Thursday, May 17, 2007

Napster: Laying Groundwork or Just Shoveling?

Napster (NAPS) reported March quarter results (its Q4 FY 2007) yesterday and held an analyst conference. As usual things were not quite as good as investors would hope, but management had a compelling story to tell about the future. You can get my full summary of the conference at

Napster's traction towards profitability has been slow and seen some setbacks. In 2006 management said they saw the future and it was music-enabled cell phones, but that was off in the distance. Last year's savior was allowing limited free song downloads at This would attract customers who could be up-converted to the full service with a monthly subscription ($9.95 if you just want to play music on a computer; $14.95 if you also want to load it to an MP3 player). In addition advertising revenues from the site would lead to a new era of profitability. Well, no one, not management, not analysts, mentioned the Web site ad revenues at this conference.

On the plus side Napster has been making some pretty big deals of late, mostly with cellular phone services and cell phone manufacturers. Japan's DoCoMo has already rolled out Napster service. AT&T is currently rolling out Napster service. Motorola [See my Motorola analyst conference summaries] has chosen Napster to provide music subscription service for its advanced music phones. Circuit City is also partnering with Napster. This is on top of Napster service becoming available in Great Britain, Germany and Japan back in 2006.

So why the gloomy stock price? Investors are treating Napster like a loser, not a potential winner. It isn't just that it is not 1999 this year. There are some very real concerns. Presumably you know about the intense competition with RealNetworks' Rapsody service, Yahoo's music service, and other subscription model providers, plus Apple's iTunes and a host of pay-per-song providers, plus just plain stealing digital music files.

The main disappointment right now is over the results from the AOL deal. AOL decided to allow Napster to be its music service provider, but sold its customers to Napster for $11.1 million. That amount, paid in the March quarter, made a big dent in Napster's cash and in net income for the quarter. Analysts expected that expense.

What they expected in return was a big boost in Napster revenues in the June quarter, of about $7 to $8 million. Instead Napster is guiding to a direct AOL boost of about $5 million. In direct response to more than one analyst's question about this, management said it is due to typical seasonality in the June quarter.

On the plus side Napster says its quarterly cash burn going forward should be $3.3 million or less. This is a dramatic improvement and it comes from the deals Napster has been making. They used to pay a lot for advertisement. Under the deals, the partner pays for advertisement and then Napster gives a bounty for each actual new subscriber.

So ladies and gentlemen, lay your bets. Napster has created an infrastructure capable of making it a major player. Potential rivals have been converted to willing partners. The only question is, will consumers decide to pay for the music subscription service on their high-end, music enabled cell phones? Even a half million subscribers in Japan would make Napster immensely profitable. The number of music enabled, Napster compatible phones with Napster promotions inside the boxes is expected to be in the hundreds of millions in the next few years.

On the whole I still think Napster is a risky stock. But the upside opportunity is very high. The downside risk, in the short run, is more stagnation, rather than imminent bankruptcy. With over $66 million in cash, and even using a pessimistic burn rate of $4 million per quarter, Napster has plenty of opportunity to find out if its strategy can be profitable.

I own Napster stock and use the music service.

Napster investor relations site
My Napster page

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