Skype’s IPO Filing Illustrates The Telecom Threat

As reported earlier this month, Skype filed with the SEC with the intent to raise near $100 million via an IPO. Throughout the filing, The company illustrated the impressive dominance it gained as an ITSP since it’s inception in 2003. During the first half of 2010 Skype users completed 95 billion minutes of voice and video.  Also of interest,  approximately 40% of all Skype-to-Skype minutes included video.  The company also sent over 84M SMS text messages during the same time period. Skype also now has 560 million registered users (which is somewhat meaningless to me as many users have multiple accounts or some have abandoned the accounts). The company also claims 124 million connected users and 8.1 million paying customers. Paying customers are those that have purchased one or more of the following: (1) SkypeOut minutes (placing calls to landlines and mobiles), (2) SkypeIn minutes (receiving calls to landlines and mobiles), (3) Sending SMS messages, (4) Voicemail and (5) Connecting to the Internet via Skype Access.

Here is a graphical representation of subscriber growth (note: subscriber growth rates for 1H10 were compared to those of 1H09):

Also interesting is the Skype paid users vs. free:

During the first half of 2010 Skype generated $406.2 million of net revenues with an (Adjusted) EBITDA of $115.8 million. The majority of the revenue is from SkypeOut services. Per the filing the company plans to grow revenue from four specific areas:

• First, we believe that there is a significant opportunity to grow our user base.
• Second, we believe that we can generate more communications revenue from our users by improving awareness and adoption of our paid products and introducing premium products such as group video calling.
• Third, we will continue to develop new monetization models for our large connected user base. We currently generate a small portion of our net revenues through marketing services (such as advertising) and licensing, which we expect will grow as a percentage of our net revenues over time.
• Fourth, we will broaden our user base to include more business users. For example, we have recently released and will continue to develop and market Skype for Business products that aim to capitalize on demand for Skype from small, medium and large businesses.

How will Skype achieve the growth?  Via the combination of the four components (per the Skype SEC filing):

1. Continue to grow our connected and paying user base. In the three months ended June 30, 2010, we had 124 million average monthly connected users and 8.1 million average monthly paying users. We aim to grow our user base and increase the portion of our users who use paid products by supplementing our viral marketing with new marketing initiatives and strategic relationships.
2. Increase usage of our free and paid products and extend our relationship with our users. As our users continue to use Skype more often, they begin to recognize the full benefits of using our products and many migrate to using Skype as their preferred communications tool across a variety of connected devices. We seek to capitalize on this migration path and to grow usage of our free and paid products through multiple initiatives, including improving our suite of free products, adding new features and paid products, increasing our users’ awareness of our paid products and making it easier for users to pay. We also intend to promote our subscription products and to continue developing Skype software for multiple platforms to increase the accessibility of Skype to our user base around the world.
3. Develop new monetization models, including advertising. Our users made over 152 billion minutes of Skype-to-Skype calls in the twelve months ended June 30, 2010. We believe this represents a meaningful opportunity to increase our revenue from alternative monetization models, including advertising, gaming and virtual gifts.
4. Broaden our user base to include more business users. We believe the business communications market represents a large opportunity for Skype. Approximately 37% of over 40,000 of our connected users surveyed in the first quarter of 2010 told us that they use our product platform occasionally or often for business-related purposes. We believe there is a significant opportunity to better serve the communications needs of the small and medium enterprise segment, as well as larger enterprise customers, by focusing on user needs in this market and developing additional products specifically tailored to business users.

As I have posted before (The Skype Empire: Disintermediation Vehicle), Skype will go after the mobile network and Enterprise for new users. This is how they will grow their base.  After all there are approximately half a billion fixed Broadband users (i.e., where Skype built their base) and over 5 billion mobile phone users. Of course not all 5 billion can use Skype on a mobile, but with the growth of smartphones the applicable device availability will reach 50% within the next year for so.

