Bulls, Bears Debate Napster
Music Pioneer Boasts Popular Brand,
But Faces Big Competition, Price War
By LAURIE KAWAKAMI
THE WALL STREET JOURNAL ONLINE
June 30, 2005
The Supreme Court ruled unanimously this week that file-sharing companies, like Grokster, can be held liable for copyright infringement if their networks are used to illegally swap songs and movies. The decision has brought renewed attention to legitimate Internet music services, such as Napster. The online music pioneer, which was forced to shutter its popular file-sharing network in 2001 after a legal onslaught by the recording industry, now operates a fee-based music service that has signed up 412,000 paying members. However, Napster faces stiff competition from bigger players like Yahoo Inc., which recently launched a lower-priced subscription service. Napster shares, which started the year at $9.36 on the Nasdaq Stock Market, have slumped more than 50% so far this year amid fears of a price war. The stock has risen 5% since the high court's ruling, closing Wednesday at $4.09, but Wall Street remains divided on its prospects.
The Bull Case
High Court Help: While the recent Supreme Court ruling won't immediately shut down Grokster and other peer-to-peer networks, the decision will result in more lawsuits and could "ultimately prove to be the beginning of a decline in usage of mainstream P2P file sharing," writes PiperJaffray analyst Gene Munster, who rates Napster at "outperform," in a report. Napster, which added 142,000 subscribers in the March quarter, should benefit as many P2P users seek out legitimate alternatives. The company has a strong international brand and its former file-swapping service was used by many current P2P users. Indeed, Napster had the highest awareness among downloaders of any online digital music service at 82%, beating iTunes at 55%, according to a March report from Ipsos-Insight.
Napster to Go: In February, Napster moved beyond its desktop computer roots by launching a portable subscription music service, dubbed Napster To Go. The service allows customers to transfer an unlimited amount of songs to their MP3 players for a monthly "rental" fee of $14.95. The music can't be moved off the devices. (Like iTunes, Napster also sells music downloads for 99 cents apiece.) "We believe the portable subscription model provides a much greater value and is much more exciting than the pay-per-download model," writes Kit Spring, an analyst with Stifel, Nicolaus & Co., who rates the company at "market perform." Although the Napster service doesn't work with Apple's popular iPod players, it is compatible with more than 20 portable audio devices from Dell, Creative and others.
Takeover Target: Although it is losing money, Napster maintains a debt-free balance sheet with $132 million in cash, or about $3 per share, so the downside risk is limited. Bulls say Napster is an attractive takeover target for a search or portal company looking to get into the music business, or a device manufacturer looking to leverage Napster's brand. Mr. Spring writes that if Napster experiences pricing pressure, "we believe it could decide to sell the company -- and we believe there are several interested parties." Last year, Yahoo bought MusicMatch, another online music service, for $160 million -- an estimated four times revenue. "We think Napster is worth more, given its stronger brand name and higher subscriber count," adds Mr. Spring, who estimates the company has a takeover value of $7 to $8.
The Bear Case
Price War: Napster faces intense competition from major players in an already crowded digital-music market. Yahoo recently launched a subscription music service with an introductory price of $6.99 a month, well below Napster's current price. Yahoo's entry may force Napster to cut its monthly fee and may slow Napster's subscriber growth as customers defect to the new lower-priced offering, says Joseph Sullivan, an analyst at Craig-Hallum, who rates Napster at "neutral." With Yahoo's aggressive entry into the market, he writes "it will take some time for investors to see a clear path to sustained growth and profitability for Napster."
Burning Cash: Napster is a small company that is spending heavily on marketing and burning cash at a rapid clip -- roughly $20 million a quarter. Much of Napster's business remains in the development stage and it is unlikely to see profits for several years -- in its quarter ended in March, the company reported a net loss of $24.3 million on sales of $17.4 million. "Napster's valuation is completely subjective given meaningful losses, cash burn and the overhang of competitive pricing uncertainty," writes Frederick Moran, analyst at Stanford Group, who started coverage of the company Tuesday with a "hold" rating and $4 price target. He notes Napster may burn through its savings over the next two years if margins don't improve.
No Napster iPod: Napster's service is Windows-based and not compatible with Apple's iPod player or the iTunes music store. "Until a device manufacturer breaks the iPod stranglehold on the market, Napster and other players on the Windows side of the market are chasing a niche opportunity," writes Steven Frankel, an analyst with Adams Harkness, who has a "reduce" rating on Napster. He expects the iPod and iTunes combo to remain leaders in their respective categories in 2005, limiting the appeal of Napster's service. He also notes that Apple could unveil a subscription service tied to its iPod player, further threatening Napster's business. |
