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Skype: On The Block

By Steve Rosenbush Skype, the rapidly growing Internet phone service, is on the block. The company, based in Luxembourg, has hired Morgan Stanley to help sell the service or take it public.

Skype has held a preliminary meeting with media giant News Corp. (NWS). The meeting was conducted during the last few weeks, but no further talks have been held and no deal is in sight, according to one person familiar with the matter. It wasn't immediately clear which party initiated the conversation, which was held in Europe and included executives from Skype and News Corp.'s BSkyB satellite unit. Skype is seeking in excess of $3 billion for the business.

News Corp., which includes the Fox media empire, wants to establish a major presence on the Web. In July, it announced it would spend $580 million to buy, the highly successful social networking site where members with home pages communicate by forming extended networks of friends (see BW, 6/13/05, Hey, Come To This Site Often?). News Corp. is likely to make more Internet acquisitions, but it's not clear that it would embark on another major purchase until the deal for MySpace parent Intermix (MIX) is completed during the next few months.

PAUSE TO DIGEST. Skype is something of an anomaly in the world of Internet-based communications. Most Web phone companies, such as Vonage, use phones that connect to broadband telecom or cable networks. They can communicate with regular phones around the world. But Skype is a Web-based service. Members use microphones and speakers attached to their PCs. They can make free calls to other Skype-enabled PCs around the world, and are able to call regular phones for a fee.

Skype was launched just two years ago by Niklas Zennstr? and Janus Friis. Their previous venture, Kazaa, rocked the music world by allowing members to share free music and video online. The founders sold the Kazaa name, but held onto the file-sharing technology after the music service ran afoul of music piracy laws.

So far, Skype has raised more than $20 million in funds from private investor Howard Hartenbaum, along with Draper Fisher Jurvetson, Index Ventures, Bessemer Venture Partners and Mangrove Capital Partners.

DELUGE OF DOWNLOADS.?That's not a lot of money compared to what Vonage has raised. It mustered $200 million from investors earlier this year. Skype may believe it needs a partner with deep pockets or the proceeds of a big IPO to keep ahead of the competition. It's exploring the possibility of a sale or a public offering, one person familiar with the matter says.

Skype can benefit from the rising popularity of online advertising. As ad revenue migrates from traditional media, companies such as MySpace and Skype can become increasingly important channels for advertising, marketing and the distribution of media.

The Skype software program has been downloaded more than 147 million times, according to the company's Web site, While that figure isn't as large as Kazaa, which was downloaded 370 million times, it indicates the presence of a large and important audience.

FINAL WORTH. With a valuation of $3 billion, Skype may be headed for an IPO rather than a buyout. It's not clear how many corporations might be willing to pay that much for what amounts to an Internet startup, albeit a highly successful one. MySpace, which has more page views than Google (GOOG) and features ads from major media and consumer goods companies, commanded a fraction of that amount.

So far, Skype has shown a knack for sucking value out of the traditional telecom world. While that may establish it as a disruptive technology, the company will ultimately be valued on the basis of how much value it creates, not what it can destroy.

Rosenbush is a senior writer at BusinessWeek Online in New York

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