EBay's Skype Sale Looks Like a Win-Win

EBay Chief Executive Officer John Donahoe says there's no downside to his company's plan to sell most of its Skype division. "EBay was able to have its cake and eat it, too," he says.

So far, he's not getting much argument. In a deal announced Sept. 1, eBay (EBAY) will sell a controlling share of the Internet-calling service to a group of investors led by private equity firm Silver Lake for $1.9 billion in cash and $125 million in short-term debt. The sale values Skype at $2.75 billion, not far below the price eBay paid for the business in 2005, and higher than the value recently placed on Skype by some Wall Street analysts.

At the same time, eBay retains a 35% stake in a high-growth business that could fare even better under private ownership. "If Skype was worth a lot more, eBay has one-third of that upside," says Collins Stewart (CLST.L) analyst Sandeep Aggarwal. Along with Silver Lake, Skype's new backers include some of the top names in technology investing, including Geneva-based Index Ventures, one of Skype's first investors. Andreessen Horowitz, a venture capital firm launched this year by eBay board member Marc Andreessen, contributed $50 million, or one-sixth of its total fund.

Skype has been a sore subject for eBay investors almost since former CEO Meg Whitman bought the company in 2005 for $2.6 billion plus $500 million in bonuses paid later. Whitman's hope that buyers and sellers would use Skype as a communications channel never came to fruition. Analysts say that even as the unit steadily grew its revenue and user base, it also kept management distracted from growing the shopping business that makes up most of eBay's sales.

Skype Buyers Have "No Plans" for IPO "I think [buying Skype] was an intelligent risk to take," says Donahoe, who, since taking the helm in early 2008, had pledged to wring more value from the telephony business—or sell it. In April, eBay announced plans to spin the company off in a 2010 public offering.

Skype is still a candidate for a public offering, but its buyers are in no hurry. "We have no plans" for an initial public offering, says Egon Durban, managing director of Silver Lake. Instead, the firm and its partners plan to invest in Skype and expand its reach and value. Durban sees several "peripheral opportunities" that might include partnerships to make the service available on more mobile phones. Already, Skype offers mobile apps for Apple (AAPL) iPhones and Research In Motion (RIMM) BlackBerry devices, and has a partnership with a Britain-based telecom service called "3," owned by Hutchison Whampoa.

"I wouldn't be surprised if you saw it go public in the next 12 to 18 months," says Peter Falvey, managing director and co-founder of Boston investment bank Revolution Partners. The group of private investors formed as early as July, and eBay held a deadline of Aug. 25 for any offers, according to one person familiar with the deal. At least one other private equity firm, Elevation Partners, bid for Skype, according to The New York Times. Google (GOOG) also expressed interest in the business, according to published reports.

Legal Wrangle Over Core Technology As attractive as Skype may be, it's not a risk-free business. Since the 2005 acquisition, eBay licensed Skype's core technology from Joltid, a company controlled by Skype founders Niklas Zennström and Janus Friis. An ongoing legal battle between eBay and Joltid has forced the auction company to develop a replacement technology should it lose the right to retain the license.

EBay and Silver Lake declined to comment on whether the replacement technology is now fully developed, how the terms of the deal addressed the ongoing litigation, and whether Zennström and Friis themselves had a role in the purchase of Skype. "My belief is that eBay has provided an insurance policy to the buyers if things turn out poorly," says Todd Wade, partner and co-leader of the private equity practice at St. Louis law firm Bryan Cave, which is not involved in the Skype sale. For example, all or a portion of eBay's 35% stake or $125 million in promissory notes stipulated in the deal could be held by the investors as collateral. Still, analysts believe a deal this big wouldn't have transpired if there wasn't sufficient knowledge on both sides that Skype's technology was not in danger. "EBay maintaining equity means it has skin in the game and an incentive to push this issue behind them," says Marianne Wolk of New York equities researcher Susquehanna Financial Group.

Meanwhile, eBay is left with two other main businesses. "This cleans up the story from an investor's point of view," says Colin Sebastian, an analyst at Lazard Capital Markets. Now that he's clinched a sweet Skype deal, Donahoe can focus more fully on reviving growth in a slowing e-commerce site and making the most of online payments powerhouse PayPal.

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