Markets

Why a Facebook-Skype Deal Isn't the Stupidest Idea Ever

By Jim Edwards

Updated on: May 9, 2011 / 8:34 AM EDT / MoneyWatch

If you have a passing familiarity with the histories of Skype and Facebook, you probably chuckled at the report that the free social networking site might acquire the free video/phonecalling service. On second glance, however, a Skype-Facebook tie-up isn't such a bad idea.

First, the case for the prosecution:

Skype gives its main services away for free. Businesses that cannot charge their customers aren't businesses. They're hobbies. Skype doesn't make money.
Skype rhymes with hype: This was the tech startup acquired by eBay for $2.5 billion and then disposed by eBay for slightly less than that. It filed for an IPO last year, which means it can't get by without more financing. Make an L-sign with your fingers and apply it to your forehead.
Facebook gives away its main services for free, etc., etc. Facebook appears to be concentrating on growth at all costs rather than solidifying its business model.
Surely, after Goldman Sachs gave Facebook $1.5 billion in equity financing, Lloyd Blankfein said to Mark Zuckerberg, "Don't spend it all at once!"

But hold the, er, phone for just a second. If you dig around inside Skype's delayed IPO prospectus it turns out there's a nice little business in there -- with an even nicer little advertising business inside that -- buried under a mountain of crud.

Skype is unprofitable is because it's loaded down with litigation settlement costs, amortization, transaction charges and separation expenses for ex-executives. If you strip those out -- or assume they will disappear in future years when Skype gets adult supervision -- then Skype is probably profitable. It's tough to tell, however, when you're given information that looks like this (click to enlarge):

Note the missing 2010 net income line (highlighted), the multiple footnotes (never a good sign) and the multiple non-calendar, non-12 month fiscal "years." These aren't the financial statements of a real company. They're a puzzle for accounting students in an MBA course.

Persevere some more and on page 98 the company describes exactly how it earns its $860 million in annual revenues. Most of it comes from selling premium services on top of its basic free service, but $60 million is derived from advertising. It has more than doubled its ad income since 2008.

There is some skepticism that a Facebook-owned Skype might try to make people sit through advertising in order to make their free phonecalls. But that is not what Skype is doing. Skype has three ad revenue streams:

Click & Call, which automatically inserts "buttons" into websites as users view them, enabling users to initiate a Skype call from a website to any phone number using Skype. By December 31, 2010, approximately 77,000 businesses had signed up for Click & Call.
Third party software downloads, so that a user has the option to download the third-party product while installing Skype, for which Skype gets a fee on each download.
In-client display advertising when people use Skype.

None of these actually interfere with the "free" user experience, yet all generate revenue from advertisers.

On top of that, Skype already has a relationship with Facebook:

Skype users can now interact with their Facebook news feed directly from Skype. They can also place low cost SkypeOut calls to their Facebook friends that have posted mobile and/or landline phone numbers on Facebook and free Skype-to-Skype calls to their Facebook friends that are also Skype users.

Facebook is all about connecting people, but it only does so silently through text and photos. In a smartphone world, that seems so ... 2005. It's a natural next step to allow Facebook's chat sessions to graduate into phone and video calling (Facebook Calls, anyone?). Rather than bear the development costs on its own, doesn't it make sense to acquire a company that's already making money doing it?

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Images by Flickr users re-ality and pretty poo eater, CC.