May 28 (Bloomberg) -- Digital Sky Technologies Co-Founder and Chief Executive Officer Yuri Milner shrugged off suggestions his company overpaid for its Facebook stake and said the purchase gives it a foothold outside its home market.

The $200 million it paid this week for a 1.96 percent stake in Facebook values the Palo Alto, California-based company at $10 billion and marks Digital Sky’s first major foray in the West. Milner says his investment company applied its experience with social networks in Russia to determine the price to pay.

“The price was suitable,” Milner said in a telephone interview from San Diego today. “We did substantial due diligence. Globally, there are not that many successful social networks. All our Russian social networks are profitable.”

Digital Sky, partly owned by Russian Billionaire Alisher Usmanov, has invested in Internet businesses including Mail.ru, the largest Russian language Web portal, and local social networks Forticom and Vkontakte. The price it paid for its Facebook stake has rekindled debate over how much social- networking companies are worth.

“There is a certain overpayment for the asset,” said Sergey Vasin, an analyst at Metropol brokerage in Moscow. “Facebook hasn’t yet learned to earn money, and there are delusions in the market about growth potential for these social networks. Digital Sky became a victim of such a delusion.”

Valuation Dispute

Facebook put its value at $3.7 billion during negotiations in a legal case, according to a transcript of a court hearing over the company’s settlement with ConnectU Inc.

The current valuation is 33 percent less than the $15 billion that Microsoft Corp. attached to the company when it made a $240 million investment in 2007. Facebook’s lawyers argued at a June hearing that the prices weren’t comparable because Microsoft received a different class of shares.

Digital Sky’s purchase price has a “very high level of future expectation built into that valuation,” said Bob Ackerman, co-founder and managing director at Allegis Capital, a Palo Alto-based venture capital firm. “The fundamental challenge for all of these social network companies is: How do they convert traffic and consumer interest into revenue and earnings? The jury is still out.”

The question is whether Facebook and its rivals Twitter Inc. and News Corp.’s MySpace will match the profits of their Internet predecessors: Google Inc. and Yahoo! Inc. Facebook and MySpace may have $820 million in combined sales this year, a fraction of the $45.7 billion online advertising market, according to New York-based research firm EMarketer Inc.

Profit Expectations

Milner maintains his company paid the right price.

“We wanted to get exposure to Facebook’s global theme,” Milner said today, adding that his Russian experience convinces him that Facebook has the potential to be “one of the most valuable Internet companies globally.”

“Facebook’s main theme in 2008 and 2009 is aggressive international expansion,” he said. “Monetization will follow this expansion and may happen in the next two to three years.”

Closely held Digital Sky has since its inception in 2005 confined itself mostly to Russia and Eastern Europe. The company has invested more than $1 billion in about 30 companies. It has stakes in social-networking sites in 13 countries. The companies it backs have 350 million social-networking users, it says.

“Even in this year of crisis we are seeing a substantial growth in profit from the previous year,” Milner said, declining to provide details.

Russian Experience

Milner and investing partner Gregory Finger own 50 percent of Digital Sky, which has offices in Moscow and London. Uzbek-born billionaire Usmanov, who has assets in iron ore and steel and has expanded into the media and telecommunication industries, owns a minority stake. Usmanov doesn’t influence the company’s management, Milner said. Digital Sky has a number of other investors, “including foreign ones,” he said.

Digital Sky began when Milner and Finger pooled their interests in Mail.ru. The portal, now more than 50 percent owned by Digital Sky, says it has 50 million registered accounts for its free e-mail and 40 other products, including search, social networking and instant messaging.

Another Digital Sky investment, Forticom, owns social networks in Russia, Poland, the Baltics and other countries. Vkontakte.ru calls itself the leading social network in the Russian language, with more than 34 million registered users.

Digital Sky’s other holdings include OE Investment, Russia’s largest operator of electronic payments, and Headhunter, Russia’s largest jobs Web site.

Out of Russia

For Digital Sky, the Facebook transaction provides a path into the bigger world of Internet networks, said Anna Kurbatova, an analyst at UniCredit SpA in Moscow.

The purchase “takes them beyond Russian borders,” she said. “This is a long-term investment.” The fund may decide to raise its stake in Facebook, “depending on their financial opportunities and ambitions if they see that Facebook’s value rises steadily,” she said.

Digital Sky faced “tough competition” from U.S. investors in its effort to buy a piece of Facebook, Milner said.

“I think we got the deal because we proved that we have a unique expertise in social networks,” he said.

Facebook has received more than $400 million in equity investments from Microsoft, Peter Thiel’s Founders Fund, and venture capital firms Accel Partners and Greylock Partners.

Founded by Mark Zuckerberg in 2004 as a social- networking service for his fellow Harvard University classmates, Facebook generates sales through advertising. The company expects revenue to climb 70 percent this year.

Digital Sky won’t help Facebook’s expansion in Russia and eastern Europe, because “we have our own interests here, with our Russian social networks,” Milner said. “Helping Facebook expand in Russia wasn’t part of the transaction.”

To contact the reporter on this story: Maria Ermakova in Moscow at mermakova@bloomberg.net.

Last Updated: May 28, 2009 06:50 EDT