Skype looks like Silicon Valley’s best IPO hope

March 15, 2010

Skype looks like Silicon Valley’s best hope for a blockbuster initial stock offering in 2010. With Facebook determined to stay private until next year, the former eBay orphan could steal the scene with a quick flip. Moreover, as a result of clarifying copyright issues and rewriting its code to attack the business market, the company may be worth twice its $2.75 billion price tag when eBay sold all but 30 percent of its stake last year.

The company already has 500 million users and made $48 million in the third quarter, its last before going private. That’s good, but eBay wasn’t a natural owner. Its core auction and payments businesses had little to do with managing a communications firm.

And eBay’s poisoned relationship with founders, Niklas Zennstrom and Janus Friis, also hurt. Because they threatened to pull Skype’s license to use the underlying source code, and shut the service, eBay was reluctant to extensively upgrade Skype’s software. Skype’s new owner, a private equity consortium led by Silver Lake, has patched things up, bringing on Zennstrom and Friis – and the source code – with a slice of equity.

The company can now improve voice and video quality on calls by revamping the software. Furthermore, many companies are reluctant to use Skype because it pierces firewalls that protect IT systems from outside intruders. Updated software should give Skype a chance to tap the larger and more profitable enterprise market.

Ebay sold the business for 3.5 times estimated 2010 sales. That’s low for an Internet company whose brand is becoming entrenched, revenue is growing a third annually and operating margins are increasing. Eliminating the possibility the business would be shut down and retooling its software to open new markets make Skype more valuable.

Google, for example, trades at more than six times revenue. Put Skype on a similar multiple, and it would be worth more than twice the purchase price based on estimated 2011 revenue of $1 billion. This sort of return should be sufficient incentive for Skype’s owners to start the countdown towards the Valley’s next hot IPO.

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