Can the Skype Deal Turn Into a Long Term Catalyst for Microsoft Shares?
Microsoft Inc. (NASDAQ:MSFT) is going green in more ways than one. Not only is Microsoft shelling out a lot of green ($8.5 billion) to acquire internet communication company Skype, but Microsoft is also going green by recycling Skype – an asset previously tossed away as garbage by eBay Inc. (NASDAQ:EBAY). While I’m certain Microsoft executives did their due diligence and a large cadre of savvy bankers provided their stamp of approval on the deal, recycling a previously disposed item successfully poses some unique challenges.
What could possibly go wrong in a sexy, strategic deal that plans to leverage Skype’s power of internet communication across Microsoft’s various businesses including mobile, business software, gaming, and advertising platforms?
- Sticker Shock: The Microsoft-Skype deal is still in its early phases, but the multi-billion price tag has already elicited heartburn from some investors (heart attacks among others). In Microsoft’s defense, what’s a mere $8.5 billion among friends, especially if your wallet is stuffed with over $60 billion in cash like Microsoft? With the 3-month Treasury bill currently yielding 0.02%, the massive wads of cash that Microsoft (and other tech giants) is sitting on appear to be burning a hole in buyers’ pockets. In a kooky internet world where IPO valuations of $70 billion for Facebook, $25 billion for Groupon, and $3 billion for LinkedIn are freely tossed around, an $8.5 billion Skype offer may seem like par for the course (or even a bargain). Sadly, however, I am having difficulty reconciling how Microsoft will take 663 million money-losing customers at Skype and balance the laws of economics by adding further volumes of money-losing customers. Apple Inc. (NASDAQ:AAPL) spends about $2 billion per year in research & development, and is expected to produce more than $100 billion in revenues in fiscal 2011, while the $8.5 billion that Microsoft spent on Skype produced less than $1 billion in revenues last year. I presume Microsoft has some aggressive assumptions built into their Skype forecasts to rationalize the price paid for Skype.
- Failure Déjà Vu: Does the desire to integrate wiz-bang technology into existing product platforms sound familiar? It should – eBay Inc. (NASDAQ:EBAY) already attempted and failed at integrating Skype before it threw in the white towel at the end of 2009 and sold a majority $1.9 billion stake of Skype shares back to a group of investors, including the Skype founders. Back in 2005, when eBay paid a then bargain of $3.1 billion for Skype (including earnouts), former CEO Meg Whitman evangelized the “Power of 3” (Skype + eBay’s Marketplace + PayPal) – I suppose new CEO John Donahoe must now promote the “Power of 2.” In Skype merger sequel of 2011, Microsoft’s CEO Steve Ballmer is espousing the benefits of Skype across Microsoft properties such as Outlook, Windows Live Messenger, Xbox, Kinect, and its newly created Nokia Corp. (NYSE:NOK) relationship. Gaudy priced mergers in the internet/social media space have a way of eventually ending up in the deal graveyard. Consider AOL Inc.’s (NYSE:AOL) 2008 deal with social network Bebo for $850 million – two years later AOL sold it for $10 million. News Corp’s (NASDAQ:NWS) high profile purchase of MySpace for $580 million is reportedly looking for a new home at a fraction of the original price ($50 million). Hewlett-Packard Co.’s (NYSE:HPQ) ostentatious $2.4 billion value (~125 x’s forward earnings) paid for 3Par Inc. during a bidding war with Dell Inc. (NASDAQ:DELL) in 2010 is another recent example of a risky high-priced deal.
- Telco Carrier Skepticism: Although Microsoft has ambitions of taking over the world with Skype, the telecom service carrier companies that facilitate Skype traffic may feel differently. As the telcos spend billions to expand the global internet superhighway, if Skype is clogging traffic on their networks then the carriers will likely require additional compensation – no freeloaders allowed.
- Rocky Past Marriages: When it comes to acquisitions, Microsoft historically hasn’t fooled around as much as some other large Fortune 100 companies, nonetheless some important past relationships have gone sour. Take for instance Microsoft’s previous largest $6 billion cash acquisition of aQuantive Inc. in 2007. As Microsoft continues to chase Google Inc. (NASDAQ:GOOG) at their heels, Microsoft has little to show for the aQuantive deal, except for a lot of employee turnover. The sizable but smaller $1.1 billion acquisition of Great Plains in 2001 has its critics too. Like Skype, the Great Plains business software deal made strategic sense, but six years after the units were fully integrated founder and owner Doug Burgum packed his bags and left Microsoft.
What happens next for Microsoft? I know it’s difficult to imagine that Microsoft’s colossal underperformance since the beginning of 2010 could worsen – Microsoft has underperformed the market by a whopping -38% over that period – but by massively overpaying for Skype’s losses, Microsoft is not making their own job any easier. Although Microsoft has missed many key technology trends over the last few years (e.g., search, mobile, tablets, social media, etc.) and its stock has been in the dumps, the PC behemoth is looking to salvage a previously failed merger into a successful one. Time will tell if Microsoft can recycle a trashed, money losing operation into hefty green profits. If not, investors will be out for blood wondering why $8.5 billion was thrown away like garbage.
Wade W. Slome is a CFA and CFP® at Sidoxia Capital Management.
Disclosure: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG), but at the time of publishing SCM had no direct positions in MSFT (NASDAQ:MSFT), Skype, EBAY (NASDAQ:EBAY), AOL (NYSE:AOL), HPQ (NYSE:HPQ), DELL (NASDAQ:DELL), NOK (NYSE:NOK), Facebook, MySpace, LinkedIn, Groupon, Bebo, or any other security referenced in this article.
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