Why Facebook and Silicon Valley owe it all to Moscow

When Russia’s Digital Sky Technologies stepped in and spent $ 200 million on Facebook stock in 2009, it took many people by surprise. The company had been little known outside its home territory, but was suddenly making a name for itself with significant investments in Silicon Valley businesses — often at aggressive valuations.

To some, the strategy looked crazy. In a deal overseen by Yuri Milner — an elusive former physics grad student from Moscow — the money was not just substantial, but it came with almost no strings attached. Not only did Milner have little say in how the company was run and no voice on the board, but he also agreed a side deal to buy back another $ 100 million in stock from existing shareholders.

It was the sort of approach that left many in the Bay Area wondering if he understood how venture capital worked at all.

But when Mark Zuckerberg’s social network goes public later this month, Milner’s strategy will score its greatest triumph, as DST and its partner Mail.ru Group plan to sell around a third of their stake for $ 1.5 billion, netting a huge profit.

Who’s crazy now?

Vindication

According to Facebook’s IPO prospectus, DST — which operates through a complicated series of companies, is lining up the sale of more than 26 million shares worth nearly a billion dollars at the high end. Meanwhile Mail.ru, another holding company related to DST, will sell in the region of 11 million shares for up to $ 400 million.

The money will not only boost Milner’s personal wealth, but also plump the bank account of his main backer, the Uzbek oligarch and industrial magnate Alisher Usmanov — who Forbes says is already worth some $ 18 billion.

But perhaps its greatest value will be in vindication of DST’s model, which has gone from being seen as the work of green investors to perhaps being the single most important factor behind the recent surge of activity in Silicon Valley and across the technology industry more generally.

After all, Milner’s approach is a little different from the risky, spray-and-pray approach taken by many VCs. Instead, he has used money to make money in the most serious fashion.

With the backing of Usmanov (their relationship was detailed somewhat in a great feature in The Deal last year) Milner has perfected a way of making huge sums when everybody else feared creating a bubble.

Essentially the tactic seems to boil down to a series of straightforward steps: first find a category leader like Facebook, Zynga or Groupon; then use heavy investment to make sure that they outpace their competition and stretch their lead even further; then continue pushing them, with more money if necessary, towards an IPO.

But while the money clearly has intentions tied to it, it also appears to have no pressure — something that made DST a darling of entrepreneurs already fed up with juggling complex relationships with investors.

This approach was detailed by Michael Wolff in Wired a few months ago, and it’s as true now as it was then:

Milner offers something radically or foolishly different: an investment with no such preferences and no board seats. In effect, his money is like IPO money—no advantages for regular shareholders—without the burden of an IPO (the time suck of a road show, the administrative costs of being public, the short-term earnings pressure of the market).

The proposal represents, too, a philosophically new and audacious view: Once a company reaches a certain size—a billion-dollar valuation by Milner’s reckoning—its investment profile changes. It holds enough market share and has established enough brand identity that it represents significantly less risk than VCs have traditionally considered startups to have.

His smartest trick was boosting the industry at a time when most investors were being incredibly meek — effectively single-handedly inflating a flaccid market.

Today, look around and you see huge rounds being pumped into companies like Dropbox or InMobi — or you see massive deals for companies like Instagram.

Without DST’s intervention, I’m not sure we’d be here.

Time for investors to send a letter of thanks to Moscow, perhaps?

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