Napster on the block?

Steve Rosenbush

Someday, I am sure, someone besides Steve Jobs at Apple Computer will figure out how to build a successful business around digital music. The new, legal Napster service, structured around the brand of the old, illegal Napster file-sharing system, is trying very hard, but victory is still a long way in the future. The most encouraging news in the earnings release that it issued August 2 was that its cash burn for the first fiscal quarter, which ended in June, fell to $9.6 million. That's down from a loss of $19.7 million in the first quarter of last year, although on a sequential basis it's modestly higher than the $9.3 million it lost in the fourth quarter of 2006. Revenues were $28.1 million, up 34 percent from the first quarter of 2006 and up 5 percent on a sequential basis from the fourth quarter of 2006.

CEO Chris Gorog attributed the growth to the launch of Napster's free-advertising supported service. It also offers an ad-free version for $9.95 a month, and a $14.95 a month vesion that allows subscribers to download unlimited amounts of music to MP3 players. They can access the music as long as they continue to pay the monthly fee. If they cancel their subsciption, they can't play the music anymore.

Gorog deserves credit for trying something new and narrowing the operating losses. But the company still has a long way to go before it really gains traction. Achieving profitability would be great, but that alone isn't enought to make it truly competitive. Apple's iPod has set a very high bar for success in the digital music market.

So it's no surprise that Gorog essentially put his company on the block. During a conference call he assured investors and analysts that "we do not have our heads in the sand" when it comes to M&A, and that the company has attracted "interest" and is weighing its options. Such a bold asseration is tantamount to putting a for-sale sign in the front yard.

The company faces two critical issues. The first is whether it has the right business model. The free version is similar to Internet radio. The $14.95 a month version is basically a music rental system. But it's not clear that a critical mass of people are all that interested in renting music from servies such as Napster or Yahoo!, which offers a similar product. The success of the iPod shows that people still get a thrill out of owning a collection of music. While it still costs 10 bucks or more to buy a CD online, the Web has made it possible to buy single tracks for less than a dollar. Such unbundling limits the appeal of renting. And even if Napster has the business model right, the success of iTunes and iPod reinforces the critical role of execution. You have to get the design and customer experience just right. Good luck figuring that one out.

Would anyone want to buy Napster? Other services do the same thing. And the flood of new entrants into the business shows that it isn't that hard to build one from scratch. Microsoft is building a new music player and music service called Zune.

Napster is a pretty good service, but the real differentiator is the brand. Just a few years ago, it had an underground allure. Now, as a revived public company with a legal business model, the company is having a challenging time, raising questions about just how valuable the brand can be, stripped of the file-sharing that made it what it was.

That notwithstanding, any number of media and Internet companies might find some value in Napster. If nothing else, an acquisition is a faster route to the market than building an online music service from scratch.

So the issue is going to be what kind of price it will fetch. The shares are trading at $2.71, down from a 52-week high of $5.17. It's hard to imagine that this company would fetch much of a premium to its market cap of $121 million.

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