Napster is one of the oddest companies. It is a deeply unprofitable startup trying to grow a business, and with a huge war chest of cash. We have the rare ability to see deep into its financial situation because it is publicly held.
Napster sells music subscriptions and the odd DRM’d download. Pay $10 per month and listen to any of the music in their library. This is a tricky, low margin business. There’s lots of price competition (see our comparison of the space here), and the labels and credit card companies take the vast majority of the revenue. In the last fiscal quarter, Napster had nearly $26 million in revenue but just $7 million of that didn’t go the labels and other costs of goods sold. Caving into this margin pressure, Virgin Music bailed out of the U.S. market just a few days ago.
Napster hired an investment bank in September to sell themselves. At the time they were losing $10 million in cash per fiscal quarter, and had $100 million in the bank. I called them unhealthy. Since that time, they’ve reported another fiscal quarter. They had stellar subscription growth, adding 48,000 subscribers. But they lost even more cash – another $11.6 million. This is a company with operating margins of -38%. And they were sued for patent infringement just a week and a half ago.
Now they’ve announced the acquisition of AOL Music’s subscription service. They’ll add 350,000 new subscribers, get promotion on AOL, and pay just $15 million in cash. It’s not a bad deal, except it adds more unprofitable customers to the struggling company, and the company’s war chest just got significantly lighter. That’s one less fiscal quarter Napster has in operating cash.
It’s unusual to see a company make acquisitions when it is itself on the market. Maybe this is Napster’s signal that the sales process isn’t going well. Or perhaps they just took this opportunity to further consolidate the market. Either way, I’m looking forward to next quarter’s financial results, which should be announced shortly.
One point of clarification. The New York Times reported that Napster paid just $43 per AOL subscriber, compared to their own valuation of $328 per subscriber. Their calculations were incorrect – they used the Napster stock price after the deal was announced, which had spiked sharply. And they failed to take into account that the majority of Napster’s market capitalization is from the $90 million or so they have in cash. Take those factors into account, and Napster’s per subscriber valuation is around just $90.