Roxio burning a new channel with Napster

BY DAVID SPEAKMAN

Buying the brains behind file-sharing bad-boy Napster Inc. has Wall Street wondering whether Roxio Inc. has its sights set on becoming a full-fledged media distribution company.

What is certain, though, is the Santa Clara company is one step closer to leaving its software pure-play days behind.

Roxio closed its $5.3 million acquisition of Napster on Nov. 27 after a Delaware bankruptcy judge cleared the sale.

Under the terms, Roxio paid $5 million in cash and forgave about $300,000 in warrants for its common stock.

The purchase came over many objections, including former Napster chairman John Fanning, who claims he owned some of the intellectual property bought by Roxio.

But the deal got the blessing of German media giant Bertelsmann AG, which as Napster’s largest media shareholder, lost millions of dollars in the bankrupt file-swapping service.

After a quick makeover of the Napster Web site and a terse press release about the deal, Roxio officials — who declined to be interviewed for this story — are keeping tight-lipped, saying “plans will be outlined in the coming months.”

But Wall Street analysts were talking plenty.

Buying all of Napster’s assets and none of its legal problems leaves Roxio at a crossroad, says Phil Leigh, digital media analyst at Raymond James & Associates in St. Petersburg, Fla.

“With $43 million in cash at the end of the September quarter and a weak short-term outlook for its core [software] business,” Leigh says, “this deal is inexpensive and opens the door for Roxio to shift its long-term focus from software sales to digital media distribution.”

Stock traders have rewarded Roxio shares, which by the time of the deal close were up about 50 percent since the buyout was announced in November. But, at under $6 a share, Roxio is still trading well below its $25.30 52-week high set in April.

Roxio has obtained two potentially significant assets through the Napster acquisition, Leigh explained, a distribution platform for digital content and a well-recognized brand name.

Leigh believes that to fully take advantage of Napster, Roxio must strike licensing deals with major music labels and movie studios.

“The value of a reincarnated Napster service is ultimately dependent on the rights that Roxio is able to negotiate,” Leigh says.

Just six months ago, Leigh says the outlook for any company hoping to license content from Hollywood was bleak.

“However, since that time, licensing deals have accelerated and three major legitimate Internet music services [MusicNet, Pressplay and Listen.com’s Rhapsody] have gradually negotiated deals with the five major music labels.”

Those “big five” music labels are Vivendi’s Universal, AOL’s Warner Music, EMI, Sony and Bertelsmann’s BMG.

Before the Napster buy, Roxio had a licensing deal with EMI under its cap and provides CD-burning software for Pressplay.

Jefferies & Co. analyst James Lin is more dubious, saying, “Beside the Napster brand name, Roxio acquires very little in the transaction.”

While applauding management’s efforts to find new ways of reinvigorating business, Jefferies is “somewhat skeptical about the company’s ability to [generate] meaningful revenue from the assets that it is acquiring.”

As for the Napster brand name, Roxio has finally snagged ownership of a household name.

“The Napster name brand is the second significant asset acquired by Roxio,” Leigh says, “and it’s importance should not be underestimated.”

“Many people would be eager to investigate a reincarnated Napster, even if it only remotely resembled the original,” Leigh says.

But, Leigh did say some of those people may not like Napster’s rebirth as a pay service. He says with that brand name, it will undoubtedly draw traffic and media attention, something Roxio could use more of.

Even though Roxio faces stiff competition from already-established legitimate online music services, Leigh says Roxio would have “a significant advantage over the current music services, which have much less brand recognition than Napster.”

And with Roxio’s DVD background, the new Napster may not be limited to music, such as the offerings from Pressplay, MusicNet and Rhapsody.

“An important realization to make is that digital [content] is not limited to music,” Leigh says. “Despite the high degree of focus in this area, there are reports that as much as 70 percent of the network traffic on KaZaA is for content other than music.”

In that space, the new Napster faces competition from Movielink, a joint venture of MGM, Sony, Universal, Paramount and Warner Bros. Leigh points out that Movielink is a rental service only and does not allow outright purchase of a movie.

For digital distribution of movies to the home, Leigh says broadband availability is critical and cash generation will be stunted as downloading full-length feature films from the Internet is all but impossible on a dial-up modem.

According to IDC Research, broadband penetration only reached 10 percent of U.S. households in 2001, and is scheduled to rise to just 33 percent by 2005.

But, Leigh thinks Roxio could use the Napster name to reinvigorate its successful, but aging, stable of CD- and DVD-burning software.

“This could stimulate demand by piquing the interest of consumers walking the aisles of a computer retailer or other store,” Leigh says.