Russians Buy Stake in Web Games

16/12/2009 22:59

SAN FRANCISCO — The Russian firm that invested more than $200 million in Facebook this year is making another bet on the United States Internet industry.

Digital Sky Technologies, or D.S.T., an investment firm with offices in Moscow and London, is leading a group that is buying a $180 million stake in Zynga, a fast-growing San Francisco company whose online games, like FarmVille, Café World and Mafia Wars, are extremely popular on Facebook.

An unusual investment structure, by an unorthodox foreign investor, might shake up many of Silicon Valley’s traditional venture capital and private equity firms, which are losing out on another promising Internet opportunity.

The investment could also raise further questions about the pedigree of D.S.T., which lists a prominent Russian billionaire with a criminal record among its major shareholders.

As with Facebook, D.S.T. will invest directly in Zynga while also buying stock from shareholders, including the company’s employees. The move is aimed at giving employees and shareholders of the prominent start-up a way to cash out before an initial public offering.

Tiger Global, a New York hedge fund, and the venture capital firms Institutional Venture Partners and Andreessen Horowitz also invested.

Zynga had previously raised $39 million.

The companies did not disclose Zynga’s valuation as a result of the new capital, but the game company’s annual revenue has been reported to be around $250 million and growing quickly.

Two experts in Internet company finance said it would be reasonable for Zynga to command a valuation of two and a half to six times its annual revenue. That could put the value of the two-year-old Zynga at $1.5 billion; one industry insider believes the value could be as much as $3 billion.

With the investment, D.S.T. is doubling down on its billion-dollar bet on social networks and online games, which draw people who do not normally play video games into virtual simulations that they can play with friends. Players might spend only a few minutes each day in the game, and are persuaded to pay real money to buy virtual goods, like bales of hay and gasoline for their tractors in FarmVille, a game in which players run a farm.

D.S.T. began investing in 2005, mostly in Internet firms based in Russia and Eastern Europe, where, as in Asia, people have adopted social games and virtual goods marketplaces faster than in the United States.

“People did not believe that this Chinese model of micropayments and social games was real,” said Yuri Milner, D.S.T.’s chief executive. “I am pretty convinced this market will have tremendous pick-up on the Western side of the world.”

Part of D.S.T.’s appeal to start-ups is that it has shown unusual patience in waiting for a return on its investment. Traditional venture capital firms invest money from limited partners, like university endowments, which expect a return on their capital every few years. But D.S.T. operates more like a holding company and invests its own capital. It also does not require a seat on the company’s board.

D.S.T. first came to people’s attention in the United States in May, with its unusual investment in Facebook. As it did with Zynga, D.S.T. agreed to buy preferred shares at a high valuation, while also buying, at a lower valuation, the employee-owned common stock that traditional Silicon Valley investors typically shun.

In the past, company shareholders cashed out when the company was sold, either to a bigger company or to the public. Today, though, companies are increasingly figuring out how to offer shareholders liquidity much earlier by letting them sell shares when the company is still private. Though Zynga and Facebook are among the best-known examples, other venture capital firms have been making similar deals.

“I believe that many successful Internet companies just went public too early,” Mr. Milner said. “We’re almost like making them public companies for a short while.”

D.S.T.’s investment in Facebook also brought it some added scrutiny. Alisher Usmanov, a Russian industrialist billionaire who spent six years in an Uzbek jail for fraud and embezzlement in the 1980s, owns 35 percent of D.S.T. Mr. Usmanov has said he was jailed for political reasons.

Responding to questions about Mr. Usmanov and his role at D.S.T., Mr. Milner said that he and his partner owned 40 percent of the firm and made all of its management decisions.

Bing Gordon, a partner at Kleiner Perkins Caufield & Byers, which previously invested in Zynga, said that Zynga’s board did the customary due diligence on D.S.T. and that he was impressed by the firm.

Mr. Milner is a “brilliant entrepreneur,” Mr. Gordon said. “He saw within Russia the importance of social media and the new social Web, and he’s got a global point of view, which is still rare even in Silicon Valley.”

For Zynga, which has 712 full- and part-time employees, the investment gives it extra capital with which to compete with newly enriched rivals.

“The opportunity every quarter is proving to be bigger than we imagined and we always thought it was prudent to keep adding to the capital of the company as we grow,” said Mark Pincus, Zynga’s founder and chief executive, who has started three other companies.

Playfish, which competes with Zynga but has a smaller user base, was recently sold to the video game giant Electronic Arts for $300 million in cash and stock, and shareholders could receive an additional $100 million if it performs well. Slide and Playdom, other Bay Area start-ups in the social games and virtual goods arena, are also well financed.

The capital infusion also indicates that Zynga survived relatively unscathed after recent criticism from bloggers. They said that Zynga and other social gaming companies were deceiving users by selling them offers from advertisers, some of which were deceptive. Zynga has since suspended all such offer advertising.