Napster announced their calendar Q3 results today, which was basically a quarter of zero growth once you take out the $2M in one-time hardware sales for the Bell South promotion. Subscribers were flat at 450K or so and revenue came in at roughly $21.4M, excluding the negative margin hardware sales. Margins dipped down to 21.4% from last quarter's 31.4%, again due to the hardware sales. Marketing spend dropped almost 40% due to the need to conserve cash, and gross new subscriber ads apparently dropped a commensurate amount, plus they had a large churn bubble hit due to people coming off their preliminary sign ups from previous quarters. Loss was $13.6M, an improvement from last quarter's $20M loss, but given the lack of growth, nothing to crow about. So the company has stopped growing, is still losing money, and faces increased competition due to the Real/Microsoft deal, although Yahoo has at least backed off a bit.
What was the good news? Well if you do the revenue per paying customer math, Napster is generating an impressive roughly 2.5x the revenue per subscriber that RealNetworks is, given that Napster had 448K subs who generated $21.4M in non-hardware revenue ($48/sub) while Real is claiming 1.3M paying subscribers generating $25M in revenue ($19/customer). But it's hard to compare the numbers since Real includes the lower revenue but very profitable Radio subscribers in that number, as well as the Comcast ones, which are of unknown revenue and profitability. In addition, Napster's revenue number is now in striking distance of Real's, which is an accomplishment, at least for this quarter until the Microsoft marketing deal kicks in for Real - they are, of course, all single-low double digit revenue market share compared to Apple. Other potentially good news was the impending launch of Napster Germany and then of Napster Japan the following quarter since they don't have any subscription competitors there, but it's too early to tell how those deals will do and non-US services can be really tough to profitably scale. Finally, the initial XM/Napster-compatible devices will ship this Christmas, but the cooler ones which integrate Napster to Go will come later in 2006 - they could really be big wins if the XM audience converts to Napster users given the traction that XM is getting (BTW: that functionality is going to be dragged into the brewing epic battle between the labels and the satellite radio services over these types of advanced music capabilities) And the company still has $100M+ cash, which is enough for the next 2 years, according to them. As a sidenote, it was a little surprising to see a relative lack of focus on mobile and an almost total lack of comment on Best Buy, given how crucial those categories were in the last 12 months, but the market continues to morph and you have to give Napster some credit for morphing with it.
However, the key part of the call (and the new investment thesis for Napster) was that, as predicted in an earlier post, Napster announced that they will be launching a free, ad-supported destination site at Napster.com sometime soon in 2006. Given that it's been 6 months since the last change in focus (first it was downloads, then subscription, then mobile), this is not a huge surprise, given the favorable advertising trends on the Web. The often repeated investment thesis is that deploying this unique destination site will take advantage of the large traffic Napster receives at its site to generate high margin advertising revenue, decrease customer acquisition costs and reduce churn since the site will be so compelling.
This is not impossible, but is certainly a tall order. The first data point you have to believe is that Napster can deploy a site substantially better or more compelling than MTV, Launch, MySpace, AOL Music, RollingStone, etc., which are sites which have been delivering strong music services for years at this point. You must then believe that Napster.com gets a very large amount of traffic due to its brand - unfortunately, most data points I can find show that Napster is a moderately popular site not listed in the 10 Internet music destinations, and if you use the poor man's data source, Alexa, it has only 10% more reach than a moderately popular site like RollingStone.com, let alone the big ones like MTV, and that Napster's traffic has actually declined 50% in the last 6 months. And finally you have to believe that the conversion to Napster subscription services will be incredibly high due to the great editorial placement of it within the new site - having run RollingStone.com, which is probably roughly comparable to what Napster will deploy, I wouldn't expect the conversion rates to be off the charts and they might be lower than the ones on Napster's current site since users will be going to the new editorial site for reasons other than signing up for a subscription music service. Those 3 data points don't lead to the obvious new investment thesis that ad revenue will be large, marketing costs will massively decrease, and churn will be lower - it's possible, but unlikely.
So we're left with a company attempting to do a large pivot to a new business model while still maintaining its irons in the other fires, none of which are large margin businesses due to supplier leverage, and all of which have intense competition. I always credit CEO Chris Gorog for making a large and incredibly passionate bet on digital music, but I'd say the odds of a winning hand for Napster shareholders are getting increasingly difficult.
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