3 Reasons to Buy the Skype IPO

I'm hungry for shares of soon-to-be-liberated eBay (Nasdaq: EBAY  ) unit Skype.

My motivations are equal parts business and personal. On weekends, I attach a video camera to my Mac and call my parents in California. They're thrilled to see their fast-growing grandchildren on camera. I know the feeling; I got to see my equally fast-growing nephew via a Skype video call from my sister a few days ago. Skype has become the connective tissue with which I keep tabs on family and friends.

But Skype is also an important business tool for me, a freelancing Fool who works far from HQ. Skype keeps a lid on my telephony costs and improves service by substituting for AT&T's (NYSE: T  ) shaky wireless service in my area.

Mine is a special case, of course. But Skype's growth is unmistakable. Revenue soared 44% to $551 million in 2008. That same year, Skype registered 129 million new users, up 47% year over year.

And growth shows no signs of slowing. Skype had added 75.2 million registered users through June 30, on pace for 150.2 million new users and 555.7 million overall by the end of 2009. Here are two reasons to expect further gains, and one really good reason to buy when Skype becomes an independent public company.

1. The rise of the work-anywhere worker
A global workforce is becoming more distributed by the day, which means more telecommuting. Recently, Cisco said it had generated $277 million in savings by letting some employees telecommute from home.

To be clear, Cisco has an agenda. The networking equipment maker is hawking IP telephony equipment and services to large clients -- making it a corporate Skype, you might say. The company's timing couldn't be better. As recently as 2007, 12 million Americans worked at home at least eight hours per week. Researcher Gartner Dataquest predicted that number would grow to 14 million this year.

The federal government could help to boost those numbers. Roughly 95,000 government employees were telecommuting in 2007, The Detroit Free Press reports. The best tool for these workers? The Web, naturally. 

And they'll get more and better tools if President Obama has his way. The president has earmarked $7.2 billion to increase broadband Internet access across the nation, a likely boon to wireless operators such as Clearwire (Nasdaq: CLWR  ) and rural-area carriers such as Windstream (NYSE: WIN  ) . More broadband also equals more opportunity for Skype.

2. Traditional networks aren't improving fast enough
Efforts to expand and stabilize Web access have left traditional landline operators such as AT&T, Verizon (NYSE: VZ  ) , and Sprint Nextel (NYSE: S  ) with little choice but to expand their own offerings. Ma Bell, in particular, has committed $18 billion to network upgrades in 2009, a spokesperson told me recently.

But that hasn't silenced critics. Users otherwise enthusiastic about Palm's (Nasdaq: PALM  ) Pre smartphone expressed hesitations about switching to Sprint Nextel from their existing carriers. AT&T took a beating on Twitter for failing to disclose its network's problems with visual voicemail delivery.

Such criticism, while fair, can be overdone. Furthermore, the Web and VoIP services such as Skype are no panacea. Think about how many times you've suffered a Web outage. In February, millions of Gmail users lost access when the service went offline for more than two hours.

Yet users remain undeterred. Cloud computing services such as Gmail will account for $56 billion in revenue this year, up 21% from $46 billion in 2008, Gartner predicts.

3. Numbers that are worth buying
Skype has become one of the cloud's most popular services. Brian Krebs, digital security reporter for The Washington Post, said in a recent blog post that he has been "a loyal Skype user for several years now," and that he has his own Skype phone number with custom voicemail.

He's a paying customer like me, in other words. My tab is just $8 a month. Krebs may or not pay more. But we know from the latest data that Skype has generated $611.9 million in revenue over the trailing 12 months, from an average of 409.4 million registered users.

Doing the math shows that Skype is taking in $1.49 per user, per year. If that ratio holds, and Skype's user base grows to 556 million, as expected? Revenue would improve to $828.4 million.

Uh-oh, here comes the math
I'm fascinated by the assumptions cooked into Skype's presumed valuation: roughly $2 billion, according to press reports. Let's project a little. Assuming $828.4 million in 2009 revenue and a 21% operating margin -- in line with the recent past -- Skype could generate $173.9 million in full-year pre-tax profit. Taxing that at 40% leaves $104.4 million. Dividing that by $2 billion equals 19.2.

Skype, at a $2 billion IPO, would sell for close to 20 times 2009 earnings -- perfectly fair for a company with a known brand, a large and loyal user base, and excellent growth prospects.

But that's my take. Do you agree? Disagree? Use the comments box below to tell us whether you would buy Skype if given the chance.

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Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article at the time of publication. Check out Tim's portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy serves fresh disclosure-y goodness daily.


Read/Post Comments (4) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 28, 2009, at 3:20 PM, VegasMartin wrote:

    I recently started using Skype and absoluely love it. People with families who live across seas are able to communicate with each other for free, saving them tons and tons of money since they can now dump their long-distance plan. Anyone who currently has Vonage will dump that $25 service for the less expensive Skype. More business will likely use this as a communication and video-conferencing tool. I love the potential for this company.

    When is the IPO? I would love to get in on this.

    www.ShootTheBears.com

  • Report this Comment On July 28, 2009, at 5:34 PM, TMFMileHigh wrote:

    Hello VegasMartin,

    The IPO has yet to be scheduled but is tentatively planned for 2010. But I'm with you; the date can't get here fast enough. There are so many reasons to love Skype's growth potential.

    Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On July 29, 2009, at 9:07 AM, DaveJUK wrote:

    I agree, Skype is a cool and useful product, both for home and business use.

    With respect to the IPO coming in 2010, I am not certain I will jump in and invest. Skype is in the midst of a legal battle with its creators/inventors about the intellectual property (IP) and the licensing thereof. When Skype was bought by eBay, eBay did not buy the technology IP rights. In fact, they license the technology from the inventors and, apparently, Skype has violated that agreement. This is supposed to go to court in early 2010, and the outcome will, according to eBay/Skype, determine Skype's future as a company. If Skype looses, they will have to shutdown operations (according to an SEC filing by eBay), if they win, most likely pay an enormous sum of money every year to keep using the technology. Not sure this is such a great IPO opportunity.

    All of this is just a bit too risky for me. Great article.

  • Report this Comment On July 29, 2009, at 10:33 AM, Melaschasm wrote:

    As a consumer I love Skype. I use Skype as my primary home phone, and keep an emergency cell phone in my car, that can be used if the internet goes down.

    In todays climate, Skype with a P/E of 20 is an okay price point, but I am not sure how much upside growth is likely at that price.

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