Here are some other salient points from the SEC filing:

1. As of June 30, 2010 Skype had 839 employees, up from 640 during the same period in 2009.
2. Skype budgeted $37 million for 2010 CAPEX investment. Compared to $13.5 million in 2009.
3. Net Revenues increased 25.1% from 1H09 ($324.8 million) to 1H10 ($406.2 million).
4. Adjusted EBITDA incresed 53.9% from 1H09 ($75.2 million) to 1H10 ($115.8 million).
5. Skype is available in 29 languages.
6. ARPU: 2007 ($81); 2008 ($102); 2009 ($98); 2010 (EST. $96).  NOTE: This ARPU for paying customer base (i.e., free users would significantly reduce ARPU).

A key facet of Skype’s strategy or growth is loyalty (see above). Skype illustrated in their filing the strength of their subscriber loyalty:

Also the Skype filing included interested Risks. The Risks themselves weren’t a surprise–required per SEC rules–however the long list interested me. They give you a glimpse into the fear factors of Skype. At the same time, don’t read too much into them, as it’s always good to share many risks with potential investors to limit legal exposure. Nonetheless, here is the list from Skype:

1. We may not maintain recent rates of net revenue growth.
2. We may not maintain profitability.
3. The rate at which we add registered, connected and paying users may decline. In addition, we may fail to successfully convert connected users into paying users.
4. Our operating results may fluctuate. As a result, we may have difficulty forecasting net revenues and planning expenditures to support development of our operations. Fluctuations in our operating results may cause us to fail to meet or exceed the expectations of securities analysts or investors, which could cause the market price of our ADSs to decline.
5. We generate net revenues almost entirely from the use of our paid communications services products.
6. We have a short operating history and a relatively new business in an emerging and rapidly evolving market. This makes it difficult to evaluate our future prospects, may increase the risk that we will not continue to be successful and increases the risk of your investment.
7. Goodwill and intangible asset impairment analysis may result in charges, which may be significant.
8. The number of our registered users overstates the number of unique individuals who register to use our products.
9. Our connected users metric is subject to uncertainties and may overstate the number of users who actively use our products.
10. Our paying user and communications services products billing minutes metrics are subject to a degree of inaccuracy due to fraudulent transactions and our method of calculating these metrics.The peer-to-peer nature of our software architecture makes it difficult to determine certain operational metrics.
11. Our industry is intensely competitive and if we do not compete successfully, we could lose market share, experience reduced revenues or suffer losses.
12. We are subject to proceedings that may jeopardize our exclusive use of the Skype brand.
13. We are subject to patent and other intellectual property litigation.
14. Certain of our technology is licensed from third parties.
15. We may be unable to protect or enforce our own intellectual property rights adequately.
16. We may be unable to protect, or enforce our intellectual property rights in, our source code adequately.
17. If our business were deemed to be a regulated telecommunications business in one or more jurisdictions, it would significantly increase our expenses and may require us to change our products and other aspects of our business in potentially detrimental ways.
18. The regulation of Internet communications products is currently uncertain, which poses risks for our business from changes in laws, regulations, interpretation or enforcement of existing laws or regulations.
19. We may be subject to laws in multiple jurisdictions.
20. As a precautionary response to the regulatory framework in certain countries, we have limited the manner in which we market and sell our paid products. We may decide to alter our business or the products we offer in ways that would make our activities more likely to be subject to telecommunications, consumer protection and other local laws and regulations.
21. In certain countries, we rely on our local partner for regulatory compliance.
22. We develop and provide new products and features that may be deemed to be subject to telecommunications and other laws and regulations in different jurisdictions.
23. Third parties have raised, and may raise in the future, concerns about the application of regulations to our business.
24. We may be required to comply with emergency calling regulations in certain jurisdictions. Compliance with emergency calling regulations may be costly and technically difficult.
25. If we were required to contribute directly to universal service funds, the cost of providing our products would increase, and if we were to seek to recover the increased cost from our customers, the cost advantage of using our products would be reduced.
26. Compliance with requests from law enforcement agencies and compliance with data disclosure and lawful interception laws is costly and difficult and might subject us to conflicting obligations and result in improper interpretation and application of complex laws.
27. Telecommunications numbering rules could require us to change the manner in which we use or contract for numbers, or require that we suspend, withdraw or otherwise limit number-based products.
28. Regulation on import, export and distribution of highly encrypted technologies can pose risks for our business.
