In early 1998 K-tel was a small Nasdaq-listed company that had no Wall Street following and traded a few thousand shares per day. The company was known to many in the 70's and 80's for their compilation albums that would take individual tracks by different artists (usually Pop Top 40 material) and put it on a single album. This was a big deal for budget conscious music fans who did not want to shell out $8 - $10 for an album by a single artist who might have only two or three songs they really wanted to own. K-tel brought music to the masses in the 70's and 80's.
In April of 1998 K-tel issued a press release indicating that it had just launched a web site and that they would begin selling their music albums online through a new website. Investors bid the shares up 100% over the next couple of trading days. Of course, the combination of the company's iconic status and its stock trading up 100% in such a short time generated a lot of attention from investors. Some traders apparently looked at the situation and decided that there was money to be made by shorting K-tel's stock. Its easy to see why they might reach that conclusion - what did the company really stand to gain with its website other than a little more publicity and maybe a few more orders each quarter? There was nothing transformative about the news of the website, the website itself or the company's strategy for it.
Short selling caused the stock to give back a significant portion of those gains briefly, but other traders started buying up the thin float and the stock began to move up rapidly. The stock became a playground for day traders and a graveyard for short sellers, as the stock eventually eclipsed the $100 mark after a few months. The unfortunate traders who decided to sell it short learned a very valuable lesson espoused by one of the greatest investors of all time, (Benjamin Graham), who famously said "In the short-term the market is a voting machine, in the long-term, a weighing one." Many of the earliest short sellers literally lost all of their capital, as they eventually had to close out other holdings and then meet margin call after margin call. Their base thesis, (that the website really would not make a big difference to K-tel's bottom line) later proved to be correct. I believe that was probably not much consolation for the material losses they incurred (not to mention the stress and anguish that came with it).
I wrote an article last week about a company named Atrinsic that recently acquired the on demand streaming and download music service called Kazaa. Like K-tel, Kazaa is an iconic brand that many of us know because a decade ago they provided us a way to have more music in our lives in a very budget friendly manner (while K-tel was cheap, Kazaa was free). While the Kazaa technology that allowed 800 million users to trade music files online for free was great for consumers, it was not so great for the music labels and the site was ultimately shut down. After several years of lawsuits that culminated with a $100 million payment by the owners of Kazaa to the record labels, Kazaa was rebirthed as a subscription service that allows consumers to pay a small monthly fee and access unlimited music with the full backing and approval of the music labels (the big four labels each now have an equity stake in Kazaa). The service has essentially been a work in progress for a little over a year as the technology has been built out to facilitate integration with Facebook and as of this week, to offer streaming music through mobile phones and tablets.
The similarities between K-tel and Kazaa are striking: both were very small companies that were operating in relative obscurity a decade or so after gaining fame for bringing music to the masses. Both became publicly traded companies listed on the Nasdaq, but were so small that they were essentially just ignored by Wall Street analysts. Each became a consumer icon approximately 10 years before there was a publicly traded stock involved in the story, both had very few shares outstanding and a publicly available trading float in the 1 million share range. Deja-vu?
K-tel Kazaa Industry Consumer Music Consumer Music Shares Outstanding 4.2 Million 6.2 Million True Public Float 1.1 Million 1.4 Million Pre Event Stock Price $6 $3 Post Event Stock Price $9 - $102 $4 - Consumer Glory Days 1970 - 80's 2000 - 2002 Stock Run 1998 2011
Have we been here before?
Earlier this week, ATRN's management released the news that the company now has a mobile version of its website and subscribers to the Kazaa service can now stream (or download) music on iPhones, Android Phones, iPads, etc. The significance of this for shareholders and consumers is twofold:
1) Kazaa’s EXISTING customers now have access to Kazaa on their iPhones, iPads, Android phones, etc. In one fell swoop the company's $19.98 per month price tag for its premium service went from less than competitive (on price) to the best deal in streaming music because it allows you to access the service from multiple devices with one account (most competitors charge per device, so iPhone + iPad + home computer = $24.99 - $29.99). Additionally, it heralded the introduction of its $9.99 mobile only plan, which gives it a lower price point to compete with the others in streaming music who offer similar pricing for their mobile only plans. The impact of this move for shareholders is that we should see:
a) Significant growth in the number of subscribers. Now we get to realize the full value of our ability to sign up new subscribers using a mobile phone number instead of a credit card.
