Thursday, January 14, 2010

Skype Founders Pondering IPO Don’t Need ’Love’ From Andreessen


One night in 2007, employees at Skype Technologies SA decided to send a message to their new corporate parent, EBay Inc. They picked up the desk of Henry Gomez, an EBay senior executive and Skype’s president, and moved it to a far corner of the company’s London office, says a former EBay senior manager.

The prank underlined how relations had deteriorated between Niklas Zennstrom, Skype’s co-founder and chief executive officer, and the online auction giant, which had acquired the startup two years earlier. In September 2007, he quit as CEO of the Internet phone company.

Two years later, Zennstrom and Janus Friis, his fellow Skype co-founder, have elbowed their way back into the company, Bloomberg Markets magazine reported in its February issue. In September, they waged a legal fight against EBay and a buyout group led by private-equity firm Silver Lake that had acquired control of Skype for $2 billion. The suits alleged that the consortium and EBay had unlawfully used the founders’ copyrighted software that they’d licensed to Skype. The consortium and EBay denied the allegation.

In November, Skype’s new owners cut Zennstrom and Friis in for a 14 percent stake and two board seats, and the duo dropped their lawsuits.

“They were not going to let Skype get away from them; that’s their baby,” says Yvette Alberdingk Thijm, a former senior content executive at Joost NV, an online video company that was also co-founded by Zennstrom, 43, and Friis, 33.

Largest IPO

Now Skype, which lets users call each other for free over the Internet, could be headed for the largest initial public offering of a technology company since Google Inc.’s 2004 IPO, says Paul Bard, director of research at Greenwich, Connecticut- based Renaissance Capital LLC.

Skype has soared in popularity since it started in 2003 and boasts about 548 million users worldwide, more than Facebook Inc., MySpace Inc. and Twitter Inc. combined. Skype earned $165 million in operating income in 2009, a 42 percent jump from 2008, Thomas Weisel Partners LLC estimates. If Skype increases its profits to $400 million by 2013, it could go public at a valuation of $4 billion, says Bard, who specializes in IPOs.

“Investors would have a big appetite for a profitable Internet IPO with its growth and scale,” he says.

Zennstrom and Friis will have to get along with some of the most powerful personalities in technology to deliver a hot IPO. Skype board member Marc Andreessen, the computer scientist who helped engineer the Web browser and usher in the Internet boom in the late 1990s, is working on the company’s growth strategy. A director at Hewlett-Packard Co., EBay and Facebook, Andreessen owns a Skype stake of about 5 percent through Menlo Park, California-based venture-capital firm Andreessen Horowitz LLC.

“Ongoing Battle”

Egon Durban, head of European investments at Menlo Park- based Silver Lake, is also playing a lead role at the Internet company. And EBay CEO John Donahoe will have a say in Skype’s direction; his company retained a 30 percent stake.

Phillip Phan, a business professor at Johns Hopkins Carey Business School in Baltimore, foresees difficulties in the boardroom between Zennstrom and Friis and their fellow stakeholders.

“It’s obvious that the founders have an emotional interest in the company,” says Phan, who teaches corporate governance. “I suspect you will see an ongoing battle in the executive suite between the founders and the rest of the partners.”

Zennstrom and Friis refute this assertion. “That skepticism is entirely misplaced,” their spokesman Tom Rayner wrote in an e- mail. “Niklas and Janus have a huge and genuine respect for their new partners, with whom they are very much looking forward to working.”

“Not Grade School”

Andreessen, 38, says he expects the founders to bring zeal and innovation to the company they created, not acrimony. Seated in a sunlit conference room of his venture capital firm, with a view of the redwood-covered Santa Cruz Mountains, he says all of Skype’s owners share the same goal of making it a Google-caliber business.

“What’s great about the alignment of interests is that it doesn’t require everyone to love each other; it’s not grade school,” says Andreessen, who fires off comments with the speed of a machine gun. “If Niklas and Janus have six ideas on how the company can increase exponentially from where it’s at, I want to hear those.”

