Elevation's $100 million Pandora stake: jinx?

August 26, 2010: 11:47 AM ET

After years of stasis, Pandora is on the verge of being rewarded for recent growth with a fat check. But can Elevation Partners' Roger McNamee -- even with U2's Bono in the backseat -- pick a winner?

By Chadwick Matlin, contributor

Pandora, that online music station you likely have open in another tab right now, is on the verge of adopting a new sugardaddy. Elevation Partners, the venture capital firm most famous for its rockstar co-founder, Bono, is rumored by TechCrunch to be putting $100 million into Pandora.

It's a major confirmation that Pandora has indeed turned the business around. For years Pandora was losing gobs of money, unable to find a monetization strategy that would make up for what it was paying in licensing fees. But then Steve Jobs and Apple (AAPL) saved the company. With the iPhone, Pandora could finally offer a way for its listeners to hear Pandora -- and its ads -- when they weren't sitting at a computer. As the iPhone's and the iPod Touch's market share got bigger, so did Pandora's profit margin. They pulled in $50 million in revenue in 2009 (but had to pay back $28 million in royalty payments to record companies), and are forecasted to do twice that this year. Speculation of an IPO is rampant.

Which is presumably why Elevation bought in. But should Pandora be thankful or worried? For a high-profile venture firm, Elevation has a mixed track record, and has inadvertently cooled off companies as hot as Pandora before. To glean some insight into what lies ahead for Pandora, let's look at what lies in Elevation's wake.

Palm

Itchy to partake in the smartphone boom, Elevation Partners sunk $460 million into Palm in 2007, two years before their Pre phone debuted. By the time Palm put itself on the block and was sold to Hewlett-Packard (HPQ), Palm's stock had lost a third of its value. Its new phones never caught on, struggling to compete against the boutique flair of the iPhone and the brute quantity of Android phones. Even when the Pre and the Pixi, Palm's other smartphone, became available through Verizon (a far larger network than Sprint), the phones couldn't break through. But despite all this Elevation still made a small profit on the Palm deal. When HP purchased the company, Elevation cashed out $485 million, $25 more than they invested in the first place. Not what VC legends are made of, but a profit nonetheless.

Forbes

Like its smartphone investment, Elevation's interest in Forbes was clearly about its vision of print media as a growth industry. What? Oh. Right.

Even when the deal was struck in 2006, the Forbes investment baffled. At the time, David Carr, the New York Times' media columnist wrote a piece that suggested the stake was about the website -- at the time one of the top business sites online -- than about the magazine. But as we've seen with Newsweek's death spiral, magazines make far larger albatrosses than websites. Forbes had 43 percent fewer ad pages in 2009 than it did in 2006. And while its subscription base has stayed steady, 2009 newsstand sales are down 22.5 percent from 2006. A recent sale of Forbes' Investopedia.com property was a rare win for the partnership. Management has also changed with Forbes alum and True/Slant founder Lewis D'Vorkin returning to the magazine with a mandate to blow up the old model and "re-architect" both print and web for the company.

Videogames

Elevation's video game investments are perhaps its biggest successes. Over several years and with more than $300 million, Elevation purchased various videogame companies and threw them into a larger umbrella corporation called VG Holdings. Once one of VG's founding partners, John Riccitiello, became the CEO of videogame behemoth Electronic Arts (ERTS), EA purchased VG Holdings for $860 million in 2007. (Riccitiello excused himself from the negotiations, but made $4.9 million because of his leftover stock in VG.) Was it a shady deal? Maybe. But it was profitable -- and helped prove Elevation's bona fides in the new media space.

Yelp and Facebook

Finally, we have Elevation's two most recent investments, offering the best hints about the direction of the company, and thus the direction of Pandora. After Yelp and Google (GOOG) couldn't figure out an acquisition deal, Yelp recommitted to its independence with the help of a $100 million allowance from Elevation. Yelp claims it can go public whenever it wants, but that it's not in a hurry.

Facebook feels the same way. In June, Elevation increased its stake in Facebook, bringing its total investment to $210 million, netting them 1.5 percent of the company. There are few sites more attractive than Facebook, yet there are some who think Elevation has badly overvalued their stake. Bono and crew valued Facebook at $23 billion, but a third-party analysis puts the company's worth at something closer to $12 billion. These pre-IPO valuations are always smoke and mirrors, but the disparity suggests Elevation is getting into a volatile corner of the Web business. Presumably it's waiting for a Facebook IPO, but Mark Zuckerberg hasn't exactly been in a rush to cash in on the company's dominance.

With the Pandora investment, we're seeing a trend. Elevation is after established dot coms that can go public -- but don't need to. All of these sites have a revenue model already in place, and have name recognition within their industry. Pandora is part of a new suite of Elevation sites, and it seems Elevation is in no rush to force the sites to go public. (Otherwise it wouldn't have invested in sites so openly nervous about IPOs.) So perhaps Pandora has landed with a patient, mature venture capital firm. Then again, it's not Elevation's character that Pandora's founders have to fret over. As Palm and Forbes can attest, far more worrisome is Elevation's business-development savvy.

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Paul Smalera
Paul Smalera

Paul Smalera is a senior editor for Fortune.com, guiding the website's coverage of tech, finance, investing and the economy. He has written about a wide variety of topics -- from the inner workings of the Google search engine, to the biodiversity protecting Svalbard Global Seed Vault, to the economics behind online dating websites and the impact of the Fed's policies on the national and global economy. A true generalist, Smalera believes every story is a business story if you follow the money.

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