September 26, 2001 1:05 PM PDT

Napster's tab: $100 million and climbing

Bertelsmann's quest to keep the controversial Napster alive has cost the media giant more than $100 million--and it could become even more expensive.

Napster's deal with music publishers announced earlier this week will cost the company $36 million up front--$26 million to settle the publishers' ongoing lawsuit, and another $10 million as an advance on future licensing fees.

That money, sources close to both companies say, is coming from Bertelsmann's pockets. Add to that the near-$60 million original loan the media company gave Napster last year, as well as a second loan "in the $7 million to $12 million range" extended to the company in midsummer, sources say, and Bertelsmann's outlays well exceed the century mark.

Napster's outlay of cash is by no means finished. The company is hoping to create a subscription service that is as attractive as those operated by much larger companies such as America Online or the Microsoft Network. Such a venture will require considerable cash. And the publishers are just one part--and likely the smaller part--of a lawsuit that still faces Napster. If it does survive, the company will likely have to pay damages or a settlement fee to record labels that exceeds the $26 million offered music publishers.

The privately owned German giant did receive warrants that can be converted to equity in Napster in return for its first loan last year. A source close to the companies said that the most recent funding, slated to fulfill the agreement with the publishers, would not increase Bertelsmann's potential stake in Napster, however.

But the succession of loans also indicates Bertelsmann is betting heavily that Napster still can become a major player in the music business, enough to repay more than $100 million despite an uncertain future.

That's a risky wager, analysts say.

"I am very skeptical about Napster's long-term revenue potential," said Jupiter Research analyst Aram Sinnreich. "They've got one shot to launch a new service that looks nothing like the old one...If they don't get it right, Napster will be dead in the water."

Napster and Bertelsmann declined to comment on the funding.

Like its major media peers, Bertelsmann is in the midst of a scramble to make sure that it establishes as much control over the digital future of its content as it now has in the physical realm. As one of the biggest publishing distributors in the world, its range of content assets is slightly different than rivals such as Vivendi Universal or AOL Time Warner, but its aims are roughly similar.

Unlike AOL Time Warner, Bertelsmann lacks a potent online distribution arm. The company hopes that a revived Napster service, which will charge people to swap or download music files, will fill that missing piece of its Internet strategy. The service potentially could let consumers trade other types of digital content beyond music files, such as books, music videos or movies.

Although Napster remains a shell of its former self, Bertelsmann executives think the service still has cachet among Net users. The hard part will be convincing them to return with their wallets.

Napster's revenue potential is cloudy even under the best circumstances, given that its brand name has been built on music-swapping services that don't cost a dime.

The company hasn't yet said how much it will charge for its monthly service or what features it will include. Previously, executives have laid out a vision of tiered services, with an entry-level fee of about $4.95 a month and an advanced service offering unlimited downloads for $7.95 to $9.95 a month.

But the landscape has changed somewhat since that time. Napster has cut a considerable number of deals with prominent independent labels in Europe and the United States and appears likely to offer the largest authorized array of popular independent artists of any of the planned subscription services.

Its grasp on major label music is more tenuous, however. It has a tentative deal with MusicNet, which includes Warner Music Group, BMG Entertainment and EMI Recorded Music, to offer those labels' songs once it proves it no longer allows copyright violations. The MusicNet content is expected to be part of a separate tier, with a fee over and above what Napster charges for basic service.

The cost structure for Napster's service is beginning to mount as well. As a part of the deal announced Monday, Napster agreed to pay music publishers a third of whatever it pays for content licenses. The company has not said how much money this is likely to be or what percentage of its overall revenues this might represent.

Analysts say this agreement could make negotiating with record labels, which continue to pursue their lawsuit against Napster, more difficult. Labels have traditionally taken well over two-thirds of the total revenue dedicated to content licenses.

The cost of all of these licensing fees is likely to leave room for only a small margin of profit, analysts say.

Napster Chief Executive Konrad Hilbers said Monday that profits were part of the business plan, however.

"I don't envision any Internet business (settling for) less than a 20 percent margin over the long run," he told reporters. "There's nobody here who's willing to lose money over the long run."

 

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