I think that $8.5B is a lot to pay for Skype. My understanding is that Microsoft didn’t have a competing offer for anything approaching this number so I’m not sure why they felt compelled to pay so much. It clearly suggests that they want Skype very badly and see it as strategically important to their future, as based on financials the valuation doesn’t stack up at all. They are paying around 10x last years revenues of $860M which is a very high multiple – plus the revenues are all for their local calling product from Skype to any phone and this is low margin revenue that costs a lot to support. Skype does have a very large user base of around 650M, higher than any of the other social networks, but the problem is people don’t go to Skype to ‘hang out’ – they go there to make free calls. Indeed only 1-2% of Skype users have upgraded to the chargeable services and that’s the issue they face.

That said, there is definitely a great deal of value in Skype. They have a huge number of users, a strong brand that has become a verb and is synonymous with internet-based calling and they are absolutely the dominant player in the fast growing market for IP communications. But I wonder whether Microsoft can really integrate the service with their various different ‘fiefdoms’ of Exchange, Office, Xbox, Mobile and MSN groups and at the same time retain the creative, entrepreneurial qualities that have been so central to Skype’s success. I have to say I very much doubt it.

But if Microsoft is able to pull this off it would give them a communications platform stitching together their various products and provide them with a much more connected and social element that would be very powerful. This is especially true if they were able to take it a stage further and use the Skype platform to reconcile a single set of user ID’s across their whole on-line environment. And they have Skype’s very large user base to tap into to sell other Microsoft products and services. But there’s a very long way to go if they are to make the acquisition a successful one and Microsoft has not shown us in the past that they are able to successfully marry third party technologies with their core products.

As an example, when we were building MessageLabs, Microsoft acquired one of our competitors called Frontbridge. This could have been a really smart acquisition building in key email security and archiving services into their Exchange product but instead the Frontbridge technology went nowhere and ended up in the backwater that is the Microsoft incubator group. So the acquisition only helped us and we won lots of new customers that were unhappy with the lack of investment and integration of the Frontbridge technology. This gave me a first-hand view of how a Microsoft acquisition can starve a business of its creativity and entrepreneurial spirit and also how they find it so difficult to integrate third party technology. I think there will be lots of Skype competitors out there thinking that this is a a great opportunity to step up and start to make some inroads into their market share.

What this acquisition does show is that the big technology companies are prepared to put up huge amounts of cash to buy big brands with large numbers of engaged users. I think there are a number reasons for this. First, all the big tech companies have a huge amount of cash on the balance sheet and they need to do something with it – this is particularly true of Microsoft whose share price has barely moved for 10 years and they are looking at ways to inject some excitement and growth into the business. Second, they feel the need to build more social elements into their products. Third, there are not many social networks out there with very large user bases of 50M+ so there is also a scarcity factor.

If I was one of the other social network players such as Twitter, LinkedIn or Zynga, I’d be rubbing my hands together at this news thinking about how much strategic value my company might represent to the big technology brands with more money on their balance sheet than they know what to do with!