Microsoft close to buying Skype for $7B to $8B? (Updated)

Update: Microsoft has confirmed that it will buy Skype for $8.5 billion. Original story below.
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Microsoft is close to a deal with Skype to buy the internet phone company for $7 – $8 billion, according to the Wall Street Journal.

If it’s true, it would be an aggressive move by Microsoft to become a big player in the convergence of communication, information and entertainment. The deal could be announced as early as Tuesday, according to sources cited by the Journal. Microsoft and Skype declined comment to the Journal. The rumor of the deal was first reported by GigaOm.

The deal could still fall part. Including Skype’s long-term debt, the value could be about $8.5 billion. Skype allows users to make calls for free to each other over the internet. The service makes money when those users want to connect to someone with a land line or hold a video phone call with multiple parties.

Microsoft could use Skype’s name value to build out a bigger consumer business and integrate the popular service with its Xbox Live online gaming service. The deal could be one of the biggest that Microsoft has ever undertaken in hits 36-year history. In 2007, Microsoft bought aQuantive, an online ad firm, for $6 billion. And it almost bought Yahoo for $48 billion nearly three years ago.

While Microsoft has successfully moved into video games, most of its profit still comes from its Windows and Office franchises. Microsoft has a a communications platform called Linc, which ties together email, instant messaging, and voice communications into a single application. Skype could help enhance that. But for the most part, Skype would be a major diversification for Microsoft.

Perhaps the biggest benefit of buying Skype will be to help out Microsoft’s Windows Phone 7 platform, which could use a free calling technology to compete against Apple’s FaceTime on the iPhone and Google Voice on Android.

Of course, Skype has been part of a failed diversification in the past. The company was founded in 2003 by Niklas Zennstrom and Janus Friis, the creators of the Kazaa file-sharing technology that was associated with music piracy. Skype was disruptive, offering free phone calls when most carriers still charged for such service. Then eBay bought Skype for $2.6 billion in 2005, presumably so buyers and sellers could communicate in eBay auctions. That didn’t work out.

eBay sold a 70 percent stake to Silver Lake Partners, Index Ventures, Canada Pension Plan Investment Board and Andreessen Horowitz. Skype hasn’t had the best of luck making a profit. The company posted revenue of $860 million in 2010 and a net loss of $7 million. It has debt of $686 million. Skype had been planning to go public since last August, seeking to raise $1 billion.