Napster: How many lives?
Napster Inc. (Nasdaq: NAPS), the pioneering music download service with the Hello Kitty-esque logo, let the cat out of the bag in 2006: It was exploring its options. Could this cool cat -- which remains a fairly popular service, especially in Europe -- be running out of lives as a publicly traded company?
Heading into the release on Wednesday of its financial results for fiscal 2007, there has been little indication that anyone is interested in taking over the Napster brand and running with it.
By all accounts, Napster is on about its fourth life, as far as an Internet company – and cats – go. The question is whether it can survive long enough to use up all nine of them.
The 1.0 version of Napster created in 1999 in a Northeastern University dorm room was a simple peer-to-peer, slightly underground, music-sharing service. It quickly ran afoul of the recording industry over copyright infringement, with the American heavy metal band Metallica the first of many artists to sue after their songs wound up on Napster's servers.
As a kitten, Napster was ferocious as it took on the titans of the music industry in fights that would make any alley cat proud. It had more than 25 million users at its peak in early 2001. But the company couldn't win its many battles, and finally in July 2001, the wildcat turned mild cat, and shut down completely, to comply with an injunction barring it from participating in the sharing of copyright material.
One technology that Napster helped bring into the limelight was digital-rights management, which often puts limits on how consumers who have legitimately purchased music or video in a digital format can listen or view the content.
After Napster went dead, seemingly for good, it cooked up a deal to sell itself to the German media giant Bertelsmann for $8 million, which also required it to file for Chapter 11 bankruptcy protection. A bankruptcy judge in September 2002 killed that plan and 
forced Napster to liquidate. At that point, CD and DVD software maker Roxio entered the picture, and bought the Napster assets including the brand and trademark for $5 million in late 2002, but not its millions in liabilities, and launched a legit Napster 2.0 in October 2003. Ten months later, in order to concentrate on digital content, Roxio sold its anchor software business to Sonic Solutions (Nasdaq: SNIC) and became a digital content company, changing its name to that of its acquisition.
Even Microsoft was embracing this new Napster, which had the licenses it needed and a seemingly viable business model. In addition to offering individual subscription services for a monthly fee and outright music purchases, Napster sought out clients for site licenses, mostly at universities such as Penn State, to supply its music content to a target audience with ideal demographics. But it was operating deep in the shadow of Apple's growing juggernaut, the iPod and the iTunes online music store.
Transitioning from rebellious rogue to a legitimate challenger to such services as Apple Inc.’s (Nasdaq: AAPL) iTunes online store has been rough, to say the least. A year ago, after reporting dismal results and a cloudy future, Napster returned to its roots by touting the availability of free tunes – many in a sample format, or singles on a short-term promotion – in hopes of luring more paying subscribers willing to pony up a $10 or $15 a month fee. You can listen for free, but just three times a month per song, and not much of the free music can be downloaded to keep.
Toss in other services such as RealNetworks Inc.'s (Nasdaq: RNWK) and Microsoft Corp.'s (Nasdaq: MSFT) Zune-related content, and you have one crowded marketplace. But it’s a lucrative one, already reaching into the billions of dollars. For instance, while The Walt Disney Co. did not break out the bottom-line impact of online sales through iTunes in the first quarter of 2007, the company said it has sold some 23.7 million TV episodes and 2 million movies through that portal overall. But Apple hasn’t cooperated with Napster or other services, which has helped keep Napster tunes off iPods.
As far as Napster goes, the Los Angeles-based company acknowledged in September 2006 that it had hired UBS to help figure out its future, hoping to find somebody that wants to take its widely recognized brand and run with it, in some direction. The company said it would “thoughtfully examine” possible partnerships or an acquisition.
Following the September announcement, Napster shares scored a run-up of about 20%, which by early 2007 had fizzled, as longer-term investors pulled out some profits. The share price drifted back to the same vicinity where it was before the news, and most recently the stock was trading around $4. Looking back at its historical prices, the stock has remained quite stagnant, showing a recent 52-week range of $2.55 to $4.92.
Napster has offered some hints about what it wants to do. In a February 8-K filing with the U.S. Securities and Exchange Commission, the company announced the addition of Ross Levinsohn, former president of News Corp.’s Fox Interactive Media, to its board. While part of Fox, Levinsohn helped orchestrate the acquisition of MySpace.com and other popular online sites.
In a research note at the time, Darren Aftahi of ThinkEquity Partners pointed out that Levinsohn’s appointment is to conclude when Napster holds its annual shareholders’ meeting in October. “An M&A scenario for NAPS has a higher probability today than previously,” Aftahi concluded.
Analysts surveyed by First Call/Thomson Financial are mostly neutral to positive. Just one of 11 surveyed has a sell rating on Napster; five say hold, three say buy and two label it a strong buy.
The company has actually been generating more news since it started weighing its options. It has become the exclusive music-subscription provider for AOL, as that struggling company restructures its business model, which included jettisoning its AOL Music Now. Napster has signed content deals with AT&T and Ericsson, plans to launch an over-the-air subscription service in Japan with NTT DoCoMo, and is working to develop a new Circuit City + Napster digital music service that the U.S. retailer will offer.
In early April, Napster pre-announced some of its results for the fiscal year that ended March 31, saying that it anticipates beating the $28 million in revenue for the fiscal fourth quarter, and that it completed the year with more than 830,000 subscribers – thanks to the boost from AOL’s 225,000 Music Now subscribers.
The company also touted that its subscriber base “makes us the largest on-demand music subscription service in the industry.”
After that preannouncement, Maxim Group issued a research note reiterating a buy rating. “While most of the NAPS upside potential is from a takeout, (we think) management is improving execution. NAPS continues to enter agreements in high-growth market segments, notably in mobile. …”
When Napster reports its results Wednesday, the First Call/Thomson Financial consensus estimate of analysts surveyed is looking for the company to post a loss of 20 cents a share, compared with the year-ago loss of 17 cents for the fiscal fourth quarter that ended in March, and a penny less than management's guidance. For the full fiscal year, the Thomson survey is calling for a loss of 88 cents a share, down from the year-ago loss of $1.28 a share.
For investors, it’s still difficult to determine if Napster is singing a new tune, or if that’s just some off-key caterwauling drifting over the backyard fence. Buying at this price still appears attractive to about half of the analysts who cover the company, and that could prove especially true if some high-priced acquisition emerges in the coming months, or weeks.
