Last May, when Facebook rejected several lucrative investment offers and sold a 1.96% stake for $200 million to Digital Sky Technologies (DST), a little known firm in Russia, the reaction was surprise, even shock.
Those feelings had barely passed when DST did it again, leading a $180 million investment in December in Zynga, which makes some of Facebook’s most popular games. Conversations between DST Partner Alexander Tamas and Zynga CEO Mark Pincus began at the AllThingsD conference after the Facebook deal was announced. Once started, the deal was finished in two and a half weeks.
“They’re extremely fast and efficient,” says Mark Vranesh, Zynga’s chief financial officer. “They like to say that if they like a deal, they come into town and get a room and don’t leave until it’s done, and it was true.”
For both Zynga and Facebook, the DST team traveled in style. Tamas and DST CEO Yuri Milner stayed in the swanky Rosewood Hotel on Sand Hill Road, with its tall windows and sweeping views of the Santa Cruz Mountains. They took a long view on Zynga, as well.
“They said, ‘What do you think you guys will be doing in revenue in 2015 or 2016—not next quarter, not next year, but really long term?’” says Vranesh. “Most VCs will give you just enough to get to the next investment, but not too much so you don’t get lazy,” he says. “DST really got our business and the Internet industry in general.”
DST’s splashy entry into the United States at a time when the IPO market is still slow, capital is tight and many investors are struggling to raise funds has created a mix of admiration, curiosity and some suspicion among people who assumed that the U.S.—which, after all, invented the Internet—would always dominate the market.
We are a company, not a fund. We don’t need to return money to investors. We plan at some stage to take DST public and then people will benefit from DST itself, so we can be relaxed.”
DST has turned the idea of late stage Internet investments on its head. The firm is small (with only four partners), doesn’t insist on board seats and is willing to hold its large investments indefinitely. “We are a company, not a fund,” Tamas says. “We don’t need to return money to investors. We plan at some stage to take DST public and then people will benefit from DST itself, so we can be relaxed.”
Because of the Facebook and Zynga investments, the term “DST deal” is now a noun. In addition to the $200 million it put into Facebook, DST also agreed to put up another $100 million or more to buy out current and former Facebook employees. Young entrepreneurs talked excitedly about DST at the South by Southwest festival in Austin, Texas, last month, a showcase for Internet startups, according to Andrew Parker of Union Square Ventures, which is an investor in Zynga. “I want my DST deal!” several reportedly said.
In the Bay Area, “dozens and dozens of CEOs” have approached Industry Ventures, a secondary investor in San Francisco, about getting a similar deal for their companies, according to founder Hans Swildens.
“They think, ‘If Facebook did it, why wouldn’t we?’” he says. “When somebody wires your neighbor $2 million, you start thinking about it, too.”
Not every company is going to get a DST-style deal, though. Swildens says about half the CEOs and boards he talks to are wary of such deals because they’re afraid their employees would sell shares and quit.
Even fewer companies are going to be able to get money from DST, which Tamas says will invest over $1 billion over the next few years in only two or three big global Internet companies per year.
They’re extremely fast and efficient. They like to say that if they like a deal, they come into town and get a room and don’t leave until it’s done, and it was true.”
DST itself is only about five years old. It was founded in Russia by Gregory Finger, a former engineer, and Milner, a former theoretical physicist who, after the fall of the Soviet Union, got an MBA from the University of Pennsylvania’s Wharton School. After Wharton, Milner worked for the World Bank and then returned to Russia to invest in the Internet subsequently lost money in the dot-com bust.
In Russia and Eastern Europe, DST is well known. The firm has talked to every Russian Internet company there is, according to Tamas. He boasts that the firm’s investments, which include the Web portal mail.ru and the social networking group Forticom, recently accounted for over 70% of all page views in Russia.
Russia is fine, but DST wants to be a global company, and that’s what Tamas has been tasked to turn it into. The Facebook deal was his first step in that direction.
