March 29, 2004

Shakeout in Music Download Already...

Some start-ups seek buyers, anticipating entry of established firms eager for a stake in selling songs

By Nick Wingfield
The Wall Street Journal
Originally published March 29, 2004

NEW YORK -- With too many players jostling for too few chairs in the online-music game, a long-predicted shakeout appears to be under way.

Not long ago, online music captured the imaginations of entrepreneurs and investors, and start-ups were popping up all over the Web. But for all the excitement generated by Apple Computer Inc.'s iTunes Music Store and others, the online-music market is still a young business where the direct profits from selling songs remain elusive -- not yet big enough for the crowd of newcomers that soon became a glut.

Pressure on start-ups will further intensify this year as big companies including Microsoft Corp., Sony Corp. and Yahoo Inc. enter the market.

Facing the music, the online-tunes start-ups are beginning to shelve planned offerings or shop themselves to more-established companies.

In recent weeks, closely held MusicNow Inc. in Chicago has approached large retailers, technology companies and other online music sites with the intent of selling itself or raising capital, say several executives at companies approached by MusicNow.

Those executives say they declined the chance to do a deal with MusicNow, although it's possible MusicNow may have reached a pact with another party. Greg Rudin, a spokesman for MusicNow, declined to comment.

Like a growing number of companies in the market, MusicNow -- formerly known as FullAudio Corp. -- was trying different approaches to delivering music licensed from recording companies to users, including selling copies of songs for 99 cents each and charging a $9.95 monthly subscription fee for access to an unlimited library of music, albeit with restrictions on how consumers listened to the music.

The company's services never gained much of a following: MusicNow signed up only about 18,000 members to its subscription service, according to outside executives familiar with its numbers.

More start-ups going to market

OnDemandDistribution PLC, a distributor of music co-founded by the musician Peter Gabriel and based in the United Kingdom, is also casting about for potential investors or acquirers; it has hired investment bank Broadview, a unit of Jefferies & Co., to help it with that goal, according to executives approached about a possible deal.

OD2, as the company is also known, is considered one of the stronger Internet music companies in Europe, with agreements to operate European music-retailing sites for high-profile partners like Coca-Cola Co. and Microsoft's MSN. OD2 will face increasingly tough competition starting later this year, though, when U.S. players like Roxio Inc.'s Napster and Apple's iTunes have said they plan to enter the European market.

Tiff Pike, OD2's finance director, confirmed in an e-mail that the company has hired Broadview. But he didn't respond directly to questions about whether the investment bankers were helping it find a suitor. "They are providing us with advice on conditions in the market generally and specifically on growth opportunities," Pike said in the e-mail.

Other start-ups are backing off from the market indefinitely. A little over a year ago, major retailers Best Buy Co., Trans World Entertainment Corp. and others formed a consortium called Echo Inc. that planned to license music from recording companies and distribute the songs through each of the retailers' own Web sites.

Los Angeles-based Echo never launched its service and its plans are now on hold as it tries to figure out how to distinguish itself from other music sites.

"We didn't want to go out with a me-too, too-late service," said Dan Hart, Echo's chief executive. "We looked at other players in the space and the results they were having and thought we needed a somewhat different strategy to be more competitive."

Very little profit

Indeed, there are more than a dozen companies with existing or planned online music ventures hawking virtually the same selection of songs licensed from major recording companies and independent labels.

The profits from such song-download services are questionable. These companies pay from about 65 cents to 79 cents a song to music companies, analysts and industry executives say. Credit-card processing fees, bandwidth charges and costs related to customer service often chew up whatever profit is left over from the 99 cents most consumers pay for a song.

Apple CEO Steve Jobs has said that Apple makes its money in the music business from selling iPods, the sleek portable music players that are the only hand-held gadgets that work with its iTunes Music Store. Apple says it has sold more than 50 million songs since it introduced the iTunes Music Store about a year ago, making it the market leader by far. The company, based in Cupertino, Calif., has sold more than two million iPods.

Apple's competitors have said Jobs is understating the profits in music sales for Apple's own benefit. Music sites like Napster and RealNetworks Inc.'s Rhapsody say profit margins are higher for subscription music services, which both companies offer, than in the business of selling 99-cent downloads. Apple doesn't offer a subscription service.

Sales vs. downloads

Whatever the approach to selling music, though, sales from commercial music sites are still small compared with the number of downloads from free, renegade alternatives like Sharman Networks Ltd.'s Kazaa, which have a much broader selection of music, most of it pirated.

Still, the transformation of music retailing into an online business is eventually expected to be so thorough that large companies, including Microsoft, Sony and Yahoo, are preparing to start their own music-downloading sites.

But the growth of online music into a major business clearly will take time.

Last week, Roxio said it expects its Napster service to post about $5.5 million in revenue for the calendar first quarter, up 53 percent from $3.6 million in revenue in the fourth quarter. What Roxio didn't remind investors is that the company had launched Napster in late October. Had Napster been in business the full fourth quarter, Roxio had previously said it was on track to report $5 million in revenue then -- meaning it had a mere 10 percent in sequential growth.

Roxio's shares now trade for less than half of their value prior to its reintroduction of Napster.

"We're still just scraping the surface of the online music market," a spokesman for Roxio said. - Shakeout winnows online music companies

Posted by Craig at March 29, 2004 04:46 PM