Any time a large company has both a lot of cash and a lack of growth, analysts love to play what I call the Chinese Menu Game. Pick a company from Column A, pick another one from Column B, and voila ... the analyst has a plan as to how the company can effectively exploit its cash hoard and reignite growth, as well as a call for that analyst's institutional salesforce to make on an otherwise slow news day.

TUTORIAL: The Internet Industry Handbook

Though there was no particular shortage of rumors surrounding possible bidders for Skype, including Google (Nasdaq:GOOG) and Facebook, and no shortage of rumors about possible targets for Microsoft (Nasdaq:MSFT), those two lines of thought never really intersected. At least, not before Microsoft announced on May 10 that it was acquiring Skype in a deal worth a total of $8.5 billion. (For more, see A Primer On Investing In The Tech Industry.)

Skype Gets Another New Home
Despite being fairly good at attracting users and becoming a significant presence in overseas voice calls, Skype has had a hard time finding a permanent home. The company was bought by eBay (Nasdaq:EBAY) roughly two years after its founding, but never really lived up to eBay's hopes of it as a new growth platform beyond auction services. As a result, three years of ownership and a $1 billion-plus impairment later, eBay sold 70% of Skype to a private investor group.

Now Microsoft has come in to the picture and made Skype its largest-ever acquisition. The company will operate the business as a division within Microsoft. At $8.5 billion, Microsoft it paying a hefty price - 10 times revenue and well above the implied valuation of about $2.5 billion about 18 months ago. (These deals can make or break investors' returns. For more, see Analyzing An Acquisition Announcement.)

What Microsoft Gets Today
It is a little difficult to get fresh information on all of Skype's numbers, but Microsoft's own press release indicated that there are 170 million connected users of Skype in comparison to Windows Live Messenger and its 330 million or so users as of 2009. While Skype is a smaller player in terms of messaging users, Skype's platform is arguably better in many respects and Microsoft can certainly leverage that across its existing users.

What's more, Skype is the largest player in the international voice call market and unlike Microsoft's Windows Live Messenger, Skype has attracted paying customers. Calls within Skype are free, but calls to external landlines and cell phones come with a fee.

What Skype Might Mean For Microsoft
If Microsoft can do nothing to make Skype more than it is today, this will be a colossal waste of shareholders' money. However, there are some interesting potential applications of the technology.

It seems natural to tie Skype and Microsoft's Xbox together; combine that with the Kinect device and there are a lot of interesting personal services that could be delivered to the home (maybe remote medical check-ups or distance learning from around the globe?).

Likewise, why couldn't Microsoft offer this to businesses as a rival teleconferencing and collaboration tool for users of systems from Polycom (Nasdaq:PLCM), Cisco (Nasdaq:CSCO) or Logitech (Nasdaq:LOGI)? After all, there's already a partnership in place between Skype and Avaya for communication and collaboration products for businesses.

And what about thinking really big? Skype already has mobile versions and there's no reason to think that Microsoft couldn't use it to develop some sort of integrated VoIP smartphone. That could be an intriguing option for mobile users, a threat to the likes of Apple (Nasdaq:AAPL) and Research In Motion (Nasdaq:RIMM) and a nightmare for carriers like Verizon (NYSE:VZ) and AT&T (NYSE:T). (For more, see How To Pick The Best Telecom Stocks.)

The Bottom Line
Unfortunately, there are a lot of "maybe" and "could be" with this deal. Microsoft is clearly making a big bet that Skype can open new markets to the company and reignite growth. History suggests that Microsoft doesn't do so well with big acquisitions, and the notorious Microsoft bureaucracy could snuff out many of the promising cross-platform opportunities for this deal. If ever there were a case for cautious, and perhaps even skeptical, optimism, this might be it.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing

    Playing The Decline of Traditional Broadcast Media

    Broadcast media is losing viewership as cord cutting by the younger generation triggers subscription losses at cable and satellite companies.
  4. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  5. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  6. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  7. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  8. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  9. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  10. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center