Microsoft is close to buying internet telephony network Skype in an $8.5 billion deal, a source familiar with the situation said, as it seeks to regain ground on growing rivals such as Google.
Microsoft's interest in the loss-making but popular Skype, which has 145 million users on average each month and has gained favor among small business users, highlights a need to gain new customers and platforms for its Windows and Office software.
Skype, which allows people to make calls at no charge but has also developed premium services, would give Microsoft a foothold in the potentially lucrative video-conferencing market as businesses shift to lower-cost ways of communicating.
This could be integrated into Microsoft software such as Outlook to appeal to corporate users, while the voice and video communications could link to Microsoft's Xbox live gaming.
Longer-term, web-based Skype would offer Microsoft another route to develop its mobile presence, an area it has already put more energy and resources into as PC usage comes under threat.
This change was starkly illustrated last year when Apple's portfolio of coveted consumer goods propelled it past Microsoft to become the world's most valuable technology company. The maker of iPhones and iPads has since been named as the most valuable brand too, overtaking Google.
The Skype deal -- which would be the biggest in the 36-year history of the world's largest software company -- is expected to be announced as early as Tuesday morning, the source told Reuters. Microsoft and Luxembourg-based Skype declined comment.
The $8.5 billion mooted price tag, including debt, was a surprise. Although the sum would not stretch cash-rich Microsoft, some said it was high for a company whose ownership has changed several times during its relatively short life.
In this atmosphere of Internet Bubble 2.0, picking up an unprofitable online company for roughly 10 times sales probably seems downright cheap, Shanghai-based Michael Clendenin, managing director of consulting firm RedTech Advisors, said.
But if you consider (it) was just valued at about $2.5 billion 18 months ago when a chunk was sold off, then $8.5 billion seems generous and means Microsoft has a high wall to climb to prove to investors that Skype is a necessary linchpin for the company's online and mobile strategy, he added.
The deal would price active Skype user at $59, compared with a price of $140 per user paid in the latest Facebook investment. Some 8.8 million paying customers used Skype to make calls in the fourth quarter to traditional phones at low rates.
The big unanswered question is how do Skype assets work for Micrososft, they already have instant messaging, IP telephony...how do you justify the price? Ben Wood, head of research firm CCS Insight, said.
Skype, which delayed plans for an initial public offering expected to raise $1 billion, has been looking at other options, including tie-ups with Facebook and Google. Such a deal was seen as valuing Skype at $3 billion to $4 billion.
Despite doubling sales and profit in the last eight years, Microsoft's stock has largely languished, as investors worry about its ability to counter new rivals or adapt to new ways of computing, especially the threat posed by new mobile devices.
Microsoft has countered with a new version of its mobile software -- which will power the next generation of Nokia smartphones -- and is developing a new operating system that will work on low-power tablet PCs.
But online video chat remains a weakness. Although the company already has video in its Windows Live Messenger service, it is not available on its Windows Phone 7 software.
Skype also makes versions of its own service for use on iPhone and iPad, Research in Motion's BlackBerry and Android phones. It cannot be used on Microsoft phones.
Apple's FaceTime video calling service -- available on its latest iPhone and Mac computers -- has been a hit. Google recently followed suit by adding video to its popular Google Talk application for smartphones running on its Android system.
Despite being its most expensive to date, the deal would still be relatively small for Microsoft, which has $50 billion in cash and short-term investments on its balance sheet. The price would likely include $686 million in long-term debt.
I think the price is quite reasonable, said Sean Lee, a Taipei-based manager of the Global Top Dividend Fund at Shinkong Investment Trust, which owns Microsoft shares.
Skype, which was formed in 2003, was bought by Ebay Inc in 2005 for $3.1 billion. Last year it had in $860 million in revenue but made a net loss of $7 million, according to data in its initial public offering filing.
In 2009, eBay sold a majority stake in Skype to an investor group including Silver Lake, the Canada Pension Plan Investment Board and Andreessen Horowitz for $1.9 billion in cash and a $125 million note. EBay retained about a third.
But 8.1 million were paying customers, using Skype to make calls to traditional phones at low rates.
A deal would exceed the $6 billion Microsoft paid for online ad agency aQuantive in 2007, which was not a success.
Microsoft shareholders are relieved its $47.5 billion offer for Yahoo Inc in 2008 was rebuffed, paving the way for a web-search agreement which gives Microsoft most of what it wanted anyway. Yahoo shares have halved in value.
Microsoft's most high profile internet buy was the $240 million paid for a 1.6 percent share in Facebook in 2007. It is also plowing money into its MSN internet portal and Bing search engine, racking up $7 billion in losses over four years.
Technology sector mergers and acquisitions have spiked since last summer, driven by increased confidence in the economy and companies facing pressure to spend mountains of cash. Global deal volume year to date is up 55 percent when compared with the same period in 2010, recent figures from Thomson Reuters show.
Goldman Sachs and JPMorgan are advising Skype, the source said, while Microsoft is not using advisers.
(Additional reporting by Megan Davies and Bill Rigby, Sakthi Prasad in Bangalore, Clare Jim in Taipei and Melanie Lee in Singapore; Tarmo Virki in Helsinki and Nicola Leske in Frankfurt; Writing by Alexander Smith; Editing by Louise Heavens)