Evaluation of the Acquisition of Skype by Microsoft (Essay Sample)

MERGERS AND ACQUISITIONS
ASSESSMENT PART B
‘MICROSOFT AND SKYPE’
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PART B Introduction After the Windows had acquired Skype in the year 2011, using a total sum of $8.5 billion; many investors scratched their heads to find solutions on the strategic advantage of the acquisition. This report focuses on analyzing the strategic rationale behind the acquisition. It also discusses if the valuation of the acquisition was justified, the financing methods used by Microsoft, whether it was a friendly or a hostile takeover and most importantly the impact of the acquisition. The report concludes by looking at the challenges Microsoft faces in integrating Skype’s operations into its business
The strategic rationale behind the acquisition Microsoft is the leading seller in its Window and office products. It is also among the leading sellers in mobile phones with its major competitors being Apple and Google. Why then would it go ahead and acquire a small company like Skype for an acquisition price that is almost 400 times its operating income? The strategic validation of this move is as discussed below: The acquisition is in line with the growth objective of Windows it advanced into the I.P telephony services. Introducing of video and real-time voice software in its products such as x-box, Outlook, and Lync pushes it forward to have a competitive advantage over its competitors. Microsoft does not have to invest heavily in building their I.P infrastructures; Skype has already established its services over the years. These services are familiar to many people and therefore it does both have to incur costs of marketing a new product in the market.
Microsoft through the acquisition was establishing a defense mechanism against its competitors Google and Facebook. This is by preventing them from acquiring Skype by doing it first. Both sites have Avery major impact on the social platform. If either of them acquired Skype, it would have lead to their competitive advantage to scale up very fast. Skype is the perfect complement to window’s existing products like the integration of live video chats in windows P.Cs and Xbox 360, having call back options when working with Microsoft Office and instant messaging features in Outlook. This makes it edgy and appealing to most of the young generation who spend 90% of their time socializing. It is a move to expand its customer base to include more young people. The inclusion of the Skype features in the Windows seven phone makes it attract more sales. Most people using the phone will have the best Video conferencing network. Skype has more of a peer-to-peer model that is different from Facebook, which is central. This will make any pair of Microsoft’s phone from a scale of one to five be a strong teleconferencing booth. This acquisition positions the phone as a major competitor in the market as it gives it a more distinguished platform. Skype has a customer base of approximately 700 million and Microsoft acquires all of them by acquiring the company. It also has strong alliances with major key players in the communications industry like Facebook, Comcast, KIDDI, Samsung, and Linux. Microsoft will benefit in the following ways by keeping alliances with these companies.
First, Facebook will enable it to reach more people by using their social platforms networks by using Skype to advertise their products to potential consumers. Merging with Facebook will give both of the companies a competitive advantage against Google, which has its similar software and a social network. Second, the alliance with Comcast will enable Windows to use Skype in HDTV and most users will be able to conduct business meetings and parties. The product will attract more customers, and Microsoft will benefit by attaining its goal of innovation. Comcast will also attract more customers. Third, keeping an alliance with KDDI and Samsung will enable Microsoft to take over the Asian mobile market. Windows can do this integrating a free messaging service when exchanging with a device using Microsoft Operating services.This strategic rationale can be summarized in the porter’s five forces theory as follows: The power of customers or buyers Most of the customers of Microsoft are the people using their software and computers, therefore, this acquisition makes the company gain more customers. The company has more control over the prices of the products as the bargaining power of the consumers is low.The power of suppliers The suppliers of Microsoft include research and innovation institutes that come up with most of their software. They also come up with most of the ideas to models of new phones and PCs. The acquisition of Skype extended its supplier’s base to Asia. This makes their control of prices be lower, however; it faces a threat of them moving to companies like Apple and Google.The threat of substitute products There is a threat to substitute products from Facebook, Google, Whatsapp and Google + which makes this strategy perilous. These companies have their social platforms similar to Skype, and it thus makes it very hard for Microsoft to be sure of customer loyalty. The threat is very high.The threat of new entrants These alliances will make the threat of new entrants in the market to reduce, as very high capital is required to start operations and build their VOIP infrastructures. However, innovations are made daily, and if a new entrant comes up with cooler video call software than Skype then competition to Microsoft will be very high.Competitive rivalry The current situation in the field of the social platform is highly competitive. The move by Microsoft to acquire Skype put it in a better position because of Skype’s already established market. However, Google and Face book, which are its main competitors, have presence that is more social and innovating, their video live chats will put them far ahead of Microsoft. The competitive rivalry that Microsoft faces is high.
Weighting model on Porter’s competitive analysis of the acquisition
Low1Medium2High3 Risk weights
The power of suppliersLow3 3The power of customers Low3 3Threat of new entrantsHigh1 3Existing competitive rivalryHigh1 3Threat of substitute goodsHigh1 3Total 9 15

Competitive score (%) 9/15=60%
Justifications of the valuation of the target company The most important component to consider is not only the compatibility and strategic advantages that companies derive from acquiring a company. A target company may fit like a glove to the operations of the acquirer, but its price might be too expensive compared to its valuation (Damodaran, 2011). Is Skype worth the $8.5 billion? The real monetary value of Skype is hard to know considering it is a private company, and most of its financial statements are not available to the public. However, according to atomic inc. Microsoft paid a$ 14.70 for each Skype user, and it would use 116 days to get the money it used from its operations. In 2010, though Skype made losses of $7 million and revenues of $860 million (Damodaran, 2011). Putting this fact into consideration the company would have been valued through the following methods and the following methods and calculations:
CALCULATIONS ON VALUATION OF SKYPE
Numbers from the base year (2010) and belowMillionsNotes Revenues $860Based on information publicly availableOperating income or EBIT $7Based on information publicly availableBook value of Equity$ 1000 From the form k-10Book value to debtCash $200Number of shares outstanding1Valuing entire company
From form k-10Current stock price $8,500When it entered the Microsoft bidTax rate 38.00%Margin tax rate in U.S.AValue driversAnnual revenue Growth over the next five years20%In 2009 the revenue growth was 20%Target Pre-tax operating margin(EBIT as a % of sales in 2010)30%Taking the upper end of a company operating in a technology fieldSales to capital ratio(for computing reinvestment) 2.14Industry average for software companies
The company has a continued revenue margin is approximately 20% comparing its revenues over the last five years prior to its acquisition. The pretax margin went up to 30% that is closely to what companies like Google are reporting. The cost of capital of the company is 12%, which is closely related to most young companies, which have a potential to grow into large entities into the future. The estimation of the value of Skype putting this into consideration gives approximately an amount of $318 billion (Damodaran, 2011). A company, however, able to have revenue growths of up to 35% and pre-tax operating charges of 30% it is probable for its worth to be $8.5 billion but not more. Apart from these monetary aspects there are some qualitative factors that contribute to the valuation of a growing company they include the following:The size of the market Skype has a large market, which had a customer base of around 270 million worldwide due to its easy to use facilities like live chats and video calls.Potential to grow Skype has already established a brand name in the VoIP network compared to similar services that Google and Facebook are trying to offer. Acquisition of Skype sells its strong brand name that has a high potential to grow compared to other social platforms providing the same like Facebook and Whatsapp. It has a huge space to grow (Damodaran, 2011).
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