Tune-Up in the Cards for Online Music Service

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Napster Inc.’s share price has been in the tank for years and it recently lost almost 60,000 subscribers. But analysts said the company has succeeded in at least one thing: making its name synonymous with digital music.

After it announced plans to purchase the online music company last week, Best Buy Inc. said it will add videos and games to Napster’s content for download or subscription use. But it will have to overcome a perception problem.

“Napster’s a huge brand, but as of now it’s a huge brand for music,” said Michael J. Olson, an analyst with Piper Jaffray & Co. “I think that there’s potential they can bolt on video and games, but it’s going to take some meaningful marketing power to turn it into something other than a music brand.”

It does have a perception, problem, though: Napster is still known for its days as an illegal download site and has had limited success as a legitimate music distributor.

Best Buy announced Sept. 15 that it would acquire Santa Monica-based Napster for $121 million, or $2.65 per share. Napster’s stock has been trading at just above $1.30 for the past five weeks, and was up to $2.53 in the middle of last week.

The deal is expected to close later this year pending shareholder approval at a meeting that hasn’t been scheduled yet.

Two shareholders launched a class-action lawsuit days after the sale was announced. They allege that the price Best Buy paid for the company is unfair to stockholders.

Analysts said it could be tough for the company to get a better offer. “From a Napster shareholder perspective, it’s a nice premium for where the stock was trading,” said Alan Davis, an analyst with D.A. Davidson & Co. “That’s the good news. The bad news is that the stock was trading at almost unheard of levels.”

Shareholders of Napster have had a rough ride. The company’s stock closed at a high of $24.64 on April 15, 2002. Since then, it has fallen almost 95 percent. As late as 2006, the company was trading at $5.

Chief Executive Chris Gorog, in an interview with the Business Journal two weeks before the sale, said he had heard from shareholders who were frustrated with the stock price.

Earlier this year, three dissident investors mounted a campaign to gain election to the company board. They cited the dismal stock performance as evidence that the company has been mismanaged, a charge Gorog has denied. The dissidents declined to comment on the sale.

Best Buy said it did not plan to move Napster’s headquarters or make “significant changes” in regard to the music service’s roughly 140 employees.

The deal makes sense from Best Buy’s perspective because the company needs to expand its digital offerings. Last week, the Minnesota-based retailer announced that second quarter net income fell 19 percent. The chain is completing an overhaul of its 973 U.S. stores.

Analysts agreed that Best Buy can shore up Napster’s marketing, one of the company’s weaknesses.

With hundreds of stores nationwide stocked with digital music players, Best Buy could effectively steer someone buying an MP3 player with downloads from or a subscription to Napster’s library of 6 million songs.

But not even a marketing blitz may be able to fix Napster’s other weakness: its subscription service. The number of subscribers tumbled last quarter from 760,000 to 703,000, as Napster trails far behind RealNetworks Inc.’s Rhapsody America, another subscription-based music service, which has nearly 3 million users.

Best Buy executives said they hope to expand the subscriber service. Napster’s subscriber base is one of the assets that made the company worth the premium Best Buy paid, said Davis of D.A. Davidson.

But Olson questioned whether Best Buy could grow the subscription service. “That’s a challenge that even marketing power may not be able to overcome,” he said, “considering consumer tendency trends toward a la carte music services” such as Apple Inc.’s iTunes store.

Gorog, who is expected to stay on with the rest of senior management after the acquisition, declined to comment for this article.

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