Don't be surprised to hear the sound of clinking cocktail glasses at the Silicon Valley offices of Silver Lake Partners. The private equity firm has emerged as the clear victor following Microsoft's (MSFT) $8.5 billion purchase of Skype on May 9.
About 18 months ago, Silver Lake led a group of investors who acquired a 70 percent stake in Skype for $1.9 billion from EBay (EBAY). At the time, it looked like the investors might be stuck with an underachieving Internet brand. Skype rose to prominence in the mid-2000s as one of the first VOIP providers, which route phone calls over the Internet, and was bought by EBay in 2005 for $2.6 billion. Its name had become synonymous with Web-calling, but the company was slow to push out new products, failed to make much money off its immense popularity, and got bogged down in an intellectual property fight between EBay and its founders. Despite these flaws, Egon Durban, a Silver Lake managing director, saw enough promise in Skype to plunk down $940 million, the firm's largest equity investment in its 12-year history.
Durban and a team of about 20 Silver Lake executives set to work performing reconstructive surgery on Skype. At one point, the firm had five people on Skype's board, including Durban, Co-Chief Executive Officer Jim Davidson, and Managing Director Charles Giancarlo. Silver Lake overhauled Skype's management, settled the intellectual property issues, and sped up product development, with updates appearing in weeks rather than months. In August 2010 the company filed papers to raise $100 million in a public offering. "Skype may have the same name today, but Microsoft is not buying the same company that we bought," Durban says.
Slim, tall, and just 37, Durban gives off a master-of-the-universe vibe when he talks about the Skype deal or, in fact, any business matter. He arrived at Silver Lake after working in Morgan Stanley's (MS) investment banking division. He is a rare hybrid in the Valley, part Wall Street whiz and part geek. "He's a brilliant buyout investor and a brilliant technology investor in the same body," says Marc Andreessen, co-founder of venture capital firm Andreessen Horowitz, which also invested in Skype. "You almost never see that." Such accolades probably flow a lot easier for Andreessen now that Silver Lake has turned its $940 million gamble on Skype into a $2.9 billion windfall for the firm.
Despite Skype's heady usage stats—170 million subscribers, 600,000 new registrations a day, and 207 billion minutes of chat time last year—challenges still loom. Last year, Skype lost $7 million on revenue of $860 million and pushed back its planned public offering. Many skeptics still question whether Skype can turn its users, most of whom don't pay for the service, into customers. Sounding like a luxury car salesman complimenting a buyer about his taste, Durban insists that Microsoft picked a winner. Plans have been put in place to flank Skype video chats with advertisements and to sell the service to businesses. "Microsoft probably got it at an inflection point before we showed the next big wave of growth," he says.
The bottom line: Microsoft's $8.5 billion purchase of Skype is a windfall for private equity firm Silver Lake. The Internet calling company is still unprofitable.