Silver Lake Expects To See 3X Return On Skype

Silver Lake and its co-investors are in line for a hefty return on their investment in Skype, which the parties have agreed to sell to Microsoft for $8.5 billion after owning it for barely a year and a half.

The deal would mark a victory for the aggressive investment campaign Silver Lake employed in 2009 and early 2010, when it invested in several technology companies at relative bargains while most private equity firms were still getting their balance back from the financial collapse.

The plan, as was widely reported, was to take Skype public. But the Microsoft offer—introduced by Microsoft CFO Paul Klein about a month ago—gave the consortium “general reason for pause,” Silver Lake Managing Director Egon Durban told Buyouts. “In our business, when you have an opportunity like we had with Skype, as fiduciaries, you need to assess the risk-return,” he said. “We concluded it was a great price for us as investors.”

In 2009, the Menlo Park-based firm led the buyout of the Internet video communication company for $3.1 billion from the online auctioneer eBay, which retained a 30 percent stake. (Most press reports put the purchase price at $2.7 billion, but that does not include an undisclosed settlement with the company’s founders, who had sued the company after the deal and who ultimately invested in the company as part of the investor group).

About $2.5 billion of the $3.1 billion transaction was equity. Silver Lake was the largest investor, plunking down around $950 million of equity—the largest investment in the firm’s 10-year history—from Silver Lake Partners III LP, a $9.3 billion fund closed in 2007. When the sale to Microsoft closes, Silver Lake would generate a return of about $2.85 billion, or more than 3x its invested capital. Durban said the exact net IRR would be hard to determine before the deal closed, but if it closed today would likely be between 70 percent and 80 percent.

Silver Lake obtained 40 percent of the company, while its co-investors the Canada Pension Plan Investment Board (a Silver Lake limited partner) and the venture capital firm Andreessen Horowitz obtained 12 percent and 3 percent respectively (other investors made up the remaining 15 percent).

CPPIB also stands to gain a huge 3x-plus return of about $930 million from the sale of its direct stake in Skype Technologies to Microsoft. CPPIB originally invested about $300 million directly, while it invested about $50 million in the deal through a Silver Lake fund, which ultimately should net the pension an additional $133 million or so net of fees. As a result, total distributions from CPPIB’s Skype investments are likely to amount to about $1.06 billion.

The consortium’s ownership of Skype was extraordinarily short, considering typical private equity investments last three to five years. But it was an incredibly frenetic period of ownership, Durban explained.

After closing the deal in 2009, the consortium settled litigation with Skype’s founders, who had sued the company, arguing they still owned the rights to the technology the company was using. The consortium also helped Skype launch new products for mobile devices, including an iPhone app that’s been downloaded 50 million times; doubled the amount of product engineers to around 400 from 200; signed strategic partnerships with Avaya, Verizon, Panasonic and others; and hired Cisco Systems executive Tony Bates as CEO.

As a result, under Silver Lake’s ownership, the number of people using Skype increased by 80 percent, Durban said. “This has been a short period of time to own the asset, but an incredibly intense period of change.”

The Skype sale, which is expected to close this year, is also a validation of Silver Lake’s risky thesis in 2009 and early 2010, when the firm invested about $3.6 billion in Skype, the online gaming company Zynga and the Chinese digital marketing company Allyes, among other deals. “We went out bought tech franchises with at relatively deep discounts to free cash flow,” Durban said. “It was systematic and thoughtful.”