I use and love both eBay and Skype. I admire their management. They are extraordinary businesses and epitomize the disruptive potential of the Internet and the creative potential of virtual communities. And yet I am struggling to make sense of eBay’s acquisition of Skype. The deal makes more sense for Skype and its shareholders, but I have a hard time buying into the deal from eBay’s perspective
My best read on the acquisition is that it is one more example of “The Curse of the High Multiple.” Many of the CEOs that I serve as a consultant struggle with low P/E ratios and look longingly at the high flying companies that sport high multiples. I certainly sympathize with their frustration and work with them to boost the performance of their companies. At the same time, I warn them that high multiples have their own challenges.
What do you do for an encore? Once your company ascends into the stratosphere and convinces shareholders that it has extraordinary potential for profitable growth, what does it do then? Well, you have to deliver. The higher the multiple goes, the more challenging it is to meet those expectations. And that’s just to hold your stock price at current levels. If you actually want to raise your stock price further (and most CEOs with large stock and options holdings certainly want nothing less), then you need to somehow raise expectations even further – and then deliver against this even higher bar.
The pressure can become overwhelming. It pushes companies to look for really big plays that can feed the expectations engine (and potentially divert attention from the slowing growth in existing businesses). Since organic growth rarely delivers big enough impact (especially once a company moves beyond a certain threshold of size), management starts to rev up the acquisition engine. Unless the industry is extremely fragmented and there are lots of consolidation plays, the pressure to find large new growth vehicles pushes management far afield from their core business. With the stock price at such a high level, capital is cheap and the temptation to acquire new businesses becomes even stronger. At the extreme, it can push companies like Enron and WorldCom over the edge, where executives end up manipulating numbers in fraudulent ways to keep the treadmill going faster and faster.
Even in businesses like eBay and Skype with strong increasing returns characteristics, increasing expectations begin to outpace the increasing returns. From my experience, CEOs of high multiple businesses rarely sleep any better than CEOs of low performing businesses – unless they are coming up to their retirement date and are about to cash out on their stock holdings in the company.
If I look at the materials released by eBay (warning: 3.5Mb PDF download) at the time of the announcement, I can’t help but feel that we are seeing the curse of the high multiple in action. It’s a good presentation with lots of helpful material, but when I step back from it, I still get the feeling that this is ultimately about entering a new, high growth business to compensate for slower growth in the core business. As a result, I share some of the early skepticism of folks like Rob Hof at Business Week and Om Malik at Business 2.0.
The eBay presentation talks eloquently and at length about the role of Skype in accelerating commerce on eBay and opening up new lines of business, new monetization models and new geographies. I agree that adding voice to transactions makes for richer communication and reduces friction, especially in certain types of transactions and certain national cultures. But then again, adding shipping services helps to reduce friction as well – does that mean eBay should go out and buy FedEx? Yes, markets are conversations as Ross Mayfield reminds us, but does that mean you need to buy a phone company to participate or even orchestrate those conversations?
Pay per call lead generation models are an interesting step beyond pay per click models, at least for certain kinds of businesses. There clearly are interesting opportunities to cross market to each other’s user base (one interesting statistic from the presentation – there is only a 1% overlap in their US user base – although this can be read both ways, as either an opportunity or a challenge).
But here are the bottom line questions:
- Is this acquisition going to improve the performance of the individual businesses in ways that either would not be possible or at least would be much more expensive without an acquisition?
- Are there any other business relationships short of acquisition that could have produced these improvements in performance?
- Will the improvement in performance be sufficient to earn an acceptable return on the very high price paid for Skype?
- Why couldn’t eBay simply have licensed Skype’s (or any other VoIP provider’s) service and embedded it in its platform to deliver voice-enriched transactions or pay per call lead generation programs?
- Why couldn’t they have negotiated cross-marketing programs to reach each other’s user base?
Both companies face intense competitive challenges in the years ahead. EBay is clearly concerned about Google. Skype should be concerned about a growing array of challengers in the VoIP arena. Acquisitions have a way of distracting management attention from challenges in the core business. They also reduce the sense of urgency – if my core business is under attack, I will be much more aggressive in my response if I have no other business to fall back on.
In fact, both companies face very similar competitive challenges:
- They need to reposition their businesses as more open platforms encouraging applications and services to be built on top
- They need to deliver more value to their users based on profiles of their activities
- They need to develop more of the virtual community opportunities latent within their user base.
Umair Haque presents some interesting charts highlighting the challenge of eBay’s economics relative to Google’s economics, but I am not sure he is compelling about why the acquisition is a necessary step in addressing this challenge.
In the end, I worry that high multiples produce dysfunctional behavior, as we saw in the Internet bubble at the end of the 1990s. Two big warning signs of dysfunctional behavior have emerged in the discussion surrounding this acquisition.
First, David Kirkpatrick proclaims that eBay may be creating the “first genuine conglomerate of . . . the Contribution Economy”, arguing that the companies are actually very similar. We have spent most of the past thirty years unwinding the conglomerates that destroyed shareholder value, but now we are going to inaugurate a new age of conglomerates? On what basis?
Second, one commenter to a posting on a blog asserted that “it’s all about eyeballs and traffic” without any apparent hint of irony or sarcasm. This is what got us into trouble during the last bubble – have we learned nothing?
Look, I am the first one to concede that my views are jaded by several decades of working with senior executives who embarked on large acquisitions in the hope of creating value, only to discover that they destroyed value. My comments probably suggest a profound failure of imagination on my part, but I just don’t get it.