Early this week, eBay announced that after four years of owning Skype, the popular, and free, online phone service, it had sold the company to an investor group for around $2 billion. The investors included the Silicon Valley private equity firm Silver Lake Partners; Marc Andreessen’s new venture capital firm, Andreessen Horowitz; a London firm called Index Ventures; and the Canada Pension Plan Investment Board. Under the terms of the deal, eBay will retain a 35 percent stake in Skype, giving it a valuation of $2.75 billion.
Many people on Wall Street — and a number of telecommunications experts I spoke to this week — were stunned by the price Skype sold for, and not just because we’re in the middle of a recession. In 2005, when eBay bought Skype from its founders, Janus Friis and Niklas Zennstrom, it paid $3.1 billion. But the company had performed so poorly that by the fall of 2007, eBay had been forced to take a $1.1 billion write-down.
Around that same time, Mr. Zennstrom, whose relationship with eBay management had turned acrimonious, stepped down as Skype’s chief executive. (Mr. Friis had already left the company.) Although Skype’s performance has improved since the installation of a new chief executive last year, it was no secret that eBay was trying to unload it. Many potential buyers had walked away, believing that eBay simply wanted too much.
There is another reason that the Skype deal has raised eyebrows, however. Not long after Mr. Friis and Mr. Zennstrom left the company, they became embroiled in a dispute with eBay that has turned into a very nasty lawsuit.
It turns out that in selling Skype to eBay, Mr. Friis and Mr. Zennstrom retained control of a key part of the Skype technology, which they licensed to eBay. Although the details are under seal in a London court, the Skype founders’ essential complaint is that eBay tampered with their software, and in doing so, violated the terms of the licensing agreement. They were demanding that Skype be forced to stop using the technology, which, for all intents and purposes, would mean shutting down Skype itself. The case is set for trial in 2010.
Companies are sued all the time, of course. But this lawsuit feels different; to put it bluntly, it feels more dangerous than the typical lawsuit aimed at a corporation. In a court hearing in London last June, eBay’s lawyer told the court that if Mr. Friis and Mr. Zennstrom won the case, the result would be “devastating.”
In its financial documents, eBay says that it is “confident” of its legal position. But it also acknowledges that an “adverse result” could mean that the “continued operation of Skype’s business as currently conducted would likely not be possible.” That is hardly your typical corporate boilerplate. Indeed, after that court hearing in June, a telecom analyst named Jayanth Angl told Bloomberg that “if eBay can’t reach an agreement over that piece of technology, that could certainly turn the Skype acquisition into a debacle.”
And so, the mystery of the Skype deal: why were the winning bidders willing to pay so a high price for a company whose very existence could be threatened by this lawsuit? One possibility is that they have nerves of steel. The other is that they know something nobody else does.
Skype was not Mr. Friis’s and Mr. Zennstrom’s first company. No, that was the infamous Kazaa, a peer-to-peer company that the two men founded in 1999, not long after Napster showed the world exactly how easy it was to steal copyrighted music using peer-to-peer computing. By 2001, the recording industry, having routed Napster, turned its sights on Kazaa.
Going after Kazaa was tougher because it was located somewhere in Northern Europe, outside the purview of United States law enforcement. (No one knew exactly where.) The Kazaa founders moved periodically to keep the recording industry from being able to subpoena them, and for years, they stayed away from the United States for the same reason. But the recording industry kept up the pressure, and as their legal costs mounted, Mr. Friis and Mr. Zennstrom finally decided to get rid of the company and move on.
Former Skype executives will tell you that the Kazaa experience did a lot to shape Mr. Friis’s and Mr. Zennstrom’s approach to business. It made them extremely secretive. They almost never talk to the press. (They didn’t speak to me for this column.) And it also made them extremely protective of the technology they created. Which is why, long before they sold Kazaa, they moved their peer-to-peer software into a new company, called JoltID.
