The Alchemy of Net Neutrality: Does Double Discrimination Create Value?
`When I use a word,' Humpty Dumpty said, in rather a scornful tone, `it means just what I choose it to mean -- neither more nor less.'
`The question is,' said Alice, `whether you can make words mean so many different things.'
`The question is,' said Humpty Dumpty, `which is to be master -- that's all.' Through the Looking Glass, Chapter 6.
`Can you do Addition?' the White Queen asked. `What's one and one and one and one and one and one and one and one and one and one?'
`I don't know,' said Alice. `I lost count.' Through the Looking Glass, Chapter 9.
The question to be considered in the context of the Net Neutrality NPRM is not that the Commission is using a word--this time "neutrality"--to mean just what it chooses it to mean, but rather, how does it all add up, when layered on top of another equally "neutral" (but fundamentally discriminatory) regulatory regime such as intercarrier compensation where the same word "termination" has so many different meanings (prices)? How do the sums add up? Like Alice, I've lost count, but let me give you an example to see if you can keep better count.
On November 19th, eBay closed on its sale of Skype, eBay's large, over-the-top, VoIP subsidiary, in a transaction that valued Skype at $2.75 billion (though eBay held on to 30% of the company). This somewhat concludes eBay's rollercoaster ride into the world of telecommunications. Though the company itself valued Skype at $1.7 billion on its own books, eBay was unable to find anyone willing to pay even $1.4 billion--eBay's asking price--this spring, and even some Skype cheerleaders were speculating that, earlier this year when eBay made the decision to sell Skype, that eBay would likely get closer to $1 billion.
In 2005, eBay bought Skype (or some part of it that, curiously, did not include the central intellectual property that made the service work) for a reported $2.6 billion, but the founders stayed on to manage the Skype subsidiary, and if all had worked out, could have earned an additional $1.5 billion over the next couple of years if certain targets were met. Less than a year later, eBay ousted the founders and gave them an additional $500 million to leave early, for a real cost of acquisition of $3.1 billion. At the time of the purchase, eBay was alternately lauded for its foresight, or criticized for paying way too much for a service that is largely "free."
Subsequent to the original purchase date, most reports about the transaction were negative--suggesting that eBay's purchase was looking like a worse and worse decision with each passing year. Business Week continued to follow the operation of Skype within eBay to see how the transaction would turn out. The articles suggested the acquisition, in hindsight, was a bad idea--and getting worse all the time.
But, what happened since April, when no buyers were willing to even purchase all of Skype for $1.4 billion? Who knows? But Skype is now valued at a higher revenue/EBITDA ratio than Google (15X vs. 11X). And, if it's relevant, Skype's 15+ revenue/EBITDA was multiples higher than the 4.4 recorded by Apple over the fiscal year ending in September 2009.
It could be argued that some amount of enterprise devaluation was inevitable over the Spring due to an overhang of potential liability created when Joltid, the company that created Skype, sued eBay to prevent it from using the core operating intellectual property that made the Skype application work, which eBay had been licensing from Joltid. Nonetheless, the basic terms of the sale, valuing the enterprise at only slightly lower than the final sale price, were announced in early September, while the lawsuit was still a potential threat.
It might be crazy, but it's hard to imagine that at least some of the "Skype-Hype" is not based on the premise that Skype's current forward-looking valuation is based, in part, on certain forward-looking regulatory assumptions. That is,unless of course you really believe that Skype's over-the-top services are truly economically superior to all others, nothwithstanding regulations that effect compensation rates for all other voice providers. So if an investor did believe that at least some of Skype's economic success was based on more favorable regulatory (versus economic) cost based rates of call origination and termination, then you would have to believe that certain existing regulations, or lack thereof, would remain in place for the foreseeable future.
Specifically, an investor cognizant of regulatory reality would value Skype with 2 critical beliefs regarding regulatory continuity. First, investors would have to be persuaded that the FCC intends to continue to provide favorable treatment to "Applications providers", --like over-the-top VoIP providers--vis-à-vis the network-based providers of "telecommunications services" and "broadband Internet access services" that the VoIP applications ride over. This is not an irrational assumption as long as the FCC implements "net neutrality" in a manner that protects VoIP providers by foreclosing certain firms from competing to provide differentiated transmission services to prospective entrants in the voice applications market, which may offer superior services to Skype. Again, this belief is consistent with the philosophy of "closing the barn door" to new applications, content, and service providers that the Commission has confirmed in the Net Neutrality NPRM. See, e.g., ¶ 106, and the proposed "nondiscrimination" rule.
