By Carl Grant, Senior Vice President of Business Development at Cooley LLP

There was big news last week in the IPO world – Skype, the internet telephony service, filed an IPO with the SEC. In the offering, Skype hopes to raise $100 million.

Why is this news so intriguing? Skype reported a net loss of more than $400 million in 2009, and isn’t expected to turn a profit this year.

However, according to an article on TechCrunch, which sited the company’s filing, Skype’s revenues were $406 million for the first half of 2010, with a net income of just $13 million (for a 3% net margin). The TechCrunch article speculated that during Skype’s IPO road show, the company will point to its adjusted EBITDA numbers, which for the first half of 2010 was $115.7 million, up 54% from last year. Currently, Skype has $85 million in cash.

Regardless, some news articles this week questioned whether Skype’s business model will work in the long run. Let’s look at why some are questioning Skype’s business model.

With 560 million registered users, Skype is one of the most popular consumer technologies. As of the end of June, Skype averaged 124 million users per month. However, only 8.1 million actually paid for the service since Skype-to-Skype calls are free. This business model, which is referred to as ”freemium,” is based on the idea that by giving away some services there is hope of getting users interested in the company’s fee-based services.

According to the filing, Skype expects those 8.1 million paying customers to pay about $96 dollars this year on average, meaning an expected $768 million or so in revenue for 2010. Therefore, Skype’s goal is to keep growing its overall number of users and convert more of them to paying customers.

With a conversion rate of about 7%, Skype falls in the middle range of what many would consider a viable business model, which is between 5% and 10%. But, what happens when these paying customers decide to switch to a competing service?  

Revenue will only increase if Skype is able to convert more users into paying customers. Since more than one-third of Skype consumers use the service for business purposes, finding a way to monetize this user segment is essential to increase revenue.

Skype’s biggest problem is that non-paying users are outpacing paying customers, making more of an issue if the company loses its paying customer base to a competitor such as Google Voice. Increasing its conversation rate is essential to long term financial success.

It will be interesting to see what investors do. What are your predictions for this IPO?

Disclaimer: The postings on this site are my own and do not represent Cooley LLP’s positions, strategies or opinions.

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