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Luxembourg-based Skype recently announced plans for an initial public offering. The company, whose software enables individuals and businesses to make free video and voice calls, send instant messages, and share files with other users, seeks to raise over $100 million from the IPO. After the deal, which will be led by Goldman Sachs (GS), J.P. Morgan (JPM - Free Analyst Report), and Morgan Stanley (MS), Skype’s American Depository Shares (ADS) will trade on the NASDAQ Global Market.

The company states that at peak times, there are up to 23 million people using its service worldwide. With a total of 560 million registered members and an average of 124 million active users a month, it comes as no surprise that Skype accounts for 12% of all international calling minutes. For the first six months of 2010, it posted revenues of $406 million. The majority of these sales were generated by the 8.1 million monthly users who pay for the SkypeOut service, which charges fees for calls made to landline and mobile phones. If the company can convert more of its large registered base to paying customers, this would likely provide a substantial boost to the top line.

Still, it will not necessarily be smooth sailing for Skype in the years ahead. First, the competitive landscape is intense with Internet telephone companies like Vonage (VG) and traditional telecom and cable companies pushing their Voice over Internet Protocol (VoIP) services. New players to hit the scene, including Google’s (GOOG) Voice service and Apple’s (AAPL) Facetime, are also looking to cash in on the growing trend of making calls over the Internet. Second, although revenue growth has been strong, high operating costs are limiting the conversion of sales into profits. Indeed, net income for the six-month period ending June 30th, was around $13 million. Finally, the fact that Skype derives most of its revenues from SkypeOut means that if demand declines for this product, the top line will suffer.

In an effort to strengthen the business, Skype has forged deals with companies like Verizon Wireless (VZ - Free Analyst Report), Samsung and LG, among others. Through these partnerships, the company hopes to increase the accessibility of its service, particularly on mobile phones and televisions, and broaden its customer base. In particular, emerging economies may hold the brightest prospects. Skype’s free services should continue to be a valuable resource for users in countries where the costs of making calls through traditional telecom entities is an issue. Plus, if economic conditions in these markets improve, the users may at some point navigate towards Skype’s paid offerings. What’s more, we expect the company to place more emphasis on increasing advertising revenues and possibly broadening its reach into such areas as gaming and virtual gifts. The expansion of services for business clients should aid in boosting sales, as well. Diversifying the revenue stream, though, will probably not be an easy task. Indeed, after acquiring Skype in 2005 for $2.6 billion, eBay found it difficult to transition the company beyond its VoIP business and ended up selling 70% of its stake in the company late last year for around $1.9 billion. 

Economic uncertainties and volatility in the equity markets have put a damper on IPO activity over the past few years. Even VoIP provider, Vonage has not fared well since coming to market in 2006 with a share price of $17 (its stock is currently trading just above $2 a share). Skype’s greater array of offerings including video, texting, and instant messaging does separate it from this rival, but even so, investors may be somewhat cautious about jumping in at the gate. We believe that Skype will be unable to attract the risk-averse investor until it experiences solid revenue gains from a number of different sources and is consistently operating in the black. On the other hand, those with a more venturesome temperament may find this higher-profile technology offering worth consideration. All told, we think the Skype IPO will be on the radar screens of many investors because of the well-known brand name. The hype, though, will probably be short-lived if the company doesn’t deliver on the earnings front.