SMARTMONEY.COM: Will Digital Music Stocks Rock The Web?
By PAUL R. LA MONICA
Dow Jones Newswires
NEW YORK -- The digital music area is shaping up as the next battleground in the world of e-commerce. The controversial technology known as MP3 has the music business up in arms because consumers can use MP3 to transfer copyrighted music from CDs to the Internet where it can be downloaded for free.
On Wednesday, Sony (SNE) announced that it will collaborate with Microsoft (MSFT) to sell virtual singles over the Internet. Earlier this month, Real Networks (RNWK) unveiled its RealJukebox downloadable music software.
Last week, Liquid Audio, which makes encrypted downloadable music software that makes it difficult to pirate existing music, filed to go public. The company includes big-time venture capital firm Hummer Winblad, Intel (INTC), Metromedia (MMG) and Paul Allen's Vulcan Ventures as its four largest investors. Some market observers think this IPO could put pressure on MP3.com, the most prominent site featuring the popular MP3 technology, to soon seek the IPO route as well. MP3.com features a multitude of free music from relatively obscure musicians and some big-name artists.
So far there aren't that many ways for investors to cash in on the craze. There's online music record label and retailer GoodNoise (GDNO) a stock that trades on Nasdaq's bulletin board. The stock has more than tripled so far this year but it is volatile, thinly traded and lacks analyst coverage. Audiohighway (AHWY), another site that allows consumers to download audio files, went public last year and has doubled from its offering price, but is 50% off its high. Then there's poor Diamond Multimedia (DIMD), which makes the portable MP3 player Rio. It has not been helped by its digital music business as its stock has plummeted nearly 30% so far this year.
The truth is, the digital music business may never reap big rewards for investors. According to Forrester Research, digital music sales will increase substantially in the next few years. But sales are still only expected to be $1.1 billion by 2003, about 7% of total music sales. Compare that to Forrester's 2003 estimate of about $7 billion for online CD sales at sites like Amazon.com (AMZN) and CDNow (CDNW) and it does seem like the digital music hype is a little overblown.
Certainly digital download market share will continue to increase. A study by the Internet Underground Music Archive estimates that 20% of music retail revenues will come from digital sales by 2007. That's a sizable gain but still not enough to herald the death of the music business as we know it.
Because the music industry is so concerned with piracy, competition to come up with some sort of secure music standard is intensifying. In addition to Sony and Microsoft, you have AT&T (T), which makes a2b encrypted software and is working with the Universal and BMG record labels. Then there's IBM (IBM), which is testing a format for all five major music labels.
You can argue all you want about what format will ultimately win out: MP3 is clearly the leader right now since files in this format can be copied easier and download faster. But the sound quality for Liquid Audio and a2b is slightly better, which some say give these formats an edge. Steve Grady, GoodNoise's vice president of marketing, says since the MP3 technology is the most popular with consumers right now, that is why GoodNoise, which is in the process of changing its name to the more Internet sounding Emusic.com., primarily features MP3 files for download. But he maintains that it does not matter what format wins out as long as digital music becomes an accepted form of retail.
That may be true but ultimately you have to wonder if the smaller sites can succeed if the music industry heavyweights make it tougher for them to feature digital music of the most popular artists. Sony's announcement on Wednesday doesn't bode well for smaller competitors. Sure, fans of non-mainstream music might have no other option but MP3.com to buy or listen to the music they want, but is that enough business to ensure long-term success? "MP3.com has 10,000 musicians but nobody recognizes them. What they've created is this chaotic flea market," says Mark Hardie, an analyst at Forrester Research.
Personally I'm rooting for the smaller companies. The oligopolies controlling record labels and radio stations have certainly foisted a lot of imitative crap on the consumer over the last few years. It's refreshing to have a site where a music lover could go to check out unsigned, unknown bands as opposed to waiting for what some A&R stiff at Sony thinks is the next big thing. Nonetheless, investors should realize that enthusiasm about this cool new consumer application of the Internet does not necessarily mean digital music will be an investment bonanza.
Just put this "craze" in a little perspective. With so many major companies scrambling for such a small piece of business right now, why should investors get excited when there's no clear-cut winner? It seems that too many people are trying to make the emergence of digital music an overly simplistic logical issue: If digital music catches on then the traditional music business as we know it must die. But not many people are thinking about this scenario: Isn't it possible for digital music sales to increase the size of the overall market without making a significant dent on brick-and-mortar and online sales of mainstream music by giving consumers more choices than they have now?
As much as I am rooting for the MP3.coms of the world to stick it to the corporate music establishment, I am not that optimistic. Eventually, the power and most of the profits will probably remain in the same hands it does now: the big record labels, with the help of major tech companies like IBM and Microsoft. I think it would be a mistake to misinterpret the music industry's slothfulness to mean that they will be hopelessly left behind in the digital revolution. And it would be a bigger mistake to invest in the smaller players of the digital music area that might not survive a shakeout.
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