Mergers and Acquisitions

What's Behind Microsoft's $8.5 Billion Acquisition of Skype?

Outline
General Information
Mergers and Acquisitions

Motivations towards the acquisition Pros and Cons Values behind the deal Valuation Internal and external impact Benefits for Microsoft

Microsoft
Mergers and Acquisitions

The company was founded by Bill Gates and Paul Allen on April 4, 1975.

The world's largest software maker measured by revenues. It is also one of the world's most valuable companies.

As for 2010, Microsoft record revenue of $62.48 billion, up 7% from last year.

Operating income in 2010 was $24.1 billion, up 18% from fiscal 2009 and net income was $18.76 billion, while earnings per share were $2.10, up 30% from 2009, according to a company statement.

Skype
Mergers and Acquisitions Skype was founded in 2003 by two software writers, Niklas Zennstrm and Janus Friiswhose. On 12 September 2005, eBay Inc. agreed to acquire Luxembourg-based Skype Technologies SA for approximately US$2.5 billion in upfront cash and eBay stock, plus potential performance-based consideration.

Skype had revenue of $860 million in 2010, which was up 20%, but a net loss of $7 million. It had 663 million registered users as of the end of 2010.

On 1 September 2009, it was announced that eBay was selling 70% of Skype for US$1.9 billion to investment group led by Silver Lake, valuing Skype at US$2.75 billion.

Motivations
In 2010 Skype had filed for an IPO and was going to do about a billion dollars in revenues. So why sell? The company had bet heavily on is video sharing service and they failed. They were aware of the fact, that they cannot fully use the Skypes potential, as the Microsoft can. The high price offered by Microsoft.

A boost in the enterprise collaboration market, thanks to Skypes voice, video and sharing capabilities. A working relationship with carriers. A lot of potential. Combining Skype's software with the Xbox Kinect and an HD television set. The biggest reason to buy Skype is Windows Phone 7 (Mobile OS) and Nokia. They need a competitive offering to Google Voice and Apples Facetime.

Pros and Cons behind the acquisition

PROS
Boosting Microsofts products Keeping away competitors Skype brand name Brand-buzz
Mergers and Acquisitions

CONS

Valuation Marginal possible earnings Similar functionalities already reached

SEPTEMBER

2005

SEPTEMBER

2009

SEPTEMBER

2011

Billion

Billion

Billion

---

+10%

+309%

Mergers and Acquisitions

$2.5 $2.75 $8.5

Microsofts valuation of Skype

Mergers and Acquisitions

32x

$14.2 0
User

Operating Profits

Skype Valuation
Revenue and EBIT
Net Revenues Revenue Growth Rate EBIT EBIT margin -143.119 -74% `06 193.696 `07 381.551 97% -1.433.981 -376% `08 551.364 45% 22.862 4% `09 718.903 30% -364.619 -51% `10 859.815

20.649 2%

Net Revenues Revenue Growth Rate EBIT

Y1 1.031.778 20%

Y2 1.238.134 20%

Y3 1.485.760 20%

Y4 1.782.912 20%

Y5 2.139.495 20%

98.076 158.695 239.640 346.615 Assumptions: 53.254 EBIT margin 5% 8%then linear 11% 13% to 6%16% Net Revenue Growth Y1-Y5: 20%, decline (Industry Average) EBIT Margin: linear incline to Target Margin 30%
*Monetary Values in Thousand USD Y6

Y7

Y8

Y9

Y10

Terminal Value

Mergers and Acquisitions

20%

FCFF
`06 EBIT (1-t) Depreciation, Amortization Net Working Capital Net Working Capital (approx.) Capital Spending FCFF -26.442 1.952 116.140 -3.035 -19.510 -199.712 7.198 -16.486 23.285 110.693 `07 `08 18.061 75.534 `09 -288.049 79.049 `10 16.313 161.297

Y1 EBIT (1-t) Reinvestment 42.071 80.823

Y2 77.480 96.987

Y3 125.369 116.385

Y4 189.316 139.661

Y5 273.826 167.594

Assumptions: FCFF -38.752 47% -19.507 8.985 49.654 106.232 Reinvestment Rate (Average Sales to Capital Ratio in Software Industry: 2.14)
*Monetary Values in Thousand USD

