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07/18/2005

MySpace Equals Mo’Money For VCs, Especially VantagePoint

You may have seen the news today that Intermix Media was sold to News Corp. for a cool $580M in cash.  Prior to 2004, Intermix’s business consisted of running a collection of largely undistinguished consumer-oriented websites.  Intermix (then known as EUniverse) didn’t do a particularly good job of running these sites and was basically a broken stock suffering from earnings restatements, a NASDAQ delisting and executive turnover.  However in 2003/2004, one of the websites, MySpace.com started to take-off thanks to the social networking craze.

As I outlined earlier, unlike Friendster and its clones, MySpace took a unique approach to the Social Networking space and concentrated heavily on building a community first (centered around music and bands), and a social network second.  The strategy worked and by the beginning of 2005 MySpace was the clear #1 player in the social networking space.

A VC Social Networking Payday …  Finally
Well today, MySpace and its VCs were richly rewarded for their success when News Corp plunked down a substantial wad of cash for Intermix.  Although Intermix owns other websites, it’s clear that News Corp. paid the high price mainly to get control of MySpace.

For VCs, this sale is significant because it represents the first real payday in the social networking space, a space that to date has seen lots of VC hype but very little returns.  Just how big a payday was it for VC’s?  Thanks to the fact that Intermix was a public company it’s possible to take very educated guesses at how the VCs made out.  There were two main VCs involved in MySpace/Intermix.  VantagePoint had been involved with the parent company for some time, while Redpoint recently invested in MySpace itself.

RedPoint: Rapid Happiness With a Tinge of Regret
In terms of Redpoint, according the latest 10-K on file, they made two investments, one in Intermix in 12/04 and one in just MySpace as a separate entity in 2/05.  The Intermix investment was $4M and it got Redpoint 1M common shares and another 150,000 warrants at $4/share.  At $12/share that would net them $13.2M on a $4M investment or a 3.3X return.  They invested a separate $11.5M in MySpace itself which got them a 25% stake (which equates to pre-money valuation of $34.5M) in MySpace.  Unfortunately for Redpoint, when they made their investment in MySpace Intermix got them to agree to a provision that Intermix could buy back all the shares of MySpace that it didn’t own at a fixed valuation of $125M if Intermix got a buy-out offer within 12 months of the investment.  That is precisely what happened and according to news reports Intermix is exercising its option to repurchase the shares.  What this means for Redpoint is that their 25% stake in MySpace (which arguably represents almost all the value in Intermix) will not be worth 25% of $580M ($145M) but rather 25% of $125M or $31.25.  That said, this still represents a 2.7X return on their investment in MySpace.  Taking its two investments together, Redpoint looks like it will take home $44.45M on $15.5M invested or a 2.9X return. If the deal closes in 3 months this should equate to an IRR of roughly 325%.  Despite, missing out on the bigger payday because of the repurchase option, this has to be viewed as a great success for Redpoint, especially because they did the deal right under the nose of VantagePoint and clearly spent a lot of time structuring and selling their way into a deal that on first blush would have looked to be too difficult to put together at all.

VantagePoint: One Man’s Loss Gain Is Another Man’s Gain
For VantagePoint, the sale of Intermix was no doubt a very welcome event as according to the latest proxy statement they own 11.56M common shares (on a converted basis) worth $139M at $12/share.  VantagePoint acquired these shares in two major transactions.  The first transaction was a  rather straightforward purchase of $8M in Series C stock on 10/31/03.

The second investment happened July 2003 and it is less straightforward, but much more interesting.  In that investment, VantagePoint purchased an option to buy all of the shares owned by Sony’s now defunct VC Group, 550 Digital Media Ventures.  They partially exercised that option in October 2003 and then they fully exercised it in April 2004.  What’s most interesting about this transaction is that under the original terms of the option, Sony was entitled to some of the profits on any of the shares that VantagePoint purchased.  However when VantagePoint exercised the remainder of its option in April 2004, they also agreed to buy a $2.5M note that Sony held for just $1.8M (handing Sony a $600K loss) provided that Sony gave up its right to a share of the profits on the shares covered by the options.  This proved to be an incredibly canny move by VantagePoint especially given the fact that MySpace was growing like a weed in April 04 and the whole social networking space was white hot.  Somebody at Sony was clearly asleep at the switch.

The icing on the cake for VantagePoint is that they didn’t even end up risking their own capital on to buy the Sony note, they simply assigned the right to Intermix, who promptly bought the note for $1.8M and realized a $600K gain.  So VantagePoint not only got to extinguish Sony’s profit sharing rights for “free”, but they got to hand a public company (which they owned close to 30% of) a gift of $600K. 

But that’s not the only canny move by VantagePoint.  Indeed the sale to News Corp is very smart move for them because if Intermix had waited another 7 months, then it would have presumably had to pay Redpoint and the other MySpace investors a much higher premium for their shares.  So by selling out “early” to News Corp, VantagePoint ended up getting a bigger share of the profits than it might have gotten otherwise.

In terms of an overall return for VantagePoint, according to this Form 4 VantagePoint’s option allowed them to acquire Sony’s shares at $1.10/share, so this means that the Sony shares cost them roughly $5.3M.  Add to that the $8M in Series C shares and the $2M in debt that was later converted to shares and you have a total investment of $15.3M and at $12/share a total return of $139M or 9.1X invested capital.  Assuming the deal closes in 3 months, the IRR would be around 223%.  This doesn’t include the cost of the option on the Sony shares, but I can’t imagine it cost them more than $500K, so it’s probably not that big a deal in the grand scheme of things, who knows maybe they even got it for free.

Between making a gutsy call to invest in a broken deal, the beautiful Sony option deal, the canny timing of the ultimate sale, and, of course, the very impressive returns, the VantagePoint partners on the deal, which look to be David Carlick and Andy Sheehan, deserve a great big “gold star” for VC deal engineering and investing.  Bravo!

UPDATE:

I talked with a reporter who had a conversation with Geoff Yang, who did the MySpace deal for Redpoint.  Apparently Geoff said that Repoint will ultimately net about 50% more ($65M+) than the $44.25M I estimated thanks to the some special provisions they negotiated for their MySpace preferred stock.  Just guessing, but it sounds to me like they were able to get what VC's call a "double participating preferred", which means you get 2X your money back before everyone else and then still get your cut of what's left.   An alternative could be that they simply negotiated with Intermix to get a better deal.  Either way, it looks like Redpoint got an even better deal than I first estimated which makes their performance on MySpace all the more impressive.  Congrats Geoff!

July 18, 2005 in Internet, Venture Capital | Permalink

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The thoughts and opinions on this blog are mine and mine alone and not affiliated in any way with Inductive Capital LP, San Andreas Capital LLC, or any other company I am involved with. Nothing written in this blog should be considered investment, tax, legal,financial or any other kind of advice. These writings, misinformed as they may be, are just my personal opinions.