* Deal is software company's biggest purchase
* Price is twice recent valuation talk
* Purchase could plug a hole in its mobile offerings (Rewrites with deal announcement, Microsoft CEO comment)
By Nadia Damouni and Bill Rigby
NEW YORK, May 10 Microsoft Corp (MSFT.O) plans to buy Internet phone service Skype for $8.5 billion, a rich price as it seeks to regain ground on growing rivals such as Google Inc (GOOG.O).
Microsoft's interest in the money-losing but popular service highlights a need to gain new customers for its Windows and Office software. Skype has 145 million users on average each month and has gained favor among small business users.
Skype delayed plans for an initial public offering expected to raise $1 billion. It 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. [ID:nN04117305].
The Luxembourg-based company, 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.
Skype could be combined with 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, 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.
Skype is set to become a new business division within Microsoft with Skype Chief Executive Tony Bates in charge and reporting directly to Microsoft CEO Steve Ballmer, Microsoft said.
"It's a strategic asset and a defensive move," said BGC Financial analyst Colin Gillis. "If they can put it on Windows 8, it gives them an advantage. It helps them in the tablet market."
The Skype deal is the biggest in the 36-year history of the world's largest software company. It was first reported late on Monday by tech blog GigaOM.
The $8.5 billion price tag 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.
Skype, which was formed in 2003, was bought by ebay Inc (EBAY.O) in 2005 for $3.1 billion. Last year it had in $860 million in revenue but posted 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. [ID:nN04117305] (Additional reporting by Megan Davies, Bill Rigby and Sinead Carew, 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 and Derek Caney)
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