Microsoft-Skype deal likely to boost the online free-calling service


Very little will change in the experience for current Skype users. But Microsoft may try to find ways to get people to pay for the service. (Katherine Frey/WASHINGTON POST)

Microsoft’s blockbuster purchase of Skype will put the free-calling service before vastly more computer users, boosting a technology that already worries traditional phone giants.

Company analysts portrayed Tuesday’s merger — Microsoft’s biggest ever — as a way for the slow-footed firm to catch up to Apple and Google as consumers and businesses begin to move away from staid desktop computers to tablets and smartphones that largely do not run Windows software.

Despite Wall Street’s dim view of the company, Microsoft’s products are nearly ubiquitous, and the company has the ability to promote Skype to hundreds of millions of people worldwide. Skype, like Google Voice and Viber, allows users to make calls over the Web without paying cellular carriers.

The all-cash deal gives the software giant an online communications tool that will be woven through its Office applications, Xbox games and nascent smartphone line. But it had to pay a high price. Skype’s owners will enjoy a multibillion-dollar payoff, even though the company doesn’t make a profit.

Very little will change in the experience for current Skype users. But by integrating Skype into Microsoft’s products, the software giant may try to find ways to get people to pay for the service. Right now, only 1 percent of Skype’s 170 million registered users pay for extra features and to reach people who are not on Skype.

“We see enormous opportunity to grow this business,” said Steve Ballmer, Microsoft chief executive.

The marriage of the companies combines a whimsical Web darling founded by European engineers with a granddaddy of high-tech. Skype chief executive Tony Bates will continue to lead Skype as a separate Microsoft division and report directly to Ballmer, Microsoft said.

It will be Skype’s fourth owner in its nine-year history, which includes an acquisition by eBay in 2005 and a private-equity investment in 2009 by Netscape founder Marc Andreessen, Silver Lake and the Canadian Pension Plan Investment Board. It’s also tried two times to go public, and analysts estimate it would have a stock valuation of about $1 billion.

But Ballmer said he expects Skype will add to Microsoft profits in the first year and that regulators will approve the deal by the end of 2011.

The acquisition doesn’t solve all of Microsoft’s problems. But it immediately makes it a well-known name brand in videoconferencing. Ballmer noted that Skype has come to personify the service it provides.

“Skype is a verb,” he said.

The merger comes at a crucial time for the maker of the Windows operating system. For the past decade, Microsoft’s star has been fading.

It bought Hotmail in 1998 for $100 million, and that business fizzled. The firm’s Zune MP3 player never made a dent in the dominance of Apple’s iPod. Its Bing search engine has slightly improved its market share in recent months but is still far behind Google in market share. And most troubling to observers, the company that transformed the PC has been stuck on the sidelines of the critical mobile phone market while Apple’s iPhone and Google’s Android platforms have taken off.

To be sure, few companies could pull off such a huge purchase.

Microsoft’s finances have been unassailable, thanks to the continued dominance of its old software hits, Windows and Office. In the past decade, the company has doubled its profits, which hit $18 billion last year. As of the most recent quarter, it was holding $50 billion worth of cash and short-term investments.

“The price is high relative to [Skype’s] revenues and profits, but it’s better than just sitting around on top of cash or giving cash back to shareholders,” said Michael Cusumano, a professor at the Massachusetts Institute of Technology Sloan School of Management.

And whatever cool factor Microsoft lacks among consumers, it makes up with a booming business among other companies and PC manufacturers. In the most recent quarter, revenue at the company’s business division grew 21 percent compared with last year.

Despite all this, the company’s stock has been anemic, barely increasing over the past five years, while Apple’s stock has quadrupled. And in the most recent quarter, Apple’s earnings even surpassed Microsoft’s for the first time in two decades.

“Microsoft’s hand is being forced somewhat in making [the Skype] deal, and I’m sure they wanted to pay less,” said Richard Edwards, an analyst at the research and consulting firm Ovum. “But there was too much pressure from Google and certainly from Apple.”

As a result, Ballmer — a close friend of founder Bill Gates — has been under increasing pressure to produce new hits for the company.

Microsoft has typically refrained from blockbuster acquisitions. It made a $44.6 billion bid for Yahoo in 2008 that failed. In the same year, it paid an estimated $500 million for Danger, the company that created the then-popular Sidekick line of mobile phones. Microsoft then tried to capi­tal­ize on the purchase by introducing a new line of phones called Kin that would appeal to teenagers. The product was a flop, being discontinued less than two months after its unveiling.

Cusumano, who has criticized Ballmer and Microsoft’s board of directors for being too conservative, said Windows and Office should remain strong enough for another decade, giving Ballmer more time to come up with Microsoft’s next chapter.

“I think Ballmer can do it,” Cusumano said. “He’s smart enough to be able to do it. He’s just got to have the courage to try.”

Cecilia Kang is a national technology reporter, writing about tech and Internet policies at the Federal Communications Commission and Federal Trade Commission and how regulations affect businesses and consumers.
Jia Lynn Yang is a staff writer at The Washington Post who covers policy and business. Before joining the Post, she worked at Fortune magazine.
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