The new owners’ big idea is to expand Skype into the $203 billion market for corporate telecommunications. The company, which has about 700 employees, will form a new division with a sales force, product development managers and customer-support teams to offer businesses a suite of services and software.

New Rules

“We’re chasing a big opportunity,” says Skype CEO Josh Silverman, 40, former head of EBay’s unit.

The Internet company will have to gain the trust of corporations, which today largely rely on dedicated fiber-optic networks for their communications. Businesses may be unwilling to switch to a phone service built on the less-secure Internet, says Vanessa Alvarez, an analyst at Frost & Sullivan in Boston.

“Enterprises aren’t completely comfortable bringing in a consumer Internet company that’s mostly used for chitchat,” Alvarez says.

Skype has also lobbied the Federal Communications Commission as part of its strategy to become available on more mobile telephones. In September, FCC Chairman Julius Genachowski proposed new rules to bar telecom carriers from blocking Internet traffic on their wireless networks, a problem that’s hindered Skype. The commission may vote on the initiative this year.

“Massive Threat”

A Skype IPO would mark a coming-of-age for Web-based social and professional networking companies such as Facebook and LinkedIn Corp. These so-called Web 2.0 startups are enlarging their online communities each month with millions of new members, who then recruit their friends, family members and colleagues to join. Skype may take market share from AT&T Inc. and Verizon Communications Inc. much like Google and Craigslist Inc. snatched advertising from newspapers.

“What’s valuable about Skype is having half a billion connected users,” says Bill Gossman, an executive-in-residence at Mohr Davidow Ventures in Menlo Park. “It has a platform for delivering all these other services, and that’s a massive threat to traditional phone companies.”

Skype makes money by charging about 2 cents a minute for calls to nonservice users. Today, seven-year-old Skype is the No. 1 provider of cross-border calls, with 12 percent of the market, estimates Washington-based TeleGeography Research Group. The company also collects fees for voice-mail, text-messaging and other services.

Like Mr. Spock

Zennstrom and Friis set out to shake up traditional industries soon after they met in 1997. Zennstrom, then a manager at Swedish phone company Tele2 AB, hired Friis to work on the customer service desk.

Zennstrom, a married Swede with dual degrees in engineering physics and business administration from Uppsala University outside Stockholm, is analytical and disciplined and shuns small talk in meetings, former colleagues say. One former colleague likens Zennstrom to Mr. Spock, the cerebral Star Trek character who prizes logic above all else.

Friis, an unmarried Danish high school dropout, is a restless man who constantly taps out text messages on his smartphone during business meetings, even when addressing others, the former colleagues say.

In 1999, the pair collaborated with engineers in Tallinn, Estonia, to write the software for Kazaa, a technology that helped upend the music industry. The peer-to-peer MP3 file- sharing program akin to Napster allowed users to copy and distribute songs without paying for them.

Whitman’s Wager

The music industry and other entertainment groups sued Kazaa for copyright infringement; Zennstrom and Friis denied wrongdoing. In 2006, the duo, which no longer owned Kazaa, took part in a settlement of the litigation.

By then, Zennstrom and Friis had already created Skype using the same peer-to-peer technology that powered Kazaa. In September 2005, Skype had 54 million users, and Google and Yahoo! Inc. were negotiating to buy it.

Meg Whitman, a Harvard Business School graduate who had been CEO of EBay from its infancy in 1998, joined the chase for Skype. Whitman, 53, boosted EBay’s sales sevenfold to $3.3 billion in 2004 from four years earlier. As revenue and profit growth slowed in 2005, she wagered Skype could spur sales by letting buyers and sellers on its auction site talk for free with a mouse click.

Missed Flight

Whitman outbid Google and Yahoo and agreed in September 2005 to pay $2.6 billion for a money-losing VoIP phone startup. The CEO sweetened the deal with an additional $1.5 billion in incentives if Skype reached growth targets between 2006 and 2009.