Tamas joined DST in 2008 from Goldman Sachs in London, where he invested in technology and Internet companies. It was people at Goldman Sachs, which is an investor in DST, who introduced DST and Facebook. At the end of 2008, Facebook wanted to raise money after the shock of the global financial crisis, according to Vaughan Smith, Facebook’s director of corporate development, so a meeting between Tamas, Milner and Facebook CEO Mark Zuckerberg was arranged.
Tamas remembers it well. “We came out extremely impressed with [Zuckerberg’s] personality,” he says. “He could have sold Facebook 10 times and gone home with a sizeable paycheck, but he’s more about building a large, global, sustainable company. And if you’re going to invest a significant amount of money, you want to make sure the company doesn’t turn around and sell the next day. Given everything we know about the business and about social networking in general, we thought Facebook was the best company for us to take DST global.”
Tamas continues: “We built good relationships. Sheryl [Sandberg, Facebook’s COO] and Mark and others came to see us not as strange people from Russia, but as people who know the business really well.”
The thing that endeared them to us, was that with other investors there was a lot of posturing around how they could add value and a board seat was appropriate, but DST said, ‘We get it; we trust you,’ and moved on.”
Once the deal was started, Smith says, it took just six weeks to complete.
Both Smith and Vranesh say they continue to be impressed with DST’s grasp of the global Internet and how successful Internet businesses work—their knowledge of how to analyze traffic, retain users, extend reach across the Web and so on.
Smith says DST was especially quick to grasp why Facebook did not want to give up a board seat for the investment, which Facebook thought was unwarranted given the small stake it was selling. “The thing that endeared them to us,” Smith says, “was that with other investors there was a lot of posturing around how they could add value and a board seat was appropriate, but DST said, ‘We get it; we trust you,’ and moved on.”
One lingering concern some have about DST is its relationship with one of its investors, Alisher Usmanov, a wealthy Russian businessman who was jailed for six years in the 1980s for embezzlement and fraud. Usmanov’s record was later cleared. DST emphasizes that Usmanov’s conviction was reversed both by a Soviet court and by the Supreme Court of Uzbekistan, which ruled in 2000 that no crime was committed and that the evidence against Usmanov was fabricated.
Smith says Facebook did its due diligence on DST and stands by the firm. And Facebook’s backing was good enough for Zynga, Vranesh says.
Tamas says most Americans don’t know much about Russia other than what they read in the press, which is bad, “but when we invite them to Moscow and they meet our people, they say it’s just a normal country, although the weather is more unpleasant.”
I want my DST deal!”
Internet entrepreneurs at South by Southwest festival
Russia, he adds, has the best engineers in the world, and 25- to 35-year-old Russians “are no different than their U.S. counterparts. For a long time they couldn’t build a business and advance themselves and now they have all the freedom in the world to do that.”
A popular guessing game these days is trying to figure out which Internet company DST might invest in next. Yelp, which recently took a DST-style investment from Elevation Partners (except that Elevation got a board seat), is out of the running.
However, LinkedIn and OLX, a competitor to Craigslist, have enough potential to be candidates, says Adam Oliveri of Second Market, which trades in private company shares. He says that DST invests in Internet companies as if they were already public and don’t require help with governance and treats them accordingly. Based on the price of Facebook’s shares on Second Market in May, Oliveri estimates that DST paid Facebook a 40% premium, at least for employees’ shares.
Tamas says DST’s offer valued Facebook appropriately and was not unduly high. But, he adds, if Russia already had thousands of Internet companies, DST wouldn’t have to canvass the globe looking for investments.
“I think DST is going to be a really interesting and fun adventure over the next few years,” says Tamas, who invested in Internet companies even after the dot-com bust, before he went to Goldman Sachs. “When we look back at this millennium, we’ll remember it for the information age and the rise of the Internet. I thought it was the thing to do to be part of all this.”