Merger post-mortem: Why Ebay overbid

Two posts on Ebay in 2 days?  I know, it may be overkill, but it is too interesting to pass up. You have to appreciate the irony of the online auctioneer overpaying for a company that is only tangentially related to their core business of auctions. How could a pro make such a mistake?  It's more complicated than bidding for that 1982 poster of David Hasselhof and Kit from Night Rider. 

The value of Skype's stand-alone business in 2005 was $1.9B after factoring in their healthy growth rates. How does Skype generate revenue?

CNET reports: "The only way that Skype makes money from its subscribers is when people use its Skype-In or Skype-Out services. Skype-In allows users to pay to rent a phone number, which people on regular phones can call. Skype-Out allows users to call traditional phones or cell phones for a fee."

Ebay falls in the synergy trap: Flush with cash from their stock's run-up and trying to build out the functionality of their site, Skype seemed like a great overlay to connect the buyers and sellers in the largest online marketplace. Instead of emailing your question about the condition of an item, a buyer could just pick up the headset and talk to another Skype-enabled seller for free. EBay was also attracted to the European customer base as a way to expand outside of their core US market. Given the $1.4B write-down, this assumes that either none of the $1.2B in synergies materialized, or the stand-alone valuation was overblown.

Maybe eBay should have applied some good old economic rationale for whether the acquisition makes sense. Economists love to discuss the allocation of resources to the highest valued use. Luke Froeb, a Vanderbilt MBA professor and former chief economist for the Department of Justice says corporations often merge for the wrong reasons. "Unless a target is worth more to the buyer than it is to the seller, there is no reason to transact." Check out his treatise on mergers in the Dealmaker's Journal,  "If merger is the answer, what is the question?"

Could it be that the auctioneer was caught up in the frenzied buying of interactive web companies? You have to imagine that Skype was also being courted by the likes of Google and Yahoo as well as old-line media companies like News Corp. In hindsight, it looks like News Corp's crafty old Rupert Murdoch got Myspace for a song at $580M. Google raised the bar with its 1.65B purchase of YouTube - a company that had not even figured out a revenue model.

Buying eyeballs hasn't been this expensive since the late 90's.