Second, a prospective investor would have to believe that Skype's current cost advantage is ensured by the Commission's willingness to continue the current, antiquated, and dilapidated intercarrier compensation regime, which requires other providers--depending on regulatory classification--to pay higher origination and termination fees than Skype. After all, if there were no originating or terminating access charges that can be "created" (by a clever CLEC partner) where none should exist, then providers of "free services" could not create revenue (and profits) out of "free" services and would have no advantage relative to the many other voice providers in the market. Thus, a rational investor would have to believe--that at least for some significant period of time--the Commission will continue to turn a blind eye to intercarrier compensation reform, despite the fact that the Commission has already applied E911 obligations, USF contribution obligations, and CALEA obligations to "interconnected" (with the PSTN) VoIP providers.
Normally, one would think a rational investor would view this assumption as a risky bet, given the Commission's prior imposition of many "telecommunications service" obligations on interconnected VoIP providers, and the fact that the Commission asserted over 5 years ago, in its IP-Enabled Services NPRM, that even if interconnected VoIP services were classified as "information services",
[a]s a policy matter, we believe that any service provider that sends traffic to the PSTN should be subject to similar compensation obligations, irrespective of whether the traffic originates on the PSTN, on an IP network, or on a cable network. We maintain that the cost of the PSTN should be borne equitably among those that use it in similar ways. At ¶ 61. [emphasis added]
But, there may be some reason to believe that, perhaps the investors were provided some more reliable assurances to rely on these regulatory assumptions. After all, the CEOs of both eBay and Skype signed on to an "open" ex parte letter to the Commission, urging the FCC to adopt net neutrality rules.
The interesting thing about the letter is that it was styled as an "open" letter, because it was sent on Monday, October 19th, only days before a scheduled FCC meeting (on October 22nd) to consider adopting a Notice of Proposed Rulemaking on this very topic. The timing is interesting because the Commission's rules forbid advocacy by private parties on any matter less than a week before that matter is scheduled for consideration at a Commission Open Meeting; hence, I guess, the "open letter."
Still, though, one does wonder whether the Net Neutrality rules, discriminatorily applied, combined with assumptions that the Commission will continue to ignore intercarrier compensation reform, really had anything to do with the price and terms of the Skype semi-spinoff. If these assumptions hold up--that discriminatory net neutrality rules will limit new competition, and the existing discriminatory intercarrier compensation scheme will only benefit current VoIP providers--then Skype's subscribership growth signals a lot of future value (for the near future, anyway). On the other hand, I think I might be just as bad at counting as Alice was when she forgot the sums posed by the White Queen.
After all, as long as a rival with VoIP ambitions and potential exclusionary power, remains outside of "neutrality" regulations, in an increasingly wireless world, Skype is not assured continued profitability. You see, while Skype does have a product that runs on Google's Android mobile operating system, it is an inferior version to its native wireline version, because Skype's service has "limited" functionality on Google's mobile operating system. The application "works" but at a disadvantage to any Google-native VoIP service, because "Skype-Lite" requires users to use airtime, and users must subscribe to a mobile voice and data plan.
This would put Skype at a serious disadvantage with respect to Android phones--which seem to only support Google VoIP. Indeed, this may be a reason that the Commission has decided to take a less critical view of wireless net neutrality obligations--because Google (an unequaled provider of lavish employee benefits, and Obama administration support and staff)--is a large benefactor. On the other hand, if Google did grant permission for Skype users to allow "real" Skype to work over Android phones, then both firms are assured--for the near term--of the ability to use the discriminatory application of the net neutrality rules to exploit the discriminatorily-designed, but decaying, intercarrier compensation regime.
As I said at the beginning, like Alice, I've lost count myself. Did Skype benefit from double discrimination, or did they lose count? I just know that as long as the Commission is the master, it can make the same word--"termination"--have so many meanings (prices), but why should it, and why should we have to count, anyway? Wouldn't intercarrier compensation reform--with an emphasis on real neutrality--make more sense?