Did the French government just sell Dailymotion back to itself?

So let’s just get this straight. Dailymotion, a French-born competitor to YouTube, has been bought by Orange which will acquire about 49% of the company for €58.8 million or about 160 million dollars. Orange can gradually increase its stake to 100% by 2013, however, it appears the deal is not formally signed yet. Reportedly Orange has an has option to buy the rest later, just as soon as the last half of the company has collapsed in value because no-one else will be competing for other 51%.

We spoke to an investor inside who told us that Dailymotion has done well against the YoTube giant and it’s P&L had started to turn a corner towards “exciting growth.” This is “not a basket case business” he said and while it wasn’t setting the world alight it wasn’t a case of investors searching around for someone stupid enough to buy it.

However, it is the case that the French government screwed around with this deal.

Dailymotion raised money from the Fonds Stratégique d’Investissement (FSI), the French government’s sovereign wealth fund. The FSI is also a large shareholder of France Telecom, of which Orange is a subsidiary.

So essentially, the French government just sold Dailymotion to itself.

More pertinently are the implications for traditional “10x” VC in Europe. Only Balderton and Index seem to be doing $100m exits but there precious few other VCs doing that kind of deal in Europe right now.

Atlas Venture and Partech International invested $9.5m in 2006. Advent Venture Partners and IDInvest Partners invested in Dailymotion in 2007 the tune of $34m and is clearly not going to see anything like the “10x” exit normal venture capitalists require. Let’s not even mention the $25m added to the pot in 2009 from all existing backers. As an early investor only Atlas will have done ok. Dailymotion and YouTube both started in 2005 but the latter was sold to Google for $1.65 billion.

But let’s not be unkind. Dailymotion has been profitable since the end of last year, it’s traffic had improved greatly, helped partly by the emerging market of India and in Turkey, where YouTube is routinely banned thus making Dailymotion the default option.

So the story of Dailymotion is not over yet. But European VCs have a lot of thinking to do right now.