Napster 2.0 gets a double scoop of disappointment

Before there was Kazaa or The Pirate Bay, or the slew of other P2P and torrent services in existence today, there was Napster which made P2P a household name.  Napster in many respects wrote the history book for P2P.  While it was not the first P2P engine, it was the first consumer engine of its scale and it also pioneered a history of legal embattlement with the RIAA and the music industry that persists to this day, a continual war of attrition.

When Shawn Fanning, the man who created Napster as a teenager, gave up the company it was in financial ruins, after being pillaged by the music industry and struggling under the weight of enormous legal expenses.  From a peak of 26 million users, Napster was reduced to bankruptcy and put out of commission. 

That's when Chris Gorog, CEO of Roxio, stepped in with a plan to buy Napster's name and logo for $5M USD.  He quit Roxio and took on a new position as CEO of his revived internet nameplate, Napster 2.0.  He made big promises, promising that millions of subscribers would come pouring in thanks to Napster's iconic kitty logo and name recognition.

However, the dreams never came true.  Apple launched its iTunes store just months before Napster.  With Apple controlling the majority of the MP3 player market, and with proprietary file-protection schemes placed on iPod files, Napster never really stood a chance.  It could not sell to iPod users and could only sell to the niche market of users who owned alternative players like SanDisk.

In the end, six years after the 2002 acquisition, the company has yet to make a profit.  In its latest fiscal year, which ended in March it posted $16M USD in losses on revenue of $127.5M USD, and a mere 760,000 subscribers.  Part of the expenses stem from the lucrative fees required to maintain the service's relatively large catalog of 6 million songs. 

Now, with Napster 2.0 stock continuing its steady plunge since 2002, Gorog is facing insurrection in his own ranks.  Leading the charge is Kavan Singh, a 26-year-old entrepreneur who owns a chain of the Cold Stone Creamery ice cream stores.  Mr. Singh, a loyal Napster user is joining with two colleagues to try to oust Gorog and revamp Napster at the company's annual September 18th shareholder meeting.

Napster has shown some signs of growth, thanks in part to finally being able to offer tracks for the iPod.  However, its subscription services have not grown as hoped.  Part of the problem is a tight market.  Aside from dominant iTunes the only real challenger is RealNetwork's Rhapsody service.  Rhapsody boasts 1.9 million subscribers, more than doubling Napster's base.  As Russ Crupnick, senior entertainment industry analyst at market research firm NPD puts it, "The [subscription] audience is limited.  Rhapsody got there first."

Napster has worked out a trial deal with AT&T to provide cell-phone downloads, but this has yielded little profit.  Part of the problem is simply the tiny profit margins associated with the business; Napster makes 10 percent revenue on music downloads.  These margins have led many competitors like AOL and Yahoo to give up on the music provider business.  Steven Frankel, an analyst at Canaccord Adams concludes that there is little Napster can do to save itself, stating, "This is a company that has tried strategy after strategy and has no meaningful traction."

However, Mr. Singh and his supporters believe much of the struggles is due to Napster's reputation as a P2P founder inherently leading to an association with illegality, something Mr. Singh contends Gorog and the company have done little to counter.  Thomas Sailors, 49, manager of personal investment holding company Cloverdale Investments, one of Mr. Singh's two partners running for a board seat fumes, "When you tell people they should get Napster, they say, 'What are you trying to do? Get me arrested?'  That tells me management is doing a poor job of communicating what this company does."

Mr. Singh and his colleagues are considering a move to sell Napster.  Such a move could yield a healthy profit for shareholders.  A prime candidate is RealNetworks, who might look to merge Napster's subscriber base to solidify its position and provide more competition against iTunes.  Whether the ice cream owner and friend succeed, it is one of the most interesting proxy battles of the year, perhaps even surpassing billionaire Carl Icahn and company's efforts to sell search-engine Yahoo to Microsoft (the other largest proxy event).  

"If a man really wants to make a million dollars, the best way would be to start his own religion." -- Scientology founder L. Ron. Hubbard

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