The Cloud: Yet Up In The Air

With all the recent activity in the digital music world, it is no surprise that investors have been attracted to the concept of cloud-based services. According to the New York Times, venture capitalists have put $57 million dollars into the digital music business. Investors are looking for companies who have great service and a substantial portfolio of subscribers.  Venture capitalists have confidence that the music business, with consumers spending approximately $8 billion on recorded music, will only become more profitable in the coming years with the integration of music subscription services.

Most venture capitalists and bankers would not invest in a company that is valued for less than $25 million; however,  new start-up streaming music services seem to have become a popular investment. When investors evaluate a digital music company, they typically inspect the service, earnings, management and potential of a company. The investors envision that streaming services are the new method for people to consume music and, as will be shown, have deemed them worthy investments.

Confidence can largely be attributed to the Swedish music streaming service Spotify, which allows users to stream songs from the catalogs of Sony, WMG, EMI, The Orchard and Universal. Spotify was founded by Martin Lorentzon and Daniel Ek and has become a major music company in the UK with approximately ten million subscribers. Currently most of the users have the free subscription, which has a limited amount of streaming time per month with advertising. Approximately 1 million subscribe to the paid service, which allows users to stream music with no restriction on usage and without advertisements. Recently, the Russian based investment firm DST, valued at $2.5 billion dollars, tentatively made a deal with Spotify to finance $100 million in exchange for a 5% stake in the company.  This investment makes Spotify’s estimated value approximately $2 billion dollars.

Like Spotify, MOG, founded in 2005 by CEO David Hyman, is an innovative digital music subscription service that gives users on-demand streaming access to its entire catalog for a $5 monthly subscription fee. The format is similar to an online radio station, like Pandora, except the features are more interactive than the usual radio format. Users have the ability to create playlists and access other users’ published playlists to discover new music. MOG has not released how many users subscribe to their service but some estimates suggest around 40,000 subscribers with a projected revenue around $14 million.  In February 2010, the company raised $10 million and plans to raise an additional $25-$30 million in 2011.  The company has attracted loyal investors like Menlo Ventures, Balderton Capital, Simon Equity Partners, Universal Music Group and Sony Music.  Additionally, MOG recently recruited high-profile producer Rick Ruben to serve on their board of directors. Investors see potential in MOG and continue to invest in their success.

Rdio, another heavily funded company, is a US streaming music service start-up founded by Janus Friis and Niklas Zennstrom, who were also founders of Skype. Rdio has created a streaming service that integrates music streaming into a social media format. Users can “follow” other users’ music playlists and “share” music with others in their Facebook network. Rdio is currently funded by Janus Friis, Atomico, Mangrove Capital Partners, and Skype.  Recently, the VC firm Mangrove Capital Partners has invested an additional $17.5 million and executives have said that “the funding will be used for aggressive expansion of the Rdio platform in 2011.” Warner Brothers Records Chairman and Grammy-nominated producer Rob Cavallo is also joining the board of directors at Rdio. Rdio has not released the amount of users they have accumulated but it is believed to be fairly low.  Despite the low number of current users, Rdio has strong relationships with major labels EMI Music, Sony Music Entertainment, Universal Music Group and Warner Music Group and Merlin as well as thousands of indie labels.  These relationships promise successful negotitions over liscening conditions and make investors feel more confident about the company’s growth. The agreement over licensing concerns with major labels continues to be a battle with Spotify, Google and the newly released Amazon Cloud Drive.

Although many companies have received a substantial amount of investment, not all streaming services are attracting investors. Kazaa music streaming service was originally created by programmers in Estonia who later sold the company to Niklas Zennström and Janus Friis, the founder of Skype and Rdio. The company was finally sold to Atrinsic, an Internet marketing firm that sells subscription services, including a music subscription service that allows subscribers to download music files. Kazaa began as an illegal peer-to-peer file sharing application but it is now a licensed music subscription service with approximately 60,000 users. Atrinsic is worth approximately $19 million but revenue has been shrinking since 2008 when Andrew Stollman became the new president. On February 4, 2008, Atrinsic’s share price was $18.08 and by the time Stollman left his position on February 28, 2011, the share price was at  $2.99.  As a result, the company continues to struggle due to not having the strong ties with the record labels. It has announced a future IPO (an intial offering of stock to the public at large)—but under the circumstances, it may wait for better times.  It may even have to change leadership. In fact, the company also suffers from accountability concerns. Thomas Plotts, the Chief Financial Officer of Atrinsic, Inc. and VP of Finance & SEC Reporting, failed to submit SEC filings for Q1 on time, dragging Kazaa’s name down further.

In the meantime, the growing potential of cloud-based investment is likely to grow. The biggest challenge that these digital music companies face are the licensing fees they have to pay to record labels and publishers.  An early agreement cannot be ruled out, but it will depend on how the court system will on streaming dues—which will itself depend on how eager the old music guard will be to leverage content at lower prices.

By Minden Jones





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