WITH his estimated personal wealth of $14.5 billion (£8.9bn), Steve Ballmer could have bought Skype without dipping into Microsoft's bulging coffers. He might have considered it too, had the board not backed what will be the Seattle software giant's biggest acquisition since the company was founded in 1975.
The $8.5bn swoop on Skype could be Ballmer's last shot at reviving Microsoft, which last year lost the coveted position of the world's most valuable technology company to arch-rival Apple. Since then, speculation has persisted that the 55-year-old might be ousted as chief executive, despite his close relationship with founder Bill Gates and a roughly 4 per cent stake in the business.
"He needs to do something big, bold and significant, not only to prove that he knows what he is doing and can make big bets, but also to get the company back on track," says Richard Edwards, principal analyst at Ovum.
The pressure on Ballmer has intensified as his company has increasingly lagged behind Apple and Google, both of whom have far outstripped the meagre revenue growth figures posted by Microsoft in recent years. The knock-on effects are evident: while Microsoft's stock has edged up 8 per cent during the past five years, Google is up 35 per cent, and Apple has surged by a staggering 395 per cent.
The latter's success has been driven by its flying start in the race for the mobile internet, as Apple's wildly popular iPhone and iPad products have played directly into the hands of the growing legions of social media users. Ballmer is betting that Skype, with 145 million active monthly users, will boost Microsoft's online offering by integrating its internet videoconferencing into the Windows Phone, Xbox games console and Outlook e-mail software.
"We want to stitch together the world," said the exuberant Ballmer last week. "We have big customer bases we can connect that can add all sorts of value."
The big question is whether Microsoft's energetic leader is gambling too much for too little return. While no-one doubts the growing power of social media, the business model for converting users into revenues remains largely unproven.
Even so, companies such as LinkedIn, Facebook, Groupon and Twitter are being valued at multiples eerily reminiscent of the dotcom boom, leading to speculation that a bubble could be in the making.
Renren, the loss-making Chinese social network, joined the New York market earlier this month with an initial capitalisation of about $6bn, or 78 times the annual sales generated from its roughly 31 million active monthly users. The stock advanced a further 24 per cent on the day of its debut, but has since been pummelled back to less than its offer price amid concerns over internal financial controls and strict regulation by the Chinese government.
Next up is LinkedIn, which like Renren will begin trading in New York later this week. Co-founded in 2003 by PayPal veteran and company chairman Reid Hoffman, LinkedIn has been hauled over the coals for adopting a dual-class stock structure that gives new investors just one vote per share. Class-B stock held by insiders carry ten votes apiece, giving them more than 99 per cent of the voting power following flotation.
LinkedIn generated $243 million in revenues last year from its estimated 75 million worldwide users. The business networking specialist is expected to be valued at about $3.3bn when it joins the market, a somewhat more sensible 13.5 multiple of earnings.
Others thought to be kicking the tyres of the IPO bandwagon include online coupon business Groupon, which is said to be pushing for an early flotation filing that could value it at up to $15bn, and Twitter, whose $200m fundraising at the end of last year valued the micro-blogging platform at $3.7bn.
And, of course, there is sector behemoth Facebook, whose 600 million users have sent investors' imaginations racing.
Privately traded shares in Facebook have surged since Goldman Sachs pumped $1.5bn into the company in January, valuing it at $50bn. JP Morgan subsequently invested at $60bn, and reports claim that some private investors buying small amounts have purchased shares on secondary markets at a price that would give the company a capitalisation of $100bn.
At that level, Facebook would be valued at 50 times this year's expected earnings before interest, tax, depreciation and amortisation (EBITDA).
Josh Olson, technology analyst with Edward Jones & Co, says he remains "on the sidelines" as to whether Facebook is correctly valued. As for the Microsoft-Skype deal, Ballmer and his Skype counterpart Tony Bates, who will head up the online telephone division once it becomes part of Microsoft, will have to prove that they can deliver on promises to "extend our global community".
"It helps move them along in mobile," says Olson, who like most agrees that Microsoft must hasten its push into the social internet space.
Polly Purvis, executive director of ScotlandIS, says Skype should add to the Microsoft-Nokia partnership announced at the start of this year. Under that agreement, the Finnish handset manufacturer is adopting Windows as its principle smartphone application as it and Microsoft collaborate on new mobile services to combat Apple's iPhone and Google's Android offering.
"The purchase of Skype complements their recent alliance with Nokia, both of which signal a move into the mainstream consumer market," Purvis observes.
Elsewhere, Microsoft is likely to integrate Skype-type services within Xbox, allowing gamers to communicate directly with one another and effectively bringing large-screen, high-definition video calling into the comfort of the living room. Skype will also be worked into existing software products such as Outlook e-mail and Lync, Microsoft's business communications infrastructure.
Microsoft also plans to place more video advertising on Skype to boost revenues, which reached $264m last year on an adjusted EBITDA basis. Additionally, there are suggestions that Microsoft will use Skype's list of contacts as the foundation for a network to link users. "We think this is a show-me story," Olson says. "The market is waiting for Microsoft to make a serious move into mobile."
At 32 times earnings, Ballmer argues that the $8.5bn cash on offer values Skype at "not a lot higher" than some publicly traded companies.
Some analysts and investors agree, arguing that with more than $50bn in cash and short-term investments, Microsoft's purchase of Skype is the equivalent of one man buying an extra hamburger when he goes out to lunch. Others describe it as a staggering waste of money, and predict Skype will prove to be another example of cash frittered away on bungled acquisitions.
Microsoft's offer, which includes the assumption of Skype's $725m in debts, is more than twice the value placed on the company when former owner eBay sold a controlling stake to private equity firms led by New York's Silver Lake Partners in November 2009. It's also 39 per cent higher than the value Skype placed on its equity in regulatory filings in April, and comfortably tops the $7bn Skype expected to get from an IPO planned for later this year.
All of this for a company that reported a net loss of $6.9m last year - its fourth money-losing year out of the past five. Edwards at Ovum concedes that it remains difficult to put a sensible valuation on many of these companies. "A lot of it is the market itself trying to figure out what works and what doesn't work," he says.
He is, however, prepared to give Microsoft the benefit of the doubt on Skype, pointing out that the "huge" price must be put into perspective alongside the software giant's massive cash resources. The challenge now is for Microsoft to prove that it can successfully utilise its new prized asset.
"If all goes well, Steve Ballmer could retire as a happy man a few years from now, with his standing in Microsoft secure," Edwards says. "If not, it may well be that ‘Skype' will be engraved on his headstone."
Bebo: Founded in 2005, Bebo was purchased by AOL in May 2008 for $850 million. Bebo's unique worldwide visitors plunged by more than half during the year to April 2010. Merchant banking and advisory firm Criterion Capital Partners bought Bebo later that year for a reported $10m.
Myspace: Rupert Murdoch's News Corp bought Myspace in July 2005 for $580m in a move the media mogul said would drive traffic to his Fox TV websites. News Corp is now looking to sell Myspace for about $100m, though potential buyers are reportedly balking. Traffic at Myspace has fallen by nearly half during the past year.
Delicious: Yahoo bought web bookmarking service Delicious from founder Joshua Schachter in 2005 for an undisclosed price estimated at up to $30m. However, it never became a mainstream product, and was sold last month to the founders of YouTube to form part of their new company, AVOS.