How Facebook May Save Elevation Partners

Things are not going great at Elevation Partners. Its initial $1.8 billion fund – that was met with great fanfare when it was raised by rockstar investor Roger McNamee, rockstar gaming executive John Riccitiello and actual rockstar Bono – is about 70% invested and the two biggest deals are duds. Elevation invested some $300 million in Forbes and a whopping $460 million in Palm—a company with a stock hovering around $4 per share, down some 75% since October.

Yet, things aren’t quite as bad as they look from the outside for two reasons. First: Elevation has hedged its risky strategy of putting so much money behind a few bets by concocting a complex system of puts and convertible issues that limit the downside of its worse deals. For instance, even with Palm at the lowly $4 a share, Elevation roughly breaks even on the fund, which not every venture fund raised in 2005 can say for itself.

The second reason? The fund secretly bought up some $90 million of Facebook shares on the secondary market late last year. One person with knowledge of the transaction told us: This deal – which anyone with $90 million could have struck – could be the only thing that tips the fund in the black, a crucial bragging point as Elevation gets ready to think about raising its second fund in a brutal fundraising environment.

The price Elevation Partners paid for Facebook stock? We’ve heard it was around $30/share, which is roughly in line with the (smaller) transactions occurring on SecondMarket at the time. That values Facebook at roughly $13 billion, double what DST paid for common stock just a few months earlier.

It’s ironic that a team that was billed as an investing dream team with deep contacts in every facet of media and technology may be saved by a deal that required no contacts and little deal making or company building expertise. It’s also ironic that it took a secondary market purchase for Elevation to invest in Facebook, given the tight ties between the two companies. Roger McNamee is a personal investor and informal advisor to the company, Bono is a personal investor in Facebook too, and Elevation partner Mark Bodnick is married to Facebook COO Sheryl Sandberg’s sister. That’s one chummy bunch.

Sources close to the firm say that Elevation has several deals in public and private companies that haven’t been announced that hedge it’s not-so-hot Forbes and Palm bets.

Such deals aside, there are three legitimate concerns for Elevation that are weighing on limited partners as they consider re-upping in the firm. The first is Elevation’s clear change in strategy. This was a fund launched to make big bets in media, gaming and music, and it has clearly veered from that strategy. That’s not necessarily a bad thing—there’s a graveyard of online music companies and other than Pandora, few that look like winners. And when Riccitiello left Elevation to head up EA, he obviously took a lot of the firm’s video game expertise with him. (He was kind enough to give the firm its best exit buying BioWare/Pandemic Studios for a combined $860 million.) But if Elevation isn’t that any more, the question is what kind of firm is it? Recent hires of former Apple Software chief Avie Tevanian and eBay executive Rajiv Dutta indicate the firm indeed intends to raise a second fund and indicate to continued deal making in devices and the Web.

The second concern is how engaged Roger McNamee still is in Elevation. McNamee—long hair and outrageous statements aside—is one of the top public and private market investors in Valley history. So what of his deal judgment with Forbes and Palm? Worse is the concern that McNamee has checked out, spending more and more time touring with his band Moon Alice while Elevation falters. McNamee carries about six smart phones with him at a time, so he’s no doubt wired in, but even the appearance of being MIA has to be worrisome to investors.

And then, there’s Palm again. It’s 20% of the fund and has the ability to make or break it. Back in October when Palm was trading at $18 a share, Elevation had one of the best IRRs in the business. Palm isn’t looking good in the smart phone wars thanks to some crucial execution mistakes when there was already little room for error. These mistakes include announcing the Pre months before it was available, launching with Sprint and botching its Verizon roll-out. Not exactly inspiring moves for a company making its comeback.

That said, the idea that Palm will go to zero being pushed by some of the many people shorting the stock is a stretch. The company has six quarters of revenue in the bank and even if it can’t compete in the smart phone market, it’s an easy acquisition target. Palm’s strength has always been its software, and that’s the precise weakness of most handset vendors who aren’t named Apple. Will Palm be the win Elevation was hoping for? No. But that doesn’t mean it’s worthless.

Similarly, Elevation will almost assuredly have a harder time raising its second fund. Some LPs will likely walk, and the fund may be smaller. But if Facebook can push it into the black, there likely will be another $1 billion out there to gamble on Elevation again.