Microsoft Acquires Skype – An Investor’s Perspective

Following up on Tuesday’s announcement, where many questioned the valuation placed on Skype by Microsoft, Ben Horowitz of Andreeson Horowitz, one of Skype’s investors in the “Silver Lake round” a year ago November, provides some interesting insight into what Andreeson Horotwitz had seen when they made that initial investment 18 months ago. And these insights provides additional background as to why Microsoft saw an $8.5B acquisition as appropriate.

And, having been involved with or witnessed from behind the scenes a few acquisitions in the past, it provides insight into assessments of acquisitions that journalists simply don’t seem to appreciate. It’s too easy to write that story about how an investment will fail.

Key points:

• Prior to the Silver Lake Round, there were intellectual property issues that, on the surface, made it appear that the company was impossible to buy.
• There was scepticism that Skype could not migrate from solely having Skype clients to the mobile and web client world while maintaining its ease-of-use.
• But the investors recognized that both Skype’s founders and employees were a unique resource:
  

  With a company as complex as Skype, investors draw different conclusions about the same facts. In this case we had the same data as everybody else, but we had a radically higher opinion of Skype’s founders and employees than the doubters and naysayers. We believed that we could work with, rather than against, the founders. And we believed that Skype’s amazing engineering team, led by the original Eastern European software wizards who created the service, could compete and win against anybody.

  We specifically thought that Niklas and Janus, two of the preeminent technology entrepreneurs of our time, wanted Skype to be a huge success and would do everything in their power to make that happen. As a result, we did not think the doomsday scenario that greatly concerned other investors—that the founders would attempt to shut down the company through the courts—was an actual possibility. Based on the founders’ motivations, we felt that we’d quickly settle the IP litigation. Both sides wanted to get on with the business of making Skype more competitive and could not afford to waste time bickering about IP ownership.

  We couldn’t have been more right about that. After quickly settling the litigation, both founders immediately made major contributions to the business through their energy, insight, and intellectual prowess.  And boy did we need them to do that, because we soon faced full frontal assaults from the both Google and Apple.

• They recognized that Skype’s founders were approachable and basically wanted to see Skype succeed.
• Working out a settlement to the intellectual property litigation, they brought the founders into the investors as a resource that could make “major contributions to the business through their energy, insight, and intellectual prowess.”
• The result of the Silver Lake round was increasing growth of the Skype user base (going from about 300,000 new accounts per day to over 500,000), Skye usage (supporting almost 25% of international calling minutes) and, at peak times, over 30 million concurrent users.
• In his summary paragraph Ben sums up how the combination of passionate employees, innovation and Skype’s powerful network effect overcame any competitive attacks, even from a respected player such as Google.
  

  In retrospect, it was easy for people to underestimate the quality of the Skype engineering team and the power of Skype’s network effect. When we bought the company from eBay, many thought that Skype, like so many acquired technology companies, had lost its technical talent. Through our research, we found that Skype had a core group of engineers who were completely dedicated to the mission. They stayed through the eBay acquisition and were hugely determined to make Skype the communications company of the future. Over the past decade, this team consistently introduced ground-breaking technologies ranging from highly resilient and scalable peer-to-peer networking to radically higher sound quality through dramatically superior codecs. In doing so, Skype out-innovated the competition in the most important areas. When combined with its powerful network effect—how valuable is a video calling service if there is nobody to call?—Skype became a formidable competitor. [Editor’s bold]

Bottom line: My long time acquaintance Rick Segal used to talk about looking first at the people before even looking into the technology when considering investments. Over my many years of meeting Skype employees I have consistently found, in spite of an oft-times critical public,  an underlying enthusiasm and passion that says they are on a mission and want to complete that mission.

Now they get to play out that mission under the guidance of a technology business that established many of the business processes for combining marketing, product management, engineering and financial resources into successes. Microsoft has the opportunity to add proven real-time communications services into their existing product line. Skype, as an autonomous business unit within Microsoft, can finally overcome many of  its inhibitors to success and expand significantly on the founders’ initial vision.

Related articles

• The End of the “Skype as Bandit” Era (disruptivetelephony.com)
• Skype’s Real P2P Network (gigaom.com)
• More Skype Rumors: Big News Soon, Microsoft In The Mix (gigaom.com)