E-Bay and Skype: a second look
After the market close on October 19, E-Bay announced its latest results. By any reasonable yardstick, they were more than impressive: 37 % increase in revenues and 40% increase in profits. Furthermore, CEO Meg Whitman sounded bullish about the outlook for months to come and her revenue forecast was higher than the Wall Street consensus. Yet, in response, EBay got no respect: the market reaction was one of disappointment, with shares falling more than 6% in after hour trading and further 7% on October 20.
Comments of pundits and analysts suggest that investors remain uneasy about the Skype acquisition. One argument is that this acquisition takes EBay into a new and rather tough battlefield of Internet telecommunications. A related argument is that Ebay has largely overpaid Skype: a consideration of at least $2.6 billion for revenues of $7 million and little prospects for profit.
It is true that E-Bay-Skype takeover may appear risky to the point of recklessness. However, I would argue that although, as SEC prospectus would put it, there is no guarantee of success, Skype acquisition makes sense for eBay. It is consistent with its long-term strategy of creating a dominant virtual market and to control directly its key nodes. I am basing this argument on the actual experience of Paypal, which I followed fairly closely. At the time of the acquisition, in May 2002, there was a widespread criticism: E-Bay was getting into banking, a tough market, and, at 1.4 billion it was overpaying for this business, which could not possibly be worth that much. Sounds familiar? Even more so, if one remembers that Paypal was widely touted as the incumbents’ killer, which would destroy traditional banking as we know it. From today's perspective, this talk appears as uninformed nonsense. Paypal did not seek to disintermediate existing banks or to conquer the traditional banking market. It confined itself to a relatively small market niche, where there was no cost-effective response to an emerging consumer demand: small and irregular payments among unrelated parties, in this instance ebay buyers and sellers. Paypal was not a venture into banking, it was a natural extension of the core eBay, internalisation of a vital trade settlement function. The market niche is quite small, particularly when compared to retail banks. Paypal may have 80 million clients but their total assets, at 3.5 millions dollars, represent slightly over 1% of assets of Citibank or JPMorgan Chase and the volume of payments handled by Paypal is quasi invisible in the total payment market. However, this segment is highly profitable in itself and also stimulates ebay trade, thus generating additional commissions. The result is that Paypal today contributes close to 25 % of Ebay revenue and, according to the company, a more than proportionate share of its profits. 'High' price paid by Ebay appears as a bargain today.
It is true that E-Bay-Skype takeover may appear risky to the point of recklessness. However, I would argue that although, as SEC prospectus would put it, there is no guarantee of success, Skype acquisition makes sense for eBay. It is consistent with its long-term strategy of creating a dominant virtual market and to control directly its key nodes. I am basing this argument on the actual experience of Paypal, which I followed fairly closely. At the time of the acquisition, in May 2002, there was a widespread criticism: E-Bay was getting into banking, a tough market, and, at 1.4 billion it was overpaying for this business, which could not possibly be worth that much. Sounds familiar? Even more so, if one remembers that Paypal was widely touted as the incumbents’ killer, which would destroy traditional banking as we know it. From today's perspective, this talk appears as uninformed nonsense. Paypal did not seek to disintermediate existing banks or to conquer the traditional banking market. It confined itself to a relatively small market niche, where there was no cost-effective response to an emerging consumer demand: small and irregular payments among unrelated parties, in this instance ebay buyers and sellers. Paypal was not a venture into banking, it was a natural extension of the core eBay, internalisation of a vital trade settlement function. The market niche is quite small, particularly when compared to retail banks. Paypal may have 80 million clients but their total assets, at 3.5 millions dollars, represent slightly over 1% of assets of Citibank or JPMorgan Chase and the volume of payments handled by Paypal is quasi invisible in the total payment market. However, this segment is highly profitable in itself and also stimulates ebay trade, thus generating additional commissions. The result is that Paypal today contributes close to 25 % of Ebay revenue and, according to the company, a more than proportionate share of its profits. 'High' price paid by Ebay appears as a bargain today.
Skype is not Paypal but Ebay must have proceeded by analogy when making its strategic decision. To begin with, forget the revolutionary rhetoric: Skype will not destroy incumbent telcos whether in voice or in data. Contrary to what the Economist asserted in conclusion of its in-depth analysis of the transaction, Ebay did not buy Skype to destroy SBC or Vodafone. It bought it to strengthen the communication dimension of its trade, in the same way Reuters or Bloomberg have deployed the combined voice-data, including instant messaging and video capability, to support their traders and their market place. Internet made such deployment cost-effective and scalable. Skype should be seen as an integrated digital communication platform for Ebay trading community.
The platform model also explains the valuation of the transaction. In other words, Skype is expected to make more than a single contribution to Ebay business. It should facilitate the core trading business, thus increasing the number of transactions and GMV (Gross marchandise value). But Skype could also accelerate the growth of Paypal, both in terms of the number of users and the transaction value. Of course, under the benevolent and nurturing embrace of Ebay, Skype should be able to continue to grow its own business at a breakneck pace. And the beauty of the platform model is that the various revenue not only are not mutually exclusive but are actually mutually reinforcing. Is it therefore completely unrealistic to forecast that within three years, Skype contributes between 20% and 25% of consolidates revenue (and a proportionate share) which could be around 10 billion. It may not happen, for a variety of reasons and it looks like the market consensus does not place a high probability on this scenario. Based on Ebay track record, this maybe a pessimistic view.
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