As I long time shareholder of Microsoft (MSFT, Financial) and value investor, I was initially disappointed about the acquisition of Skype. Buying a company for 9X sales made me feel as though I was purchasing a momentum stock like Salesforce.com or Lululemon. However, I always remind myself that even Buffett would buy Microsoft if he did not have a close relationship with Bill Gates.
The Skype purchase opens up three new business markets for Microsoft. The deal may prove to be an intelligent allocation of capital in the long run.
What most investors do not understand is that Microsoft is an enterprise company. Yes, there have been forays into the consumer market such as Xbox and Kinect and even some ill-fated projects like the Zune media player.
However, the majority of revenues come from businesses. Businesses cannot function without two Microsoft products – Windows and Office. Perhaps this will change someday but disruption of the backbone of Corporate America is not on par with a company like Expedia disrupting travel agents.
In that way Microsoft is like a utility company. Businesses cannot function without electricity and they cannot function without these two Microsoft products.
This “utility” status will not change anytime soon because Fortune 500 companies are not going to gamble with some open source, cloud-based operating system just because some pimple faced teenager thinks it’s a cool idea.
Skype is largely business software. I use Skype to communicate with staff overseas and many small businesses do the same.
However, for video conferencing I use Webex. I expect that Microsoft will bundle a video conferencing solution into Skype in order to take a chunk out of Cisco’s (CSCO) market. Cisco bought Webex for $3.2 billion in 2007. This was also at a valuation of 9X sales, a similar multiple to what Microsoft paid for Skype.Thus, Microsoft has now opened up a new revenue stream with the Skype purchase.
The second way that I use Skype is on my iPhone. In order to avoid paying outrageous roaming charges when traveling for business, I use Skype and make local calls. When I’m trying to save my mobile minutes I might also use Skype. Thus, with the Skype deal, Microsoft has now entered my mobile world that was previously dominated by Apple (AAPL). As a matter of fact it was the only way that Microsoft was going to get me to use their software on my iPhone. Secondly, if a new smart phone comes out that has Windows 7 software and highly subsidized data rates I might even switch from my I-Phone. I would not mind a local Skype number that I can use to replace my wireless number if it meant that I could cut my cellphone bill in half.
The third benefit of the Microsoft acquisition is that Microsoft is now dominant in voice over IP. Yes, Microsoft paid a hefty price for the 600 million users of Skype. However, Skype could have a virtual monopoly on voice over IP.
Despite a lack of profitability, Skype did have a "moat." The reason is that once a user becomes accustomed to using Skype, he is unlikely to switch to a competitor. For example, Google Voice may be a cheaper and better product than Skype, but I’ve been using Skype since 2004 and it’s just not worth the hassle of switching over to Google. If Skype increased prices by 25% I still wouldn’t bother switching to Google.
Skype may not have been profitable but that does not mean that the service does not have pricing power. The main reason for this is that the prices are negligible relative to other services that I pay for. My cable and my wireless bill are $100/month and I notice price increases. I will always look for ways to cut those bills. However, if my Skype bill goes up from $10 to $15, it is not going to even register with me.
For all those Ballmer bashers who insist that Microsoft does not know how to allocate capital, let us remember that Microsoft bought 1.6% of Facebook for $240 million in what was largely panned as a dumb deal. It is now considered a brilliant deal as Microsoft has made six times their initial investment.
The big loser in the aftermath of the Skype acquisition is Research in Motion (RIMM).
Microsoft has now allied itself with Nokia and Skype. One can imagine that Nokia will provide the hardware and business users will make calls over Skype using Windows based phones.
Thus, there will be three dominant players in the smart phone industry. Apple (AAPL), Google (GOOG, Financial) and Microsoft + Nokia + Skype. This means that RIMM is destined to lose market share and looks like the odd man out.
The Skype purchase opens up three new business markets for Microsoft. The deal may prove to be an intelligent allocation of capital in the long run.
What most investors do not understand is that Microsoft is an enterprise company. Yes, there have been forays into the consumer market such as Xbox and Kinect and even some ill-fated projects like the Zune media player.
However, the majority of revenues come from businesses. Businesses cannot function without two Microsoft products – Windows and Office. Perhaps this will change someday but disruption of the backbone of Corporate America is not on par with a company like Expedia disrupting travel agents.
In that way Microsoft is like a utility company. Businesses cannot function without electricity and they cannot function without these two Microsoft products.
This “utility” status will not change anytime soon because Fortune 500 companies are not going to gamble with some open source, cloud-based operating system just because some pimple faced teenager thinks it’s a cool idea.
Skype is largely business software. I use Skype to communicate with staff overseas and many small businesses do the same.
However, for video conferencing I use Webex. I expect that Microsoft will bundle a video conferencing solution into Skype in order to take a chunk out of Cisco’s (CSCO) market. Cisco bought Webex for $3.2 billion in 2007. This was also at a valuation of 9X sales, a similar multiple to what Microsoft paid for Skype.Thus, Microsoft has now opened up a new revenue stream with the Skype purchase.
The second way that I use Skype is on my iPhone. In order to avoid paying outrageous roaming charges when traveling for business, I use Skype and make local calls. When I’m trying to save my mobile minutes I might also use Skype. Thus, with the Skype deal, Microsoft has now entered my mobile world that was previously dominated by Apple (AAPL). As a matter of fact it was the only way that Microsoft was going to get me to use their software on my iPhone. Secondly, if a new smart phone comes out that has Windows 7 software and highly subsidized data rates I might even switch from my I-Phone. I would not mind a local Skype number that I can use to replace my wireless number if it meant that I could cut my cellphone bill in half.
The third benefit of the Microsoft acquisition is that Microsoft is now dominant in voice over IP. Yes, Microsoft paid a hefty price for the 600 million users of Skype. However, Skype could have a virtual monopoly on voice over IP.
Despite a lack of profitability, Skype did have a "moat." The reason is that once a user becomes accustomed to using Skype, he is unlikely to switch to a competitor. For example, Google Voice may be a cheaper and better product than Skype, but I’ve been using Skype since 2004 and it’s just not worth the hassle of switching over to Google. If Skype increased prices by 25% I still wouldn’t bother switching to Google.
Skype may not have been profitable but that does not mean that the service does not have pricing power. The main reason for this is that the prices are negligible relative to other services that I pay for. My cable and my wireless bill are $100/month and I notice price increases. I will always look for ways to cut those bills. However, if my Skype bill goes up from $10 to $15, it is not going to even register with me.
For all those Ballmer bashers who insist that Microsoft does not know how to allocate capital, let us remember that Microsoft bought 1.6% of Facebook for $240 million in what was largely panned as a dumb deal. It is now considered a brilliant deal as Microsoft has made six times their initial investment.
The big loser in the aftermath of the Skype acquisition is Research in Motion (RIMM).
Microsoft has now allied itself with Nokia and Skype. One can imagine that Nokia will provide the hardware and business users will make calls over Skype using Windows based phones.
Thus, there will be three dominant players in the smart phone industry. Apple (AAPL), Google (GOOG, Financial) and Microsoft + Nokia + Skype. This means that RIMM is destined to lose market share and looks like the odd man out.
