Looking at Skype’s valuation

Let me be clear: Skype is an amazing business and one of the great startup success stories. Still, they have proven capable of getting some crazy valuations on more than one occassion.

History has proven that EBay overpaid when it bought them for $ 3.1B ($2.6B in the end according to gigaom). Now they are being valued at $ 2.75B in their majority purchase by Silver Lake et al.

My question is: how is Skype valued at this price? I have incomplete info to be sure, but I don’t see how this business can be worth this price.

Skype is in the long distance calling business. With over 400M members, its a big player. Depending on what blog you read, the purchase price comes in at around 3X – 4.58X revenues. By comparison, Verizon (the largest mobile operator in the U.S.) is valued at 0.8 revenues.

Now, this may or may not be a fair comparison. But, I have been in the VoIP business before. Gross margins are razor thin after you pay termination costs for all those minutes. Traditional carriers (fixed and mobile) don’t make much money on minutes. Instead, they gouge us on all those access fees and other charges. Skype has none of those. It does have leakage (if you don’t use your credits they eventually get booked as revenue) but there are no contracts, no access fees and they pay termination charges on every paid minute.

Skype does have serious advantages over traditional carriers on its customer acquisition costs. Again, no real data here, but I am sure virality continues to play a big role in this key aspect of their business. So, the company may be bottom line profitable. But profitable enough to justify this purchase price?

The only other factor that could justify such a premium would be if Skype was going through massive growth. But Skype’s growth is slowing (10% this year, I think).

So, what’s up? Pure and simple in my opinion: eBay wanted to sell, but did not have to. So, it could hold out. Also it paid a very high price and since it did not have to sell, any buyer would have to come somewhere near the purchase price to get their attention. Then you have potential buyer competition. So, a combination of a scarce and great asset, a seller under no pressure to sell and potential competition on the buy side creates a situation where the price goes up.

Now, the typical private equity play book says you buy low, operate it like crazy, build value and cash out. From what I have heard, the PE sponsors would not have to work too hard to improve execution from the level eBay’s managers were delivering. But, if they have overpaid, then this profit equation won’t work.

Anyway, this is all speculation and fun. I of course don’t really know the scoop. But I definitely look forward to seeing if and when skype goes public so we can all look under the covers. In the meantime, I’m calling it: the buyers overpaid for Skype – again.