b) Significant reduction in the rate of attrition as the new mobile capability gives existing customers more than they bargained for. In November when I signed up for Kazaa, I could only use it at home and where I could find Wifi access for my laptop. Now I can use it literally anywhere on my iPhone and there is no extra fee. Juxtapose this with the situation facing Kazaa's competitors who are scrambling to find a way to tell their customers that either their price is going to have to go up due to Apple's (AAPL) 30% App Store (link) fee or that they will no long be able to access it as an App.
2) The new Kazaa mobile site is a way to access streaming music on smart phones without using an App, thereby skirting Apple's new subscription rules that exact a 30% levy on all subscriptions through the App Store. This is great for consumers because the company will not have to raise the price of the service to cover the fee and its great for shareholders because the company will not have to trim its margins or somehow "split the difference" between a price increase and lower margins. Even more importantly, we believe that it highlights the advantage of Kazaa's model over its competitors; all of whom get a significant portion of their subscribers through the App Store.
In the days since that announcement, the company's entire public float has turned over at least 4x and the stock has traded up more than 100% from where it started. In Tuesday's trading session, we began to see telltale signs of a significant short interest creeping in, then barreling in as they pushed the shares lower, all the way down to Wednesday‘s closing price of $4.22. Have we been here before?
K-tel's meteoric rise was sparked by savvy traders who saw the opportunity for a short squeeze that would be exacerbated by the tiny public float in K-tel shares that made it difficult to cover those short positions without pushing the stock dramatically higher. If you watched the trading in the days that followed, you saw what appeared to be legions of small investors (K-tel album fans maybe?) buying up the very few available shares in lots of 200, 300 and 500 shares, making those with short positions pay increasingly higher prices to cover their position. The short sellers that stuck to their conviction and waited for "sanity" to return to the market watched the stock climb from $6 to over $100 per share at one point.
Similar to the K-tel scenario, it appears that there is a growing and substantial short interest in ATRN. A number of factors lead me to believe that there has possibly been as many as 350,000 - 400,000 shares sold short with intraday peaks even higher than that during the last two trading sessions. While that would not be a large short interest for many stocks, it would represent as much as 1/3 of ATRN's public float. This is a bold (or foolish) gamble in light of the micro float and the first recognition (this week) by investors that there is a way to get a stake in the white hot streaming music space without waiting for the $1 Billion Pandora IPO.
If a K-tel like scenario were to emerge and some small percentage of the 800 million people who have downloaded Kazaa in the past decide to invest a few hundred dollars each in hopes of making thousands like the early K-tel investors did, Kazaa’s stock (ATRN) could make a legendary run too. Whether savvy traders and/or Kazaa fans start to buy up the shares in a K-tel like fashion is anyone's guess, but so far the Kazaa story is walking in step with the K-tel story and that is kind of interesting.
Regardless whether an epic short squeeze of K-tel proportions evolves, we believe that the recent increase in ATRN stock is not a K-tel-like situation, in that the news released this week has significant positive long term implications for Kazaa users and for ATRN shareholders. We believe that the increase in ATRN stock was warranted and was simply a valuation correction. At yesterday's closing price of $4.22, the cash adjusted market cap still sits below $20 million.
Given our valuation of the Atrinsic Interactive Marketing division of $10 million, this would value the entire Kazaa operation at less than $10 million, significantly below the valuations given to any other players in this space. This valuation does not come close to reflecting the value of Kazaa's brand name and operations nor ATRN’s considerable marketing resources (Top 10 SEO agency and affiliate marketing network) and we believe that the company will ultimately achieve a valuation premium over its peers in the streaming music space rather than the current discount. While there is certainly execution risk, we feel that the stock is an extraordinarily compelling value in its current trading range and believe that investors buying at these levels will profit handsomely.
Disclosure: I am long GOOG.
Additional disclosure: I am long ATRN