Skype: How A Startup Harnessed The Hoopla

The buzz began building this summer. In June, reports surfaced that Yahoo! was in merger talks with Skype Technologies, the Internet-telephone company. Before long, rumors were circulating that News Corp. (NWS ) and Google, too, were interested in Skype. In the end, the acquirer was perhaps the least likely suitor of all: eBay Inc. (EBAY ), which announced on Sept. 12 that it would pay $2.6 billion in cash and stock for the Luxembourg outfit, with a further $1.5 billion to come by 2009 if Skype hits key performance targets.

How did Skype, founded just three years ago, manage to parlay itself into that kind of prize? Sure, it has 54 million users hooked on its free phone service. But with revenues expected to hit just $60 million this year and break-even not likely until late 2006 even should Skype's rapid subscriber growth continue, the price astonished many observers. Good timing is part of the answer, given the huge appetite among media and Web companies for an Internet-telephony play. At the same time, Skype and its advisers proved themselves to be master salesmen.

Skype's founders insist that they never set out to pump up the company and flip it for a quick profit. "Our objective was to build the business," says Niklas Zennström, who, along with co-founder Janus Friis, also started the free music-downloading service KaZaA. As Skype began to take off last year, says Zennström, it started looking for partnerships with other Internet companies to help broaden its distribution. Shortly thereafter, Zennström and Friis began meeting with Yahoo! (YHOO ), Google (GOOG ), Microsoft (MSFT ), and others.

None of those discussions came close to a deal, say sources close to Skype, but by this summer, all the buzz had attracted the attention of the world's most powerful media tycoon, Rupert Murdoch. In June, Skype's top dogs sat down in London with the News Corp. chief, who was considering buying a 20% stake in Skype as part of his new Internet push. People with knowledge of the meetings say Murdoch was impressed with Zennström, but the two couldn't agree on price.

With potential suitors buzzing around, Zennström and Friis began to consider selling the whole company. Skype hired a Morgan Stanley team from London to help it explore strategic options. Then in late July, Timothy C. Draper, whose Menlo Park (Calif.) venture-capital firm, Draper Fisher Jurvetson, is one of Skype's biggest investors, put the world on notice that Skype wouldn't go cheap: Anyone who wanted to acquire the company would have to shell out a minimum of $1 billion.

By then, eBay and Skype had been quietly talking on and off for nearly three months. When Zennström and Friis first met eBay CEO Margaret C. Whitman in May in London, both sides felt they had little in common. "But when we started talking, we had an Aha! experience," Zennström recalls. "We went crazy on the whiteboard, mapping out ideas."

At first, their discussion focused on partnership. But before long a larger deal took shape. By merging with eBay, Skype could get what it had sought all along: a big parent that could widely distribute its product. EBay, in turn, would gain a fast-growing young business to supplement its core e-commerce business. All that was left to work out was a price -- one that would meet Skype's lofty expectations. And by Sept. 12, they had that, too.

By Justin Hibbard in San Mateo, Calif., with Andy Reinhardt in Paris, Tom Lowry in New York, and bureau reports

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