ANALYSIS OF MICROSOFT'S STRATEGIC ACQUISITION SKYPE

Michael Osypenko

Veranika Zdanovich

Ruslan Samchuk

Denis Solyan

MAIN GOALS OF PROJECT

• Analyze Microsoft’s latest acquisition of Skype

• Understanding Skype’s and Microsoft’s business models and their product portfolio respectively

• Microsoft’s reasoning behind the acquisition

• How Microsoft got best benefits from the acquisition

• To analyze data support of acquisition

• Make your own critical conslusions

KEY FACTS AND FIGURES10th May 2011: Microsoft acquirers Skype at a price of $8.5 billion (cash)

Financial multiples (Skype 2010): Very high relative to other companies

Enterprise value/EBITDA: > 32x within the IT sector!

Skype is growing rapidly (from 2009 to 2010):• User base: 40%

• Calling minutes: 150% (18 months)

• Revenue: 20%

• EBITDA (adj.): 40%

AIMS OF THIS ACQUISITION FOR MICROSOFT Strategic reason

• In line with Microsoft’s growth strategy

• Prevent competitors such as Google and Apple from buying

Product reason

• Skype is the perfect complement to Microsoft’s existing products

• Live video chat on Windows computers and Xbox 360

• Communication when working with Microsoft Office

• Call-back and instant messaging features in Outlook

• Increase competitiveness on the Windows Phone 7 mobile platform

Network reason

• Leverage the network effects

• Direct line communication with Skype’s large customer base (ca.700 million)

• Connect Skype users with Lync, Outlook, Xbox Live and other communities

MICROSOFT CAN LEVERAGE SKYPE IN SEVERAL WAYSPros:• Acquisitions is in line with the company’s growth strategy

• Prevent competitors from acquiring Skype

• Skype’s technology is complementary to MS products and can be integrated in all of the company’s business segments

• The company got access to Skype’s large customer base

Cons:• Concerns about the high acquisition price

• Problems to integrate (retaining employees, organizational etc.)

MICROSOFT

World’s largest software company

based on software revenue.

Microsoft’s mission is to create

technology that transforms

the way people work,

play and communicate.

MICROSOFT’S PRODUCT PORTFOLIO

REVENUE AND PROFIT OF MICROSOFT

MICROSOFT’S OBJECTIVE AND STRATEGY

• Time is a critical factor in this business it takes much longer time to develop a well functioning product themselves than to acquire.

• By buying Microsoft gets Skype’s existing customer base leverage the network effect

• Large pile of cash is being put to work

“Strategic partnerships and acquisitions have always played an important role in Microsoft's strategy for growth and technology leadership.”

Steven A. Ballmer (Microsoft CEO)

SKYPE BUSINESS MODEL

• Freemium• Free-of-charge services • Premium services

SKYPE

SKYPE REVENUE

THE DEAL

- Total consideration would be $8.5 billion in cash

- Skype will become a new division of Microsoft

- Microsoft’s largest acquisition till date, surpassing the $6 billion paid for aQuantive

The division of the consideration between Skype’s shareholders Silver lake and other investors - $4.76 billion for 56% stake which they purchased from

eBay for 1.9 billion in 2009 eBay – 2.55 billion for 30% stake (they had acquired Skype in 2005 for 2.6 billion and

sold it for 1.9+2.55=4.45 billion) Skype’s founders – 1.19 billion for 14% stake

REACTION TO ACQUISITION ENOUNCEMENT

KEY RISK FOR MICROSOFT

The rate of financial performance may decline

How have the acquisition affected on the share performance?

