Internet investment's new champions

The emerging online giants
DST, Naspers and Tencent have made promising internet investments in many emerging markets. Now even Western internet financiers are emulating them
Jul 8th 2010 | From The Economist print edition


THEY may not have the name recognition of a Google or a Yahoo!, but they can claim to belong in the same league. The websites of Digital Sky Technologies (DST) account for more than 70% of page-views on the Russian-language internet. Naspers is Africa’s biggest media group, both offline and online. And Tencent is China’s largest internet company by market capitalisation—and the third-largest in the world.

Now these firms are increasingly making their presence felt beyond their home markets. Between them they have invested in dozens of internet firms around the globe. The most adventurous of the three, DST, has already moved west—and paid top dollar for stakes in fast-growing American companies, notably Facebook, the world’s biggest social network.

At first glance the three firms could not look more different. DST was created in 2005 when two Russian internet investors, Yuri Milner and Gregory Finger, pooled their interests in mail.ru, a Russian web portal. Today the firm controls many of the country’s leading websites and boasts an interesting mix of owners, including Goldman Sachs and Alisher Usmanov, a Russian billionaire, who holds 27%.

Based in Cape Town, Naspers is nearly 100 years old and is the publisher of the Daily Sun, South Africa’s biggest newspaper. But it is one of the most ambitious old-media companies anywhere in its move online. It still makes most of its sales—28 billion rand ($3.6 billion) in the year to March—from print and pay-television, but it uses the cash to buy online firms.

Tencent hails from Shenzhen, near Hong Kong. Founded in 1998, it had revenues of $1.8 billion in 2009. Although best known for QQ, a popular instant-messaging service with 567m users, much of its profits come from online games and a virtual currency, called Q coins. Users purchase this with real money and use it to buy digital wares, such as virtual weapons to increase the powers of their avatars.

Despite their differences, the three firms can be seen as a block. For one thing, they are financially intertwined. Naspers owns part of mail.ru and was an early investor in Tencent, of which it now holds 35%. In April Tencent invested $300m in DST, giving it a stake of more than 10% and DST a valuation of about $3 billion. Tencent also has an interest in the Indian arm of MIH, Naspers’s internet division.

What is more, the firms are on the same mission: finding promising internet companies in countries where Western investors rarely dare to go. DST’s territories are Russia and its neighbours, most of which are home to one of its collection of companies; these include social networks such as VKontakte.ru and Nasza-Klasa.pl. Naspers has the largest portfolio of internet firms in developing countries, for instance in Brazil (BuscaPé, a comparison-shopping site), India (ibibo, a social network) and at home in South Africa (24.com, a portal). Tencent has so far been the most cautious of the three. Besides its recent investment in DST it has some minority stakes in games companies, such as VinaGame in Vietnam.

This international presence allows the firms to apply lessons they have learned in one country to another. “We spend an enormous amount of time on sharing knowledge,” says Antoine Roux, the boss of MIH. For its part, DST knows which web businesses work and how much room for growth they still have, given a country’s GDP and internet penetration. Alexander Tamas, a partner at DST, calls this “geographical arbitrage”.

In Russia DST has seen how quickly social networks can grow: latecomers to the internet, many Russians skipped e-mail and went right to social networks to communicate online. With advertising roubles in short supply, DST’s companies also experimented early with other ways of making money from social networks and online games, such as charging for services and selling virtual goods. In December it merged mail.ru with Astrum Online, a gaming firm—in effect forming a Russian Tencent. Free communication tools such as instant messaging create the audience that then pays for other services and virtual goods, Mr Tamas explains.

Tomorrow, the world
It was only a question of time before one of the three firms tried to apply these emerging-market lessons in the West. DST has been the pioneer, for several reasons. Its partners learned their trade in America. It intends to go public one day. And it saw an opportunity: after the financial crisis, conventional investors were cautious and did not fully realise how fast social networks, for instance, would grow.

One further factor was essential in helping DST to gatecrash the party of the handful of private-equity funds, such as Elevation Partners, TCV and Silver Lake Partners, which typically provide successful American internet firms with additional cash. DST’s corporate structure allows it to act quickly, and to make offers that are hard to refuse. In the case of Facebook, it agreed to what at the time seemed a high valuation, waived any right to special treatment should things go wrong and was willing to buy stock from employees. That is especially popular with young internet firms. It allows founders and key employees to make money without having to sell the company or go public prematurely. “This is an IPO substitute,” explains Mr Milner, adding that DST’s investments give firms more time to focus on their product rather than thinking about a flotation.

Will DST’s strategy work? Buying into Facebook certainly looks like a smart move. DST has spent an estimated $800m for a stake of about 10%. When Elevation Partners recently invested $120m in Facebook, that deal put the company’s value at $23 billion, implying that DST’s investment has almost trebled.

In contrast, analysts say, DST may have overpaid for Zynga, the world’s largest online-gaming service, and for Groupon, a website that aggregates buyers and gets them special deals. Yet sceptics may again underestimate how quickly both can grow and what Zynga, for instance, is worth in combination with Facebook: taken together they look much like Tencent. In May, after lengthy negotiations, both firms agreed that Facebook Credits, the social network’s currency, would be accepted in Zynga’s games.

A bigger problem for DST may be that some see it as Russian—and thus “murky”. To counter this the firm has gone to great lengths to be open, inviting executives from firms in which it wanted to invest to Moscow to look at its books. The success of this strategy is demonstrated by the quality of its recent deals and its co-investors, which include such noted venture-capital firms as Accel Partners and Andreessen Horowitz. Even so, DST’s national origin could still matter as the firm makes further investments. Authorities in Washington, dc, are reportedly worried about DST’s latest acquisition: ICQ, an instant-messaging service previously owned by AOL.

However DST fares, it seems to attract copycats. Before Elevation Partners invested in Facebook, it had already cut what is now called a “DST deal” with Yelp, a fast-growing user-review site for local businesses. And although Naspers does not intend to make any investments in Western countries, Tencent may follow DST in doing so. Martin Lau, Tencent’s president, recently said it would step up its forays abroad—which has led to talk that it may be interested in buying Yahoo!.

Conversely, the apparent success of the three emerging-market internet pioneers may prompt Western venture firms to take more interest in developing countries. Tiger Global Management, a New York hedge fund that is also a shareholder in DST, has already specialised in investing in start-ups beyond the West’s well-known technology clusters. Clearly, internet investing is going global and the West is losing its monopoly, not just in thinking up clever ideas for web businesses but in financing them.