Mergers and Acquisitions

43.632

CAPM / Cost of Equity

Mergers and Acquisitions

10yr treasury bond rate as of 05/11/11

CAPM = ke = Rf + (Rm Rf) + FSP = 0,0319 + 1,1 x 0,1 + 0,006

Firm Size Premium for Market Value $2.6 5.25 bn

Computer Software: 0.98 Telecom. Services: 1.15

Assumed Risk Premium: 10%

>> Cost of Equity = 14,79 %

*Monetary Values in Thousand USD

WACC
Cost of Equity: 14,79% Equity: 2.246.690 Debt: 686.348
Mergers and Acquisitions

WACC = ke x

E E+D

+ i(1-t) x

D E+D

Assumed Interest Rate: 4%

Marginal Corporate Tax Rate Luxembourg: 21%

>> WACC = 12,07 %

SKYPE Valuation (PV)

WACC Y1 12% Y2 12% Y3 12% Y4 12% Y5 12%

WACC 11% 10% 9% 8% 7% Assumption: WACC: Y1-Y5: 12%, then linear decline to 7,2% (WACC Software Industry 7,15%, Telecom. Services 7,05%, Entertainment 9,09%)

Terminal Cash Flow 823.384 Terminal WACC 0,072 Terminal Value 20.533.514

PV (Terminal Value) PV (FCFF over 10yrs)

7.575.712 1.029.046

$8.604.758

*Monetary Values in Thousand USD

Mergers and Acquisitions

Y6

Y7

Y8

Y9

Y10

Terminal Value 7%

Internal Impact
Microsoft Live Messenger phased out
Mergers and Acquisitions

Microsoft Lync to be synchronized with Skype Additional funding for Skype

More aggressive development of software Upgrade of infrastructure Introduction of new version of Skype to Linux

Live Messenger phased out

Skype pre-installed on Microsoft Windows 8 Introduction of Ads to Skype

Skype and Lync integration will begin in June 2013

External Impact
Increasing competition for classic Telecoms
Mergers and Acquisitions

Prevention of Skype acquisition by other entities (mainly Google) Skype has become an advertising platform thanks to Conversation Ads

An example of a Conversation Ad

Benefits for Microsoft

Acquisition of a strong brand
Mergers and Acquisitions
Skypes Concurrent Users Online 2003-2013

Access to large large base of Skype users (600+ M) with over 55 millions Concurrent Users Online Possibility to enhance other products (Windows Phone, Outlook, Lync, Xbox) Extension of Microsofts reach across other platforms (i.e. TV sets) Possibility to make money

References
Mergers and Acquisitions

http://www.forbes.com/sites/tomiogeron/2011/05/10/microsofts-acquisition-of-skype-internet-and-mobile-plays/ http://about.skype.com/press/2011/05/microsoft_to_acquire_skype.html http://www.microsoft.com/en-us/news/press/2011/may11/05-10CorpNewsPR.aspx http://phys.org/news/2011-10-eu-microsoft-skype-takeover.html http://www.bbc.co.uk/news/business-13343600 http://www.microsoft.com/investor/reports/ar10/10k_fr_dis.html http://www.techwell.com/2013/01/microsoft-goes-all-skype http://www.guardian.co.uk/technology/2011/may/16/ballmer-microsoft-skype http://aswathdamodaran.blogspot.com/2011/05/is-skype-worth-85-billion-exercise-in.html http://www.businessinsider.com/numbers-microsoft-skype-deal-2011-5 http://www.forbes.com/sites/chuckjones/2013/02/06/sp-500-revenue-and-eps-estimates-ratchet-down-after-january-results/ http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/wacc.html.htm http://techcrunch.com/2011/03/07/skype-revenue-up-20-percent-to-860m-in-2010-paid-users-up-19-percent/ http://techcrunch.com/2011/05/09/microsoft-skype/ UNITED STATES SECURITIES AND EXCHANGE COMMISSION. AMENDMENT NO. 2 TO FORM S-1 REGISTRATION STATEMENT. Skype S. r.l. As filed with the Securities and Exchange Commission on March 4, 2011.

Mergers and Acquisitions

Thank you for attention!