Microsoft is buying Internet phone service company Skype for $8.5 billion dollars in a move aimed at carving out a bigger presence in an online arena dominated by Google and Facebook.
The acquisition of Skype, which had reportedly also attracted interest from Cisco, Facebook and Google, is the largest ever by the US software giant.
Microsoft said Skype will become a new business division within Microsoft with Skype CEO Tony Bates assuming the title of president of the Microsoft Skype Division, reporting directly to Ballmer.
Tens of millions of people use Skype to make low cost or free phone calls over the Internet using their computers or smartphones. Skype bypasses the standard telephone network by channeling voice and video calls over the Web.
Buying Skype could be a way for Microsoft to shed some of its business software image and gain momentum in a hot smartphone market at a time when Internet lifestyles are going mobile.
Microsoft's biggest acquisition until now had been its 2007 buy of digital marketing firm aQuantive for $6.3 billion. Microsoft unsuccessfully tried to buy Yahoo! in 2008 for $47.5 billion in another bid to make an online splash.
Microsoft and Skype said the deal has been approved by the boards of directors of both the Redmond, Washington-based Microsoft and the Luxembourg-based Skype, which is owned by investor group Silver Lake.
The companies said Skype will support Microsoft products like the Xbox game console and Kinect motion controller, Windows Phone and a wide array of Windows devices. Microsoft will also support Skype clients on non-Microsoft platforms.
Magnus Rehle, managing director of Greenwich Consulting, said Microsoft is "buying a brand and a big chunk of customers."
"It could (also) be a defensive strategy from them... to block Facebook and Google from doing it instead," Rehle added.
Analyst Douglas McIntyre of 247WallSt.com said Microsoft "may expect that Skype's primary value will be to drive its search engine share much higher and allow it to more successfully attack Google."
"Microsoft's real motive for a Skype buyout is likely to be to increase its mobile search engine share, something it has been unable to do so far," he said. "Skype may be a cheap ticket to the next huge search market."
Skype was founded in 2003 and acquired by online auction giant eBay in September 2005. It was sold to the investment group led by Silver Lake in November 2009 in a deal that valued the company at $2.75 billion.
Skype has 170 million users and logged more than 207 billion minutes of voice and video conversations in 2010.
Skype last year announced plans for an initial public offering of stock and appeared on its way to profitability, but investors are evidently eager for a payoff.
Other members of the investor group led by Silver Lake include eBay, CPP Investment Board, Joltid Limited, Europlay Capital Advisors and Andreessen Horowitz.
The acquisition is subject to regulatory approvals which the companies said they expect to obtain this year.
Microsoft shares were down 1.16 percent at $25.53 shortly after the opening bell on Wall Street.