In 2003, when they started Skype, that same technology that had powered Kazaa became an important part of the Skype code; it was the means by which computer users connected to each other and created a larger network. (VoIP — voice over Internet protocol — was the means by which they spoke to each other online.) But Skype never owned the technology; JoltID did.
Why eBay was willing to go along with such an arrangement when it bought Skype two years later will forever be a puzzle. But so long as the two men remained part of the eBay “family,” it didn’t matter much. Any changes to the peer-to-peer code were ones they approved.
When the deal went sour, however, and the founders left eBay, that all changed. And when eBay continued to tinker with the code — something eBay contends it has a right to do under the license — they entered into negotiations that went nowhere. Finally, by March of 2009, the two sides had sued each other.
At the same time, the founders, together with some big private equity firms, including Elevation Partners in Silicon Valley (yes, the Bono firm), and General Atlantic in New York, were trying to buy back Skype. It was, after all, their one big success. (Their third start-up, Joost.com, has gone nowhere.)
It is hard to know precisely what happened next. EBay claims that all the bidders were treated the same, and that the losers simply didn’t put up as much money as the winner. But according to supporters of the Skype founders, their investing consortium made three serious efforts, over the course of a year, to bid for the company. Every time, they say, they were stiff-armed by eBay’s investment bankers. About a month ago, they wrote a letter to eBay protesting their inability to get a hearing for their proposals.
And maybe the Skype founders did try to buy back the company on the cheap. The sense I got, however, is that the founders would have been willing to come up with a price that suited eBay — if they had been able to enter into negotiations. What is clear is that the bad blood that had developed between eBay and the founders was infecting the potential negotiations over a buyback of the company. (EBay denies this.)
And then, a few months ago, out of the blue, came the $2 billion bid from the Silver Lake consortium. One way it has dealt with the litigation risk is by persuading eBay to assume 50 percent of any losses resulting from the lawsuit. But that still doesn’t mitigate against the possibility that the founders could win the lawsuit — and put their creation, Skype, out of business.
So why were they willing to bid so high? One theory is that the Silver Lake people think they can win in court. Indeed, if by next summer the two sides are still arguing in court, we’ll know that is the answer to the mystery. That is the “nerves of steel” theory.
But how likely is that? In this environment, big-time private equity firms don’t commit $2 billion if there is a serious possibility the company they’ve just bought might be put out of business. As it happens, not long before Index Ventures became interested in Skype, it brought on board a man named Michelangelo A. Volpi, a highly respected former Cisco executive who — hmmm — once sat on the Skype board. In fact, he was so well liked by the Skype founders that they hired him to run Joost. Wouldn’t you know it? Joost uses the same peer-to-peer technology as Skype and Kazaa.
Mr. Volpi told me that not long after he arrived at Index Ventures, he discussed the possibility of making a run at Skype — and he and another Index Ventures partner, Danny Rimer, in turn rounded up Silver Lake and Mr. Andreessen, who — hmmm — sits on the eBay board. (As soon as he got involved with the bid, Mr. Andreessen recused himself from any board discussion about the Skype sale.) In the end, Mr. Andreessen committed $50 million to the deal — a very large percentage of his $300 million venture fund.
So another theory: because of his friendship with the Skype founders, Mr. Volpi believes he’ll be able to settle the lawsuit. Rich Tehrani, the president of TMC, a telecom publishing company, told me that he had just come from a conference where rumors were rife that the Silver Lake consortium had already cut a side deal with the Skype founders. (All the parties deny this.)
The third possibility is that Mr. Andreessen and the others have figured out a technology “workaround” so they no longer have to rely on the JoltID technology, something eBay had already begun working on. But almost everyone I spoke to said such a workaround would be, at best, difficult and expensive — and could cause such severe disruption to Skype’s business that it might never recover.
It is, alas, unsatisfying to delve into a mystery like this and not be able to solve it. But over time, it will become clear. Either the case will linger, and we’ll know that Silver Lake, Andreessen et al. do indeed have nerves of steel.
Or it will quickly go away, which will provide an answer of a less seemly sort. The mission of Skype, after all, is to shrink the world and bring people together.