Is Microsoft About To Overpay For Skype?

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Update 5/10: Confirmed, $8.5 billion in cash.

The deal buzzards are swirling around Skype, and Microsoft may end up with the prize. Om first reported the rumor, which is now getting major play by the WSJ. Microsoft is in final negotiations to buy Skype for $7 billion, according to the WSJ report. The final price might go closer to $8 billion. (Update: Actually, $8.5 billion).

Google and Facebook were also sniffing around Skype, which put off its IPO earlier this year to buy more negotiating time. Microsoft will certainly be overpaying for Skype, which is a better fit for Google or Facebook. But Microsoft is desperate for a legitimate Internet business beyond Bing.

Skype would fit into Microsoft’s enterprise business as a communications hub for telephony, video conferencing, and online meetings. But is it worth 8 10 times revenue and 26 32 times operating profits (Skype’s 2010 revenue was $860 million, adjusted EBITDA was $264 million, and it had no net income to speak—it lost $7 million)? Maybe, if Microsoft doesn’t screw it up.

The chances that it does screw it up if the deal goes through, however, are large. To make Skype work financially, Microsoft would have to turn it into more of an enterprise play to go up against Cisco’s WebEx, for instance. Skype is already making money from businesses to some extent, but it’s roots are with consumers who want to bypass the traditional phone companies and their outrageous bills.

When you think of Microsoft, you don’t exactly think about voice communications. You think about productivity, and to some extent collaboration (although I find its products to be designed more for solitary use). Skype is not a natural fit. Just like it wasn’t a natural fit for eBay, which bought it and then spun it off.

But what about Windows Phone, Microsoft’s mobile OS? Well, that’s where it gets interesting. Skype baked into Windows Phone would be a powerful combination, exactly the type of tight integration that could give it a fighting chance. Except that Skype on iPhone and Android is already pretty good.

So yes, there is logic to the deal. But $7 billion to $8 billion for a company still hasn’t figured out how to turn 663 million users into a profit machine is a stretch. But then, Microsoft was never any good at making money on the Internet either. It feels like Skype really wanted to sell to another company like Google or Facebook, but when the bankers started to shop it around, Ballmer bit and now he won’t let go. Could Google or Facebook have done the deal for less? I think so.