Can a dead cat bounce?
The relaunch of Napster, which reinvented the music business, may come too late for the company to take part in the party it started.
September 23, 2003
For everyone but its fanatical users, Napster has been an endless series of headaches. First it was the recording industry, whose five major labels – BMG, Sony, the Universal Music Group, EMI, and the Warner Music Group – cried copyright infringement and forced Napster to shutter its music file-swapping service in 2001.
Next it was the German entertainment goliath Bertelsmann, which tried to buy Napster in 2002 but was blocked by a U.S. bankruptcy judge – this, after sinking $85 million into the company to keep it afloat.
Now it may be Roxio’s turn. The struggling CD-software company, based in Santa Clara, California, bought Napster in 2002 for $5.3 million, promising to tame the once-maverick company. Napster 2.0 is expected to launch by Christmas. It has deals with all the major music labels and plans to offer 500,000 songs.
But Roxio has a long way to go before it proves it can bring the brand back from oblivion. If Napster 2.0 is a crashing failure, it may even drag Roxio down with it
Roxio has little hope in transforming the service into a major cash generator, says Justin Cable, an analyst with the research firm B. Riley, citing the company’s recent fumbles with its software, slim margins in the music-sales business, and competitive pressure on pricing in a field where new pay-to-play services are announced seemingly monthly. Mr. Cable says he doubts Roxio has the staying power to see the new Napster through to maturity. “We have seen Roxio achieve the largest market share in CD-burning software a couple of years ago, and then lose it,” he says.
Three years ago, Napster’s fortunes looked more promising. It had 60 million rabid users and a brand name that was one of the most recognized – if controversial – in the industry. Most of its users engaged in the dubious act of swapping copyrighted MP3 music files among themselves.
While Napster made the recording industry apoplectic, it also fueled tidy little cottage industries – like hardware and software for burning CD-ROMs – in which Roxio was involved.
Chapter 11 bankruptcy officially put Napster out of business in 2002, but the demand for MP3 services and related products lived on.
Napster’s day in the sun may have already passed, however, having been superceded by music services like MusicNet, RealNetworks’ Rhapsody, and Apple Computers’ high-profile iTunes.
Roxio, for its part, has spent the past year furtively trying to build a pay-to-play music service that is both law-abiding and large enough to live up to the Napster brand. In May, Roxio spent another $40 million ($12.5 million in cash and approximately 3.9 million shares of Roxio common stock) to buy Pressplay, a struggling pay-to-play music service that the Universal and Sony studios started. It plans to use Pressplay as the bones of the new Napster, with Pressplay executive Mike Bebel taking the reins as chief operations officer.
Roxio has been tight-lipped about how the increasingly expensive new Napster will work. So far, the company only speaks through press releases, where it says it will offer music from all five major labels in both subscription and pay-per-download formats. It says it will also offer some Napster-only content.
The new Napster also is taking a cue from the current pay-to-play leader, Apple, by partnering with Samsung to make an MP3 audio device similar to Apple’s iPod. The device will come bundled with Napster software that will connect a user’s computer directly to the Web site.
As part of a $20 million advertising campaign, Napster’s infamous cat-with-headphones logo already is popping up on billboards throughout major U.S. cities. The cat is also chronicled as a Flash-animated cartoon at Napster.com.
With Napster, Roxio is entering a new market as it distances itself from a spotty track record in its core but declining CD- and DVD-software division, which has been dependent upon the struggling PC market.
At the end of its June quarter, Roxio’s quarterly revenue was down 25 percent sequentially to $24.2 million, as royalty payments from PC manufacturers that bundle their machines with Roxio’s CD-burning software also fell.
Jupiter Research analyst David Card says initial sparks among competitors could both splinter the market and drive down already-slim margins. At least one of Napster’s future competitors agrees. “With all the launches you will see a lot of hype. This is a case of who is here and who is not in two to three years,” says Sean Ryan, vice president of music services for RealNetworks.
Mr. Ryan says he foresees aggressive and expensive marketing campaigns and super-slim margins as more and more pay-to-play services enter the field. Ultimately, Mr. Ryan says he expects the weaker vendors to drop out by next year, leaving only two or three standing once the dust settles.
Citing strong branding, US Bancorp Piper Jaffray analyst Gene Munster says he is optimistic about Napster’s potential for success. The Napster brand was recognized by 93 percent of people in a survey taken by Piper Jaffray in September; only a quarter of those in the same survey recognized Apple’s iTunes, which was first to market. Mr. Munster says he is convinced that the market potential of the Napster brand far outstrips that of iTunes, which he estimates as generating one-third of Apple’s revenue and is worth about $1.2 billion. By comparison, Roxio has a market capitalization of about $280 million.
“It does not make sense that there is so much of a gap, given that the brand has three times the brand recognition,” says Mr. Munster. Piper Jaffray makes a market in the stock. Mr. Munster says Roxio has a good leader – CEO Chris Gorog cut his teeth in the entertainment industry, including gigs with Walt Disney, Universal Studios, and House of Blues Entertainment.
Business know-how may be the key to Napster’s future if it wants to avoid a second bankruptcy in a crowded, low-margin pay-to-play music market. At the end of June, Roxio had $63 million in cash on hand but projected that would drop to $50 million by the end of September.
If the popularity of the Napster brand initially attracts a large number of curious consumers, as Mr. Cable says it will, intense competition could pressure Roxio to spend more on marketing to expand or maintain market share - money which Roxio can ill afford to spend frivolously. Like an old rock star reduced to playing dinner theaters, Napster may discover that its glory days may never return. |
