajiv Dutta, eBay’s chief financial officer, for the firm’s valuation of Skype does little to inspire confidence. He first compared Skype with eBay’s previous biggest acquisition, of PayPal, an online payment system that is not obviously comparable to a phone service (and which, unlike Skype, eBay knew intimately before the acquisition). PayPal cost 8% of eBay’s market capitalisation in October 2002, said Mr Dutta, whereas Skype cost only 4.8% of eBay’s current market cap. But is that the right measure? Skype’s revenue growth in the 12 months in which it has charged for some of its services, he noted, was faster than eBay’s at a similar stage in its development. Again, why is this relevant? Skype and eBay have completely different business models. Finally, its current losses notwithstanding, Mr Dutta thinks that Skype will have a long-term operating-profit margin of 20-25%—apparently for no other reason than that eBay also assumed that PayPal would achieve that same margin.
Ouch.
What’s interesting is that they aren’t knocking the importance of Internet telephony, just this deal. In fact, their cover story a few weeks back focused on the rise of Internet telephony.
I happen to buy the arguments put forth by The Economist. My reaction to the Skype deal was a muted, “Holy crap!” when I heard the numbers. Then, I was confused as to what Ebay and Skype could do for each other as part of the same enterprise. These aren’t complementary businesses as far as I can tell, even if they do some of the seller/buyer communications things I’ve been hearing about. In fact, I haven’t read one good explanation of why this makes sense as a acquisition and that’s probably the most unusual thing about this. It strikes me as a strategic partnership discussion that got way out of hand…
