Is EMusic a takeover target?

Online music seller EMusic recently acquired RollingStone.com in its extended shopping spree, charming Wall Street analysts and quite possibly some future suitors of its own.

In its quest to build a successful music download business through the Net, EMusic has made exclusive distribution deals with a plethora of independent music labels to sell their tracks for 99 cents apiece. It also bought at least one label outright and merged with the Internet Underground Music Archive, which showcases thousands of music artists.

Last week the company snapped up content by RollingStone.com and DownBeatJazz.com--which together get more than 28 million page views and about 1.3 million unique visitors per month--in a $130 million deal to acquire Tunes.com. The buy follows EMusic's $38 million merger with Cductive.com, which represents more than 350 independent labels. EMusic estimates that it has 6 to 8 percent of the music market covered.

"They are creating the new business model for downloadable music," said Joe Butt, director of the consumer technology group at Forrester Research. "People don't know how to differentiate between the good stuff and the junk, so now EMusic is providing guidance in addition to music."

The acquisitions could help EMusic cash in when consumers and artists truly embrace digital music, as well as allow it to compete with sites such as ArtistDirect.com, MP3.com and MusicMaker.com. But EMusic's growing archive also could make it the next target for a buyout in the brewing battle to sell music on the Net beyond the CD.

"The model is correct, but it's not clear whether EMusic will survive alone," Butt said. "They might become fodder for a Yahoo or an America Online."

Although EMusic has some attractive content, the site's lack of mainstream music artists could hinder it as bigger industry players come online. That is why EMusic will have to align itself with strong forces, analysts say.

"That is a challenge for them--they don't have some of the big-name artists," said Jason Noah Ader, an analyst at H.C. Wainwright. "They could become this full-scale content company and a natural partner for the big portal companies. They are building into a prime acquisition candidate."

The leading portals are proven experts at aggregating content and products that Net users want, and they're gunning to get a piece of Net music sales. AOL and Yahoo, for instance, already point visitors to EMusic's downloads through distribution deals.

There has been a string of prominent buyouts in the Net music industry this year. Viacom bought Imagine Radio to use its technology behind its MTV Internet sites, which include SonicNet. And AOL bought Net radio firm Spinner.com, which it's turning into a download site.

But EMusic won't be a target for a buyout because of its revenues. The company has sold $100,000 in music so far this quarter, but like most Net companies, it is reporting a steady stream of loses. Most of the Net music sales are in CDs, although digital music sales are no longer a flicker in analysts' crystal balls--thanks to the free MP3 craze.

Digital music promises to give consumers more flexibility and portability than vinyl albums, tapes or CDs ever did. If all the pieces come together--the music, the sellers and the players--people will be able to collect singles or albums by their favorite bands, organize their collections any way they want, and, most importantly, take their music with them wherever they go without having to lug around droves of delicate discs that may only contain one or two songs they really love.

Still, many obstacles stand in the way of the day when the masses use the Net or kiosks to click, pay and carry away digital music tracks to play on any computer, device or stereo. For one thing, the most popular music is not available for download yet--at least not legally--and most of the major record labels are still mulling how they will sell digital tracks in the near future, if at all.

Nonetheless, EMusic's team of music and high-tech veterans are convinced they are on the forefront of a revolution. All of the company's acquisitions have been aimed at making EMusic a premier online music store.

"We'd like to be one click way from every music fan on the Net," said Gene Hoffman, EMusic's president.

Hoffman wouldn't say whether EMusic had been approached by hopeful buyers.

"We're figuring out how to sell downloadable music today. All of our assets make us very attractive as a major partner," he said. "We'll always do what is best for our shareholders."

The "Big Five" record labels and their national retail partners also will be eyeing firms such as EMusic for distribution and cross-marketing, analysts say. EMusic will no doubt need the majors as well. After all, consumers are looking for artists, not record labels. That is why people frequent stores and Web sites that offer the most extensive collections of CDs.

Through RollingStone and DownBeatJazz, EMusic could strike content syndication deals with the major labels, at the very least.

"They can use those properties to sell albums for the major labels," said Aram Sinnreich, an analyst with Jupiter Communications. "EMusic could shift in their focus from making the majority of revenue from retail to making it from advertising; this creates a short- and long-term revenue strategy."

But EMusic may not be able to house its music under the same roof as the majors, because EMusic doesn't support the digital music security initiatives the industry is working to standardize. EMusic fears that consumers won't buy music if they have to tinker with copyright-protection devices or if they can't copy their tracks for use on other devices.

Companies such as EMI Recorded Music and thriving independent labels such as Zomba, which represents the Backstreet Boys and Britney Spears, may be more inclined to partner with digital download sales partners that employ encryption to curb music piracy.

MusicMaker.com, for example, already has deals with both labels to license their music for custom compilation CDs. MusicMaker offers more than 100,000 tracks for download, which cost $1 per song or are free promotional cuts.

But the downloads MusicMaker sells are not by the chart-topping popular artists represented by EMI or Zomba. The company aims to change that, however.

"We are absolutely working with them on download projects--that is a part of the mission," said Bill Crowley, vice president of marketing and sales for MusicMaker. "If you have the content people want, that is the only advantage that matters."