Tencent Investment in DST Shows International Confluence of Social Games, Social Networks, and Virtual Goods

Digital Sky Technologies, the investor/holding company that made big late-stage investments in social gaming leader Zynga and social service Facebook last year, announced that it has an investor of its own now. China-based online gaming and media giant Tencent has put in around $300 million, in exchange for a 10.26% ownership stake, 0.51% voting power and the right to nominate a board observer.

Tencent has been considering a variety of ways to expand, from buying AOL’s ICQ chat service to buying social gaming company CrowdStar. It was reportedly bidding against DST on the former deal. The latter one is no longer on the table — apparently, Tencent balked at CrowdStar’s push for a $200 million price.

With $300 million in DST, Tencent has a more diversified and arguably stronger portfolio than it could through most any other move. DST’s wide range of investments in Russia, in market leaders like, Mail.ru, Odnoklassniki and VKontakte, give it control of more than 70% of page views in the country. It also has investments in top web sites in Eastern Europe.

Those markets are relatively small, of course, but DST is well-financed. Along with money from founders Yuri Milner and Gregory Finger, it is 35% owned by industrialist Alishar Usmanov, “the hard man of Russia,” and has additional minority investments from Goldman Sachs, Tiger Global and Renaissance Capital. The money has enabled it to buy stock in later rounds from Facebook and Zynga, and at higher valuations than what other big investors were looking for. Those investments look shrewd in hindsight, given that both companies have continued to grow traffic and revenue in the following months — at the time, many people in Silicon Valley still believed Facebook and its platform to be worth significantly less money than what DST paid.

It bought $200 million worth of Facebook preferred stock last summer at a $10 billion valuation. It followed this by announcing it was purchasing up to $100 million in employee common stock at a $6.5 billion valuation, giving it a total Facebook ownership of around 3.5% by the time those deals were complete last August. Then it spent an unannounced amount of money on stock from former Facebook employees, so we’re not sure how much Facebook stock it currently has in its possession. From what we’ve heard, Facebook has helped the firm get as much available current and employee stock as possible, effectively making it harder for other third-party investors to do so.

Facebook has quickly grown in the past year to more than 400 million monthly active users, 70%of whom are outside the US; we estimate it made between $600 million and $700 million in revenue last year, up sharply from previous years.

DST then put $180 million into Zynga last year, in a scantly detailed investment where early employees were similarly able to sell some stock. Partner Alexander Tamas told us at the time that DST itself was looking to get some liquidity, even though its investments were intended to be long-term. So the Tencent investment makes sense. From that interview:

We’re organized as a company, not as a fund. We don’t need to distribute money to investors. That means we can take 5, 10, 15 year views on these companies. This is why it’s so important to find founders who are working for the long-term. The way that people get liquidity is trading in DST shares. There may be a DST IPO at some point, which would give our investors liquidity without them having to sell shares in DST.

We’re more like Berkshire Hathaway than a venture capital firm. That’s what resonated with [Zynga chief executive] Mark Pincus and [Facebook chief executive] Mark Zuckerberg. We told them: “You’ll never have any pressure to sell or go public. You won’t have to do what’s not right for the business.”

It’s not clear if Tencent will rely on DST to make big international investments or acquisitions, or separately continue to look at deals itself. It’s also possible that DST might get more active in China.

DST and Tencent will embark on a long-term partnership and co-operation as they seek to benefit from each other’s insights gained from their respective markets. DST’s deep understanding of the Russian Internet market, together with its leading brands such as Mail.ru, Odnoklassniki and VKontakte, will enable Tencent to benefit from the high growth of the Russian-speaking Internet market. At the same time, Tencent’s leading position in China will provide DST and its companies with unique and valuable operational insights and access to its regional network that can help DST further accelerate its growth path.

One final note here. In case you thought this was just about Russian and Chinese media conglomerates combining forces, there’s also a third in the mix — South Africa-based international media company Naspers (which, we should mention, has also looked at ICQ). Naspers owns a 34.5% stake in Tencent, meaning it now indirectly owns a small amount of of stock in Facebook and Zynga. With social gaming, social networks and virtual goods becoming increasingly global operations, we expect social gaming and other apps on Facebook’s platform to continue to see more investment from international companies.