Quick uptick on Skype?

An IPO? So soon after the initial acquisition? To think we might already be in the green on Skype (see prior post “Skype deal: is it a tech or infrastructure deal?” Sept 2-09).

Canadians may want to keep quiet about this, but our very own CPP Investment Board is benefiting from the decision by buyout shop Silver Lake and VC fund Andreessen Horowitz to take Skype public, just 11 months after we acquired our stake in the internet phone service. According to the WSJ’s Venture Capital Dispatch, Skype’s growing great guns:

– revenue is up 25% year over year
– 560 million registered users, up 47% from June 30, 2009
– 8.1 million “paying users”, up from 7.3 million six months earlier

Last Fall, this wasn’t seen to be anything but a traditional private equity-type buy/grow deal, despite the tech flavour of Skype. According to Mark Wiseman (CPPIB) at the time of the initial investment:

“This acquisition represents an opportunity to acquire a leader in the rapidly growing internet telecommunications market and one of the most strategically valuable internet brands in the marketplace. We look forward to working with our partners to help grow Skype in this accelerating industry.”

When the deal closed, eBay predicted revenue would hit US$1 billion in 2011, which seems very achievable on the back of run rate revenue of US$800 million as at June 2010.

Although the WSJ reported that Skype turned an accounting profit of US$13.1 million for the first six months of 2010, I’m not going to get excited about that figure. The more important number to consider is operating income, which came in at US$1.4 million according to the S-1 (pg. 95); a US$29 million income tax benefit is tough to put an earnings multiple on during an IPO roadshow. US$1.4 million might be small, but it is a great improvement over the pro forma US$20.2 million operating loss for the six months ended June 30/09.

I’ll never forget a few years ago when 2/3rds of RIM’s EPS came from interest income on the cash balance and not the sale of BlackBerries; one has to dig into the numbers to get a true sense of the metrics of any business.

One naturally expects that usage and paying customer growth will be what matters to fund managers on the IPO roadshow. Usage is definitely there, which means the IPO hinges on management’s credibility around converting usage to revenue. Fund PMs will be asking why the annualized average communications services revenue per paying user only grew to US$96 from US$94 between June 2010 and June 2009. Not much organic growth there.

Tech stories are usually marketed on their topline numbers, and Skype definitely has fabulous momentum there.

Last September, Marc Andreessen, Co?Founder of VC firm Andreessen Horowitz said “we will work with the Skype team and eBay to build the company into a core Internet franchise at huge scale.” Those “build” days aren’t over, clearly, but Skype’s backers have signaled that they are prepared to let retail investors in on the action a lot sooner than people may have expected.

“Use of proceeds” will be another fascinating part of the roadshow presentation. Skype generates enough margin to market the product to management’s delight. And staff grew by 200 employees without needing to tap the markets.

Cynics will have to shelve the great media storyline about “patient pension fund investors” having enough capital to see an investment through its build & growth phase. Perhaps Skype’s Board isn’t as comfortable with US$700 million of senior debt as they were a year ago, but none of Skype’s investors need to tap outside capital sources if they want to reduce debt.

For the limited partners in Silver Lake III, which includes the CPPIB, Skype’s proposed IPO couldn’t have come at a better time. The software buyout space has gone through a tough couple of years, as is evidenced by the current carrying values at their fund. With 36% of 2006-vintage Fund III deployed, Silver Lake investors were down 2% on their deployed capital as of December 31, 2009 (see prior post “CPPIB U.S.A. general partner Q4 2009 performance numbers” June 1-10).

I read somewhere that this will be the largest tech IPO since Google. What investors really hope, of course, is that Skype’s IPO will perform in a similar fashion. The IPO market seems topsy-turvy to me right now.

SMART Technologies is down 20% in just over three weeks; 70% of the IPO float traded on the first day, which means many of the funds that bought the IPO no longer hold it. The Mitel Networks IPO is off 35% in less than four months. But other high and not-so-high profile names have been fine out of the gate, such as Ancestry.com (+55%), Qlik Technology (+46%), HiSoft (+19%) and Tesla (+15%).

It’s our money on the line, so watch this one with interest. We want this to work out well for everyone!

MRM