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Yahoo! and Musicmatch: A Hot Duet

By Ben Elgin Since grabbing the helm at Yahoo (YHOO) in 2001, CEO Terry Semel has banked on key acquisitions to speed the Internet outfit's improving fortunes in a post-meltdown era. On Sept. 14, Semel returned to this battle-tested formula for the first time in six months, snatching online music service Musicmatch for $160 million.

The deal should bolster Yahoo's position in the fast-growing market for downloading and listening to music over the Internet. Despite boasting the most-trafficked online music site in the U.S., according to Nielsen NetRatings, Yahoo has yet to turn the service into a major moneymaker -- unlike competitors such as Apple's (AAPL) iTunes. Founded in 1997, San Diego-based Musicmatch is privately held and doesn't disclose revenues or profits.

Musicmatch should help Yahoo, with over 200,000 subscribers to its ad-free radio service and nearly 10 million users of its desktop software for creating playlists and burning CDs. "This is the leading application for managing music on the Web," says Dave Goldberg, vice-president for music at Yahoo. "This gets Yahoo on people's desktops in a way we weren't before."

HIGH-TRAFFIC DESTINATION. It's also a pivotal move in Yahoo's ongoing quest to diversify beyond Internet advertising. Yahoo now generates 17% of sales from nonadvertising sources, such as online personals and fantasy football. Sure, it's more diverse than key competitor Google (GOOG), which snares only 2% of sales from nonadvertising operations.

But it's a far cry from Semel's initial goal of gleaning half of Yahoo's sales from sources other than advertising -- an ambition largely harpooned in 2003 by a sudden surge in online ads. That lifted Yahoo's sales by 55% in 2003, to $1.5 billion, with profits jumping fivefold, to $238 million. Still, diversification remains a critical goal, given that Yahoo's sales remain heavily concentrated in a business that has proven volatile in the past.

And although a number of Yahoo's for-pay services have cratered, music could be a different story. Apple has proved that this market is ripe by selling over 70 million songs in the first year of its iTunes service. Jupiter Research predicts the market for downloading and online listening will nearly triple in the U.S. in 2004, reaching $270 million.

While Musicmatch boasts fewer subscribers than several competitors, it ranks third among the most-visited music destination on the Internet, according to research comScore Media Metrix, giving Yahoo two of the three most-trafficked music properties. Showcasing the more robust for-pay features of Musicmatch to its unrivaled audience, Yahoo should be more successful in transforming music aficionados into paying customers.

"I like this deal," says Jupiter analyst David Card. "Musicmatch has a good product, but they were going to get lost in the noise."

SUBSCRIPTIONS VS. SONGS. The acquisition also highlights a growing distinction between the strategies of Apple and those of Internet incumbents, such as AOL (TWX) and Yahoo. Apple has successfully wagered that consumers want to buy music downloads by the song. Many other Internet companies are betting heavily on subscriptions. For instance, with Musicmatch, users pay up to $10 per month to access a library of 700,000 tracks. Although it offers a download feature, Yahoo is emphasizing the subscription model. "It offers a better value proposition than paying on a per-song basis," says Goldberg.

Of course, the onus is on Yahoo's management team to adroitly integrate the deal. Based on Semel & Co.'s record, they have a good shot at succeeding. Reversing a string of poorly executed acquisitions during the bubble era, Yahoo in recent years has successfully integrated acquisitions such as career-site HotJobs, as well as search firms Intkomi and Overture Services.

With the Musicmatch deal expected to close in the fourth quarter, Yahoo once again has an opportunity to prove its M&A salt -- and move to solidify its position in this promising online market. Elgin is a correspondent BusinessWeek's Silicon Valley bureau

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