net.wars: Money talks
by Wendy M Grossman | posted on 19 October 2007
One of the fun things about making predictions is that, as every year-end psychic knows, you can generally count on people to remember only the successful ones.
For them to remember the unsuccessful ones the prediction has to be really outrageous. And even then it may not matter – people do remember Ed Yardeni's prediction that the Year 2000 would bring global doom and chaos, but he is, astonishingly, still working. Most predictions don't involve putting your money where your mouth is.
But buying companies does. This week, eBay announced it was taking a $1.43 billion one-off charge on Skype, which it acquired just a little over two years ago for $2.6 billion, half cash and half stock. I think it's pretty meaningless to talk about how much a deal is worth when it's a staight stock swap: stock costs the acquiring company comparatively little, for one thing, and for another, stock deals are always inflated to ensure that the company being bought up doesn't get shafted if the stock goes down. You can buy a lot more stuff in boom times – say, 1999 – than after sane valuations return. Just ask Time-Warner.
In this case, though, eBay paid half cash (and of course its stock has gone up a good bit since then) and the writedown it took this week is known as a goodwill impairment charge.
Goodwill is the set of intangible assets – branding, intellectual property, good customer and employee relations – that a company brings with it when it's acquired. It's hard to value directly; in practice it's the difference between the acquired company's tangible assets (physical plant, inventory, receivables) and the price the buyer paid. The inflated valuations of the dot-com boom have left behind an SEC requirement that goodwill must be assessed annually and charged off if its fair value differs too much from the value the company is carrying for it.
eBay's charge, therefore, is an admission that the company overpaid for Skype.
The charge turns eBay's profitable quarter into an overall loss. Bear in mind that of all the Internet businesses eBay is the only one I'm aware of that has been profitable throughout: as a weird, new business in 1995, as an established Internet name taking off during the boom, and as a mainstream phenomenon ever since.
It's not like Amazon.com, which lost money for years before finally turning black, or AOL, which was always going to struggle once the conditions that sent it skywards changed, or Yahoo!, whose volatility reflects that of advertising spend. eBay has always had a solid business model, for a simple reason: the more you buy on eBay the more you buy on eBay.
In an economic downturn, people turn to eBay to get stuff cheaper or turn the unwanted items in their attics into money. In an upturn, people turn to eBay to flesh out their collections of antique Tasmanian Zorks.
Of course, over time the stock has gone down as well as up, but the business has remained solid. As it does, even now. So does Skype's: according to eBay's SEC filing, Skype has continued to grow in all geographical areas, and its net revenues nearly doubled in the past year on an increase in accounts of 81 percent.
Two years after the acquisition, Skype's usefulness to eBay is less clear.
Of course, there's the diversification argument: I am frequently told that the hardest thing for a technology company is coming up with its second product. Google, for all the embellishments it's added to its search engine, basically has one core product that produces revenues: text-based, contextual advertising. But if diversification is why eBay bought Skype, it might as well have bought the perfectly profitable kind of thing Warren Buffett is famous for buying: brick, carpeting, and paint. ("Try to contain your excitement," he wrote dryly to his shareholders in 2001.)
At the time, I thought owning Skype would enable eBay to increase the interconnectedness of its user community. This was much what the companies themselves said : eBay would be able to offer, essentially, premium call services, and Skype would help buyers and sellers communicate.
In fact, that hasn't happened: people do not have Skype options to enable on their eBay accounts that would allow other users to make direct contact with questions, and you do not see Skype buttons, whether talk or chat, under buyers' or sellers' names, next to "email the seller". The number one way that buyers and sellers communicate is email, both inside eBay's secured Web platform and outside it once communication has been established.
And this despite the fact that systems allowing live telephone callbacks from or real-time chats with a live customer service representative have been well established for a long time, and are built into many of the bigger ecommerce sites.
PayPal, which eBay acquired in 2002 for $1.5 billion, has been much more successfully integrated into eBay's core business. The good news in all this is that financial analysts covering the Internet seem to have matured.
No one is writing that eBay is doomed, or that VoIP is all hype, though some are arguing that Skype may still become roadkill. It seems unlikely: Skype's revenues are robustly increasing and after all, it does have pretty smart owners.
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Wendy M. Grossman’s Web site has an extensive archive of her books, articles, and music, and an archive of all the earlier columns in this series. Readers are welcome to post here, at net.wars home, follow on Twitter or send email to netwars(at) skeptic.demon.co.uk (but please turn off HTML).
net.wars: Money talks