The Future of Skype: An IPO Test


A successful IPO, a profile in The Wall Street Journal, signing up your 1 millionth user—these are all signs that your technology company has arrived. The rarer mark of success, though—the sign that you've truly changed how people behave—is when your service becomes a verb.

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As the Internet has radically transformed the flow of information around the world, only a few companies have been so successful as to intertwine their own name with a particular aspect of the revolution. Skype is one of those companies, having become synonymous with free or cheap phone calls over the Web.

Some 124 million people use Skype every month. Its simple interface allows users to place calls to one another for free—as well as to Skype-less landline and mobile phones for rates much lower than what local phone companies have traditionally offered. Dialing a phone in Hyderabad, India, for example, costs just 9.2 cents a minute. To Skype a friend also embodies much of what the Internet is about: instant communication over a decentralized network, in which geography is rendered irrelevant, all for nothing or next to nothing. The numbers speak for themselves: Skype says that at peak times, 23 million people are using the service around the world. Its users also make up 12 percent of all international calling minutes.

Photos: Companies that succeed despite or because of conflict Chris Martinez / AP

It's easier to be disruptive when you take something that used to be expensive, like international telephony, and make it available for free. Skype's founders, Niklas Zennstrom and Janus Friis (37 and 27 years old, respectively, at the company's birth in 2003), had already seen the truth of this approach with their first breakout product, the peer-to-peer file-sharing program Kazaa. Like Napster before it, Kazaa was a vehicle for downloading mostly illegal music—but also movies, TV shows, e-books, applications, and other copyrighted files. (The company's eventual owner, Sharman Networks of Australia, paid a $100 million settlement to the major music companies in 2006.) Kazaa earned its reputation as a great way to steal things because connections were fast and the library of available content was enormous—two advantages that came with the network's decentralized structure. Users could connect to each other directly, without going through a central station. The same peer-to-peer idea that made Kazaa so powerful also drove Friis and Zennstrom's follow-up smash, Skype. The gist: two people who wish to call each other no longer need the middleman known as the phone company. "We had a very, very simple realization that once there is a critical mass of broadband, telephony can be delivered as a software service," Friis says. "It's such a simple idea. Getting free calls is a pretty good proposition."

The biggest difference between the two services, of course, is that Skype has always been legal, and that gave it the potential to become a powerful business as well. Skype charges low rates for out-of-network calls, and users also pay fees for SMS messaging, voice mail, call forwarding, and other services. Multiplied by millions of users, it adds up to real revenue—$406 million in the first half of 2010, an increase of 25 percent from the same period in 2009.

Skype's early success at signing up its users made it an attractive target for acquisition, and on Oct. 14, 2005, eBay bought the company for about $2.5 billion, a significant premium. Skype was an awkward fit with the online auction giant, and eBay was forced to take a $900 million write-down two years later when Skype, though profitable, failed to perform at an order of magnitude that would justify its 10-figure price tag and impress analysts and investors. Zennstrom and Friis left the company to pursue other ventures. In 2009 eBay's purchase of Skype was further cemented as a blunder when, as the company moved to sell off much of its stake, a colossal oversight emerged: eBay had neglected to obtain from Zennstrom and Friis the intellectual property underpinning the service; if the pair wanted, they could cripple Skype by blocking its use of their peer-to-peer technology. A flurry of litigation ensued, ending in November 2009, with eBay owning 30 percent of Skype; Friis and Zennstrom, 14 percent (and seats on the company's board); and a consortium of investors, 56 percent. A new valuation put Skype's worth at $2.75 billion. But the market will soon get to put its own price on the business, as Skype filed initial paperwork with the SEC on Aug. 9 for a public offering, with plans to raise up to $100 million. Investors will have to weigh Skype's growth against thin profit margins—operating income was just $13 million in the first half of this year—and high costs paid to do business with traditional telephone companies.

On top of the IPO, the next challenge for Skype will be surviving the mobile Internet revolution. It appears well positioned to do so, with popular apps for the iPhone and Android handsets. Though the two companies are competitors in some respects—Apple is basing its advertising campaign for the iPhone 4 on a video-calling feature that Skype has supported for years—Skype has hundreds of millions of fans that want the service on the iPhone, iPod Touch, and iPad. (When Apple introduced multitasking for the iPhone earlier this year, Skype was one of the event's marquee partners.) A stronger challenge may come from Google, whose Google Voice service offers many features similar to Skype, and which last year purchased a startup, Gizmo5, a direct competitor to Skype in the voice-over-Internet arena.

As in the publishing business, which has seen print advertising dollars turn into online advertising pennies, Skype may find that the ocean of money once available to telephone companies will become just a pond as more and more calls are routed over the Internet. And those incumbents may encroach on Skype's territory by improving their voice-over-IP products. Skype has built an enormous lead in the space since 2003, though, based on a belief in simple software that connects people by voice and video cheaply. "Ultimately, if the cost of communication is going down, which it is, then that's good for everyone involved—especially the users, which is what we always focus on," says Friis. Whatever forms communication takes in the future, Skype looks poised to be there—loud and clear.