“With the leader in Internet voice communications, we will create an extraordinarily powerful environment for business on the Net,” Whitman said in a statement in September 2005.

Whitman didn’t obtain total control of Skype. Zennstrom and Friis kept ownership of the underlying peer-to-peer software in a company called Joltid Ltd., which licensed the technology to Skype. And Zennstrom intended to continue running Skype as an independent enterprise.

“We didn’t look at this as selling the company,” Zennstrom said at a technology conference in Athens in October 2005, according to Bloomberg News. “We were looking for a partner, a company that would help us grow. We hit it off well with EBay.”

Imposing Discipline

Not for long. In late 2005, Whitman and her lieutenants flew from California to Estonia, the site of Skype’s engineering staff, for their first in-depth review of the company with Zennstrom and Friis. The two men didn’t show; they’d overslept in London and missed their flight, says a former senior EBay executive familiar with the meeting. After traveling across 10 time zones, Whitman and her team had to wait hours in Estonia for the founders.

As startup entrepreneurs, Zennstrom, Friis and their engineers seemed to chafe under EBay’s bureaucratic rules, the executive says. They were obliged to produce a stream of budgets, employee reviews and weekly metrics reports.

“They didn’t say it to us directly, but they kind of looked at us and said, ‘This is stupid,’” the executive says.

EBay grew frustrated at its inability to impose discipline on the Skype camp. EBay wanted the founders to embrace a long- term growth plan that generated profits. Instead, Skype’s engineers produced applications with limited interest to consumers, such as three-dimensional chess, instead of VoIP business services, as they chased the short-term growth targets set by the acquisition’s $1.5 billion incentive agreement, the former executives say. Rayner, the founders’ spokesman, declined to comment on their tenure at EBay.

Regaining Control

When Zennstrom quit as Skype’s CEO in September 2007, EBay paid the founders and other early Skype investors $530 million from the 2005 incentive agreement. EBay also wrote down the unit’s value by $900 million.

“The Skype deal didn’t make any sense,” says George Shipp, a money manager at BB&T Asset Management Inc. based in Richmond, Virginia, which holds 1.4 million EBay shares.

Whitman stepped down as CEO of EBay in March 2008 and is running for the Republican Party’s nomination in the 2010 California gubernatorial race. Sarah Pompei, Whitman’s spokeswoman, defended the Skype deal.

“Meg strongly believes this is and will continue to be a beneficial acquisition for EBay,” Pompei wrote in an e-mail.

Legal Battle

In early 2009, Zennstrom and Friis saw their chance to regain some control of Skype as Donahoe, Whitman’s successor, moved to spin it off. They joined with Elevation Partners LP, a Menlo Park-based private-equity firm, to bid for it. On Sept. 1, EBay instead agreed to sell 65 percent of Skype to the Silver Lake-Andreessen group, which includes the Canada Pension Plan Investment Board, in a deal that valued the company at $2.7 billion.

In response, Joltid, Zennstrom and Friis’s holding company, sued in two courts in September. The suits claimed that EBay and the consortium misused the peer-to-peer software in making their deal and asked the courts to block them from proceeding. Eager to eliminate the legal distraction, the buyout group offered to bring Zennstrom and Friis into the deal.

On Nov. 5, the two agreed to invest $83 million, transfer ownership of their software from Joltid to Skype and drop their suits in exchange for a stake in the company worth $378 million. EBay reduced its equity position to 30 percent, and the buyout group decreased its stake to 56 percent from 65 percent.

“They created a big legal kerfuffle to edge themselves into the deal,” Mohr Davidow’s Gossman says.

Zennstrom and Friis disrupted the music industry with Kazaa and then earned a windfall by selling Skype to EBay. Now, they must prove that they’re entrepreneurs capable of winning corporate clients on the way to an IPO -- not just tech rebels who play by their own rules.