KEY QUESTION OF MICROSOFT

FINANCIAL OVERVIEW OF SKYPE AND MICROSOFT

REASONS BEHIND NEGATIVE REACTION

• Skype did not seem to improve Microsofts and profitability

• The valuation of Skype was very high (10x revenues and 34x EBITDA v/s the industry average of 7x-8x EBITDA)

• Given that there was no actual bidding war and that Microsoft’s bid was launched to pre-empt Skype’s investors from an IPO, offering USD 8.5 billion was to high

• Microsoft had large cash balances it would have been a good time for the deal

• Skype itself had insisted USD 7 billion as the starting point of negotiations

• Success of this acquisition depends on whether Microsoft can convert the thrifty users into future Microsoft revenues

• Skype revenue is low

• Only 8.8 million Skype users out of 663 million users were paing customers (meagre 1.3 of total users)

TRANSACTION COMPARABLES

Paid User Base of Skype (in ‘000s) = 8,800

Estimated equity value = $2,173 billion

Premium paid by Microsoft = 291,2%

SKYPE FINANCIALS BEFORE QUIZITION, THOUSANDS OF U.S. DOLLARS

December 31, 2007

December 31, 2008

November 18, 2009

June 30, 2009 June 30, 2010 0

100

200

300

400

500

600

700

Net revenue

Gross profit

Total operating expenses

Net income (loss)

DISCOUNTED CASH FLOW

MICROSOFT FINANSIALS BEFORE AND AFTER AQUIZITION MILLIONS OF U.S. DOLLARS

June 30, 2009 June 30, 2010 June 30, 2011 June 30, 2012 June 30, 20130

10

20

30

40

50

60

70

80

90

Net revenueGross profitSG&A ExpenseNet income loss

June 30, 2009

June 30, 2010

June 30, 2011

June 30, 2012

June 30, 2013

8

8.2

8.4

8.6

8.8

9

9.2Microsoft's shares oustanding, figures in

billions

Basic Shares Outstanding

Diluted Shares Outstanding

June 30, 2009

June 30, 2010

June 30, 2011

June 30, 2012

June 30, 2013

0

1

2

3

Microsoft's EPS

EPS (basic)EPS (diluted)

POST ACQUISITION RESULTS

Skype has been integrated with Microsoft link and integration efforts are continuing

Skype has reported high revenue growth (CAGR) of 55% in the past two years

BENEFITS AND SYNERGIES OF THE ACQUISITION

1. Strategic reason

• a. In line with Microsoft’s growth strategy

• b. Prevent competitors such as Google and Apple from

buying

2. Product reason

• a. Skype is the perfect complement to Microsoft’s

existing products

• b. Live video chat on Windows computers and Xbox 360

• c. Communication when working with Microsoft Office

• d. Call-back and instant messaging features in Outlook

• e. Increase competitiveness on the Windows Phone 7

mobile platform

3. Network reason• a. Leverage the network effects• b. Direct line communication with Skype’s large

customer base (ca.700 million)• Connect Skype users with Lync, Outlook, Xbox Live and

other communitiesDEFENSIVE RATIONALE

If Microsoft did not buy Skype, it may have ended up in the hands of a competitor such as Google, who might be able to use it to strengthen its ecosystem at the expense of Microsoft.

OFFENSIVE STRATEGY

Google’s acquisition strategy is usually to acquire earlier-stage companies than Microsoft’s deal to acquire Skype. Google purchased YouTube for $1.6 billion in 2006.

Benefits and synergies of the acquisition

POSSIBLE ISSUES WITH THE ACQUISITION

1. High price• Skype is growing quickly• Value is exponential correlated with number of user• Price/user: Skype 12 $ a Facebook 62 $2. Hard to integrate• Ebay had a hard time integrating• Skype complementary to Microsoft’s business strategy.

Acquisitions are a quick way to move into the space that these tech giants see evolving, such as Microsoft seeking to broaden its communication base, Google expanding beyond search to experiment with new models of advertising, and Facebook’s attempts to learn from the human capital that they are able to acquire

CONCLUSION

Microsoft bought a complementary company, hence Skype mirrors many of Microsoft’s existing products and in our opinion can Microsoft leverage Skype in several ways.

• Pros

1. Acquisitions is in line with the company’s growth strategy2. Prevent competitors from acquiring Skype3. Skype’s technology is complementary to MS products and can be4. integrated in all of the company’s business segments5. The company got access to Skype’s large customer base

• Cons

1. Concerns about the high acquisition price2. Problems to integrate (retaining employees, organizational etc.)

THANK YOU

FOR

YOUR

ATTENTION!