29. Compliance with disabilities access regulations could be technically difficult and could impose significant additional costs on our operations.
30. If our online credits were regulated as a currency or if we were regulated as an electronic money lending institution or similar entity, we would face additional compliance costs.
31. Certain countries are reported to have prohibited or blocked the use of our products; however, consumers in those countries may continue to use our products, which may cause these countries to impose penalties on us or take other governmental action against us, any of which may harm our business.
32. Because we are not a regulated telecommunications provider, we do not receive certain protections that regulated telecommunications providers receive.
33. Our business depends on our users having continued and unimpeded access to the Internet. Companies providing access to the Internet may be able to block or degrade our calls, or block access to our website or charge us or our users additional fees for our products.
34. We depend on key personnel.
35. Rapidly evolving technologies could cause demand for our products to decline or could cause our products to become obsolete.
36. Errors in our products could harm our business.
37. System failures could harm our business.
38. Our business depends on the continued reliability of the Internet infrastructure.
39. Use of our products for illegal purposes could harm our business or brand.
40. Our business is subject to online security risks, including security breaches and identity theft.
41. The peer-to-peer architecture of our software may create, or may be perceived as creating, additional security risks and system constraints.
42. Failure to deal effectively with fraudulent transactions would increase our loss rate and could increase expenses, result in the loss of our ability to accept certain credit cards and harm our business.
43. There are many risks associated with offering products worldwide.
44. User concerns about our use and protection of personal data and the privacy of their communications and data protection breaches could harm our brand and our business.
45. Acquisitions and other strategic transactions could result in operating difficulties, dilution, and other harmful consequences.
46. We do not have operational control over entities and strategic alliances in which we hold a minority interest and the conduct of the controlling partner in such arrangements may harm our reputation or adversely affect the value of our investment and may limit our ability to offer our products in certain markets directly or through other third parties.
47. Our SkypeIn and Skype To Go businesses are highly dependent on partners in different jurisdictions, and the conduct, business practices and financial health of those partners expose us to potential risks that could harm our reputation and adversely affect our products in those jurisdictions.
48. Use or delivery of our products may become subject to new or increased regulatory requirements, taxes or fees.
49. We may become subject to additional income tax expense, which would adversely affect our results of operations and the value of our ADSs.
50. We or certain of our subsidiaries may become subject to net income taxation in additional jurisdictions which would adversely affect our financial condition and the value of our ADSs.
51. We may be subject to indirect taxes (such as value-added tax or sales tax) in jurisdictions in which we currently do not collect or pay such tax.
52. Governments may levy new taxes on us which could adversely affect our financial condition and the value of our shares.
53. We may be unable to use some or all of our net operating loss carryforwards, which could adversely affect our reported financial condition and results of operations and therefore the value of our ADSs.
54. We may incur additional tax assessments.
55. Problems with or price increases by third parties who provide services to us or to our users could harm our business.
56. Our business may be adversely affected by factors that cause our users to spend less time using our products, including seasonal factors, worker migration patterns, national events and increased usage of other websites.
57. Our plans to expand our products may not be successful.
58. Our costs will increase significantly as a result of operating as a public company, and our management will be required to devote substantial time to complying with public company regulations.
59. Failure to achieve and maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley could have a material adverse effect on our business and stock price.
60. Our substantial indebtedness could adversely affect our financial health and our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate indebtedness and prevent us from fulfilling our obligations under our indebtedness.
61. Our credit agreement imposes significant restrictions on our business and the lenders are entitled to take possession of and sell the assets we have pledged as collateral if there is a default under the credit agreement.
62. A significant part of our historical financial results is unlikely to be representative of our results as a stand-alone company.
63. We have entered into a tax cooperation agreement with eBay pursuant to which we may be required to pay eBay an indemnity if we engage in certain changes to our operations without eBay’s consent.
64. Our connected users metric is subject to uncertainties and may overstate the number of users who actively use our products.