Microsoft is close to buying internet telephony network Skype in an $8.5 billion deal, a source familiar with the situation said, as it seeks to regain ground on growing rivals such as Google.
Buying the loss-making but popular Skype would underline Microsoft's need to gain new customers and platforms for its software as smartphones and tablets explode in popularity.
Skype, which allows people to make calls at no charge, would also give Microsoft a foothold in the potentially lucrative video-conferencing market as global businesses seeking to reduce expenditure shift to lower-cost ways of communicating.
Microsoft has already put more energy and resources into mobile and internet technologies as the use of PCs, which underpin its Windows and Office franchise, is under threat.
This change was starkly illustrated last year when Apple's portfolio of coveted consumer goods propelled it past Microsoft to become the world's most valuable technology company. The maker of iPhones and iPads has since been named as the most valuable brand too, overtaking Google.
The Skype deal – which would be the biggest in the 36-year history of the world's largest software company – is expected to be announced as early as Tuesday morning, the source told Reuters. Microsoft and Luxembourg-based Skype declined comment.
The $8.5 billion mooted price tag, including debt, was a surprise. Although the sum would not stretch cash-rich Microsoft, some said it was high for a company whose ownership has changed several times during its relatively short life.
"In this atmosphere of Internet Bubble 2.0, picking up an unprofitable online company for roughly 10 times sales probably seems downright cheap," Shanghai-based Michael Clendenin, managing director of consulting firm RedTech Advisors, said.
"But if you consider (it) was just valued at about $2.5 billion 18 months ago when a chunk was sold off, then $8.5 billion seems generous and means Microsoft has a high wall to climb to prove to investors that Skype is a necessary linchpin for the company's online and mobile strategy," he added.
This was echoed by Ben Wood, head of research firm CCS Insight: "The big unanswered question is how Skype assets work for Microsoft, they already have instant messaging, IP telephony... how do you justify the price?"
"That being said, Skype is a vibrant community, a diverse global community with a young population and Skype is making inroads into older parts of the population too," Wood added.
Skype, which delayed plans for an initial public offering expected to raise $1 billion, has been looking at other options, including tie-ups with Facebook and Google. Such a deal was seen as valuing Skype at $3 billion to $4 billion.
Despite doubling sales and profit in the last eight years, Microsoft's stock has largely languished, as investors worry about its ability to counter new rivals or adapt to new ways of computing, especially the threat posed by new mobile devices.
Microsoft has countered with a new version of its mobile software – which will power the next generation of Nokia smartphones – and is developing a new operating system that will work on low-power tablet PCs.
But online video chat remains a weakness. Although the company already has video in its Windows Live Messenger service, it is not available on its Windows Phone 7 software.
Skype also makes versions of its own service for use on iPhone and iPad, Research in Motion's BlackBerry and Android phones. It cannot be used on Microsoft phones.
Apple's FaceTime video calling service – available on its latest iPhone and Mac computers – has been a big hit. Google recently followed suit by adding video to its popular Google Talk application for smartphones running on its Android system.
Despite being its most expensive to date, the deal would still be relatively small for Microsoft, which has $50 billion in cash and short-term investments on its balance sheet. The price would likely include $686 million in long-term debt.
"I think the price is quite reasonable," said Sean Lee, a Taipei-based manager of the Global Top Dividend Fund at Shinkong Investment Trust, which owns Microsoft shares.
Skype, which was formed in 2003, was bought by eBay Inc in 2005 for $3.1 billion. Last year it had in $860 million in revenue but made a net loss of $7 million, according to data in its initial public offering filing.
In 2009, eBay sold a majority stake in Skype to an investor group including Silver Lake, the Canada Pension Plan Investment Board and Andreessen Horowitz for $1.9 billion in cash and a $125 million note. EBay retained about a third.
Last year, Skype had about 124 million connected users every month by the end of June. But 8.1 million were paying customers, using Skype to make calls to traditional phones at low rates.
A deal would exceed the $6 billion Microsoft paid for online ad agency aQuantive in 2007, which was not a success.
Microsoft shareholders are relieved its $47.5 billion offer for Yahoo Inc in 2008 was rebuffed, paving the way for a web-search agreement which gives Microsoft most of what it wanted anyway. Yahoo shares have halved in value.
Microsoft's most high profile internet buy was the $240 million paid for a 1.6 percent share in Facebook in 2007. It is also plowing money into its MSN internet portal and Bing search engine, racking up $7 billion in losses over four years.
Technology sector mergers and acquisitions have spiked since last summer, driven by increased confidence in the economy and companies facing pressure to spend mountains of cash. Global deal volume year to date is up 55 percent when compared with the same period in 2010, recent figures fromThomson Reuters show.
Goldman Sachs and JPMorgan are advising Skype, the source said, while Microsoft is not using advisers.
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