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Microsoft to buy Skype for $8.5B

Microsoft will acquire Luxembourg-based Skype, with 170 million active users, from an investor group led by Silver Lake, the companies said in a statement today. The agreement was approved by the boards of directors of both companies.

The takeover may help Microsoft Chief Executive Officer Steve Ballmer attract Web users and narrow Google Inc.’s lead in Web advertising. Microsoft will connect Skype to its Outlook e- mail, Xbox game console, Windows mobile phones and corporate- phone software. The acquisition is Redmond, Washington-based Microsoft’s largest, surpassing the purchase of AQuantive Inc. for about $6 billion in 2007.

“This could give Microsoft a much-needed kick-start” in telecommunications, said Paolo Pescatore, an analyst at CCS Insight in London. In voice services, “Skype has certainly set the benchmark and gained a lot of traction.”

Skype will become a Microsoft business unit, the companies said. Skype CEO Tony Bates will be president of the Microsoft Skype Division, reporting to Ballmer.

‘Intelligent Move’

A purchase by Microsoft would divert Skype from a plan, announced in August, to sell $100 million of shares in an initial public offering. The company has struggled to convert users of its free PC-to-PC phone services into paying customers, according to a March regulatory filing. The company has 663 million total users, most of whom aren’t active callers.

Microsoft, the world’s largest software maker, slid 44 cents, or 1.7 percent, to $25.39 in Nasdaq Stock Market trading at 9:37 a.m. New York time. The stock had lost 7.5 percent this year before today.

The price includes debt, Microsoft said. Skype reported about $775 million in debt, along with a revolving credit line of $30 million, in a filing in April. Microsoft had cash and short-term investments of about $50 billion at the end of March.

“It looks like an intelligent move. They have the motherload of cash sitting there,” said Mike Holland, chairman of Holland & Co. in New York where he oversees assets in excess of $4 billion, including Microsoft shares. “They’ve been smart in not going crazy” with the price.

Internet Losses

Ballmer is aiming to revive Microsoft’s online services division, which had an operating loss of more than $700 million in the three months that ended in March. The company lags behind Google in Web search and related advertising.

“Microsoft has a lot of areas in its overall Internet business that it could be working on, and whether the acquisition of Skype is the key silver bullet that fixes all of that remains to be seen,” said Kunal Bajaj, head of telecommunications consulting firm Analysys Mason India Pvt. in New Delhi. “People go to Skype to make phone calls, and there isn’t much else in social networking, instant-messaging and status updates and things like that.”

Microsoft offers corporate telephony services through its Lync product, as well as consumer video-chat products as part of its instant messaging software and Xbox online service. The company said last year that Lync has the potential generate more than $1 billion a year in sales. Sales from the product rose 30 percent last quarter, the company said last month without disclosing specific numbers.

‘In the Game’

Tightly integrated Skype services could be an added selling point for Windows Phone, the mobile operating system Microsoft is promoting as a competitor to Google’s Android and Apple Inc.’s iOS, said Colin Gillis, an analyst at BGC Partners LP. Skype’s services include voice and video calling.

“Apple’s got their Face Time video chat. Android has video chat,” said Gillis, who is based in New York and rates Microsoft “buy.” “Now Microsoft is in the game.”

Microsoft said it will continue to develop and support Skype for rival products. Skype currently makes applications for products like Apple’s iPhone and iPad and mobile phones running Google’s Android operating system.

Microsoft abandoned an unsolicited effort to buy Yahoo! Inc. for as much as $47.5 billion in 2008 and instead struck an agreement to provide search services on Yahoo’s pages. The two companies said last month that so far the partnership is bringing in less revenue than expected. Microsoft has less than one-fourth of Google’s U.S. Web-search market share.

Free Chats

Skype was founded in 2003 by Niklas Zennstrom and Janus Friis and its investors include EBay Inc., private equity firm Silver Lake and venture capital firm Andreessen Horowitz.

Zennstrom and Friis sold the company for $2.6 billion in 2005 to San Jose, California-based EBay, which in turn sold off most of its stake four years later.

Skype, which started as a way for consumers to chat for free online, is developing premium services such as group video calling and pursuing corporate accounts. Skype’s competitors include the fledgling Google Voice service and video chat client Fring.

“Google is probably the one that’s getting the closest to Skype” with its voice product, though the Google Talk service is “not on par in terms of quality” and the Google Voice product is a late entrant and will find it difficult to catch up, said Leif-Olof Wallin, a telecommunications analyst at Gartner Inc. in Stockholm. Vonage Holdings Corp. is another rival in the paid-for business in the U.S., he said.

Microsoft will need to figure out how to make money from Skype. In a December regulatory filing, Skype disclosed that little more than 1 percent of users paid for the service.

“The biggest monetization potential is through ads, but you’d need to understand how often people are using Skype, like measuring calls, but that is difficult,” he said.

Goldman Sachs Group Inc. and JPMorgan Chase & Co. advised Skype on the deal.

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