Skype: Taking Junk Public

eBay (EBAY) announced that it would do an IPO of its Skype internet phone business. According to eBay’s CEO John Donahoe, “Skype is a great stand-alone business with strong fundamentals and accelerating momentum. But it’s clear that Skype has limited synergies with eBay and PayPal.” Put another way, the business does not have enough economic value for us to keep it, we can’t find a buyer at any reasonable price, so we want to dump Skype on the market by focusing on its very small number of strengths.

Skype brought in about $550 million last year.  eBay believes that sales at Skype can move above $1 billion in 2011. But, the company was founded in 2003, so it will have taken eight years for sales to reach that $1 billion level.  This means that either the company cannot convert its free users to paid users or that VoIP competition from cable TV and independent providers is so strong that Skype cannot create a reasonable business.

There is strong evidence that Skype customers do not want to pay for the Skype service. The firm had 405 million registered users at the end of last year, so on average it received only $1.35 in revenue from each person who had signed up for the service. And, the 405 million figure is a “shock and awe” number aimed at investors.  Skype is lucky to have 20 million people using the service at any given time.

Skype’s strategy to get money out of users is by moving them from the free service which typically involves the use of a PC as a telephone to more traditional products including mobile handsets to call from one telephone number to another instead of between PCs. The premier service that Skype offers is SkypeOut.  This allows subscribers to make calls to landlines or wireless phones for as little as 2.1 cent a minute. The offer seems extraordinarily good so it is astonishing that it brings in so little revenue.

Skype is in a crowded business which is driven by ruthless cost cutting and services which allow subscribers to combine voice, TV, and broadband products for relatively low fees. Cell phone carriers are vendors of hundreds of “free minutes” plans, and the mobile handsets that come with them are not as ungainly as a PC and can readily take advantage of 3G networks to move data or handle video calls.

The pioneer of the low-cost VoIP service that Skype would like to have as its primary business is Vonage (VG). The company had revenue of $900 million last year, about where Skype hopes to be in two years. Vonage ended 2008 with 2.6 million paid subscribers. The operative part of that number is “paid”. Vonage does a little better than break even and its stock trades at $.38 down from its IPO price of $17 on May 24, 2006. So, Vonage has had almost three years to perfect its act for investors. For all of those years of effort, Vonage has a market capitalization of $60 million.

Skype does not have a business. It many ways it is like Facebook and YouTube. Skype has a following, a community of people who use it for free. It has always been free and subscribers never had any plan to pay for it. Skype and Vonage may have hurt the traditional phone business by introducing consumers to services that cost little or nothing. But, wrecking someone else’s business is not always a path to building a new and more viable one.

Douglas A. McIntyre