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Will Skype fever abate before it's too late?
A regular column on the information industries
Will Skype fever abate before it’s too late?
When the stock market first rose then fell sharply at the turn of the decade, a common excuse put forward for the highly inappropriate advice tendered by many investment banks and the like was that few people employed by them had actually lived through a period exhibiting similar characteristics. This is clearly an excuse that cannot be used a second time in the same decade, which gives one cause to reflect upon recent events in the “internet economy”.
While it is reasonable to argue that the precipitous ascent of the stock market during 1998-2000 was not driven solely by hugely over-optimistic valuations placed upon anything remotely connected with the internet, it is certainly reasonable to argue that this was a major causal factor and that the ensuing collapse was largely driven by the realisation that company valuations should, perhaps, bear some reasonable relationship to their ability to earn revenues and profits within the foreseeable future. At any rate, that was the view which prevailed during 2003-2004 when the financial markets took a dim view of anyone who tried to talk up the prospects of companies connected to the internet. During 2005, however, the signs of “irrational exuberance” have begun to reappear, albeit in a somewhat muted fashion compared to the late 1990s. Take, for example, eBay, an acknowledged success story of the “new economy”. By and large, the valuation of eBay during 2005 did appear to have remained earthbound, but what was to be made of its takeover bid for Skype, worth up to roughly $4 billion (partly depending on future performance) at the time? On the one hand, Skype was heavily into VoIP, and as everyone knows there is nothing trendier in the telecommunications arena than that. So it obviously followed, or so many investment bankers claimed, that it would be a huge money-spinner. On the other hand, VoIP is a so-called disruptive technology: in other words, it is designed to undercut existing ways to do business and make money, and the only way to get it established is basically to start by giving it away and then offering a prayer to the telecoms deities that it will be used heavily at a later date to convey high-valued-added services.
Heard it before? If not, the reader must be very young and very junior. But, however inexperienced in the world of “high finance”, the reader’s knowledge of mathematics will probably struggle to match that of eBay CEO Meg Whitman who was reported to have justified the bid by claiming that “one plus one plus one equals at least four”. This is presumably another way of expressing the famous dictum that “the whole is greater than the sum of the parts” – in this case eBay, its online payments subsidiary PayPal and Skype. The acquisition of PayPal was indeed something of an inspired move and has proved to be a major driver for the eBay business model, but the dictum – rolled out as a matter of course to justify any merger proposal – is not thereby rendered a truism that can be generalised – just ask any executive at Time Warner.
Now there is a fundamental point at issue here. Equipment vendors have been going through a period of deep retrenchment and are mostly still valued well below the giddy heights of 2000-2001, yet the internet can only work efficiently if their equipment is constantly improved via intensive and expensive research and development (R&D), which depresses their market value. The companies are essential if the internet is to function smoothly yet signs of irrational exuberance in this sector are understandably non-existent. eBay, in comparison, provides a service. It is clearly a service that is valued by millions of people, but even if it disappeared completely, commerce would not grind to a halt. This suggests strongly that one should expect, inter alia, ever-increasing competition for its services and hence not get carried away by its prospects with or without Skype, yet its CEO and many in the financial markets are claiming that it defies the logic of mathematics.
According to the Skype web site (www.skype.org), Skype generated approximately $7 million in revenues in 2004, with $60 million forecast for 2005 and $200 million in 2006. But living as we do in a post-dot.com crash-based world, talk of a current market value in terms of “billions of dollars” might just seem hard to justify. It might, for example, remind us not merely of 1998-2000 but the recent flotation of Baidu-com, an internet search engine in China. Launched at $27 a share, the share price rose sharply to peak at $153, valuing the company at $3.6 billion. Even the investment banks that had underwritten the offer, in sharp contrast to their typical behaviour in 1998-2000 and doubtless suffering from a nasty dose of dejà vu, promptly called the situation “unsustainable” and thereby wiped out one-quarter of the company’s value within a matter of hours.
But Skype is different, is it not? Not only will it enable anyone with a computer to engage in free telephony with anyone else armed with a computer and Skype software, it will also – which is why eBay decided to buy it – enable those engaged in e-commerce to negotiate by speaking directly to one another rather than by sending e-mails. eBay understandably played down the factor that e-mails were more than adequate for most transactions, and chose to emphasise that a direct phone link would improve the likelihood of a complicated, high-value transaction reaching fruition. It also argued that in markets such as China and Russia that were characterised by low levels of trust, direct personal communications would help to eliminate that problem, and that eBay would be able to charge online merchants a fee every time that an Internet user clicked on a link in an online advertisement to be connected by telephony to the merchant. However, this latter claim is, as yet unproven.
eBay also claimed that Skype would make profits from its communications services unconnected with the eBay link. But free downloads to facilitate the use of free telephony – or as the Skype web site succinctly puts it, “with Skype you can talk to anyone, anywhere for free. Forever” – is not exactly a money-spinning venture, and it is also very easy to emulate as a service. Skype had over 50 million users by September 2005, thereby entitling it to call itself the “market leader”, but there are those who would probably prefer to stick with the Vonage model whereby roughly one million subscribers pay $25 a month for superior QoS. Not surprisingly, it is from its equivalent service, SkypeOut, which like Vonage uses standard fixed-wire links at a cost of $0.02 a minute, together with SkypeIn, which allows subscribers to buy a normal telephone number that Skype-less callers can use (at a cost of $37 a year), and the SkypeZones service whereby Skype calls can be made from roughly 17,000 Wi-Fi hotspots around the world (via link-ups with Boingo and The Cloud) for $8 a month, that Skype currently makes its money.
Skype and Vonage do appear to have gained brand recognition benefits from being early into the market, but the first-mover advantage has been shown to be of dubious value in many telecoms-related markets. While it is true that there were already large numbers of competitors by mid-2005, these were not the “big-hitters” of the internet industry, and it is now evident that the likes of Microsoft (which bought Teleo), Google (with Google Talk), AOL (with TotalTalk, launched at only $19 a month) and Yahoo! do not intend to let Skype have it all its own way, let alone their equivalents such as AT&T or the cable operators in the traditional world of telephony even if for the time being their offerings are not competitive.
Skype is working hard to maintain its image as a market innovator. For example, it linked up with E-Plus in Germany to incorporate its software within the E-Plus UMTS data card service commencing in October 2005. However, developments of this kind are unlikely to do much for the bottom line. Hence, the really significant questions remain:
Can the takeover of Skype really be worth up to $4 billion?
Is it an early symptom of a second internet-driven bubble?
For the moment, neither question can be answered with any certainty, but one thing is clear: if Internet company CEOs begin to repeat the mantra that “one plus one plus one equals at least four”, and investment bankers pick up the chant, investors had better buckle up for a rocky ride ahead.
Peter CurwenVisiting Professor of Telecommunications at the Strathclyde Business School, Glasgow, UK. E-mail email@example.com