) IPO has spurred one of the hotter debates on Wall Street. On one side, the Internet music business has caught fire. Bulls focus on Pandora’s market-share dominance and exploding customer base. Bears counter that the market’s barriers to entry are low. They also contend that the royalties Pandora pay to record labels will limit the company's profitability, making it hard to justify its multi-billion dollar market cap.
No matter which side you're on, there are some hard facts telling investors that shares of Atrinsic (ATRN) are poised to triple (in fact, with proper execution, the facts show they could rise by 10x or more):
1. ATRN is the parent of Kazaa, which was one of the original file-sharing programs (along with Morpheus and the iconic Napster). Kazaa comes with an enviable pedigree -- some of its early owners went on to create Skype.
In 2007, after lawsuits shuttered the file-sharing companies, Kazaa paid $100 million for on-demand licensing rights with the four major record labels. With those rights, Kazaa began offering legitimate Internet music services. It's important to note that its on-demand licenses are required for users to choose the specific songs they want to hear.
Only six companies in the world hold these licenses and only three of the six are associated with public companies -- Rhapsody (which is owned by RealNetworks (RNWK
) and Viacom (VIA
)), Napster (which is owned by Best Buy (BBY
)), and ATRN's Kazaa.
Pandora's music rights are more common and limited in scope. Thus, with its runaway lead in the market, holding the rare on-demand licenses may be the only way for competitors to gain an advantage (or for Pandora to extend it's lead). Indeed, the market seems headed toward an end-game where 1) Pandora will acquire one of on-demand license holders and 2) the remaining on-demand license holders will develop Pandora-like functionality. The eventual market winner will likely come from this group.
In this regard, Kazaa has already made some major moves to become more like Pandora. Thus, ATRN has been thrust into the right place at the right time.
2. Writing software to stream music is relatively easy. But entering the Internet music market against Pandora is not as simple as many believe. With the explosive popularity of Internet-based music, major record labels have become resistant to hand out new on-demand licenses to anyone. Just ask Apple (AAPL
), Amazon (AMZN
), and Google (GOOG
) -- they've tried for a long time with no luck.
If these giants want a legitimate and significant foothold in the marketplace, they may need to acquire one of the existing on-demand license holders. However, Rhapsody and Napster's owners are unlikely to sell at an attractive price. As for the private vendors, only two appear ripe for acquisition, but their VCs surely know the value of their licensing rights (I'll discuss the third shortly). Thus, ATRN may be the only underpriced asset left in the market.
And here’s where it gets good...
Kazaa paid $100 million for those hard-to-get licensing rights. However, this value does not show up on ATRN’s balance sheet. As result, ATRN's market cap has drifted well below those levels. At present the company is only valued around $20 million. A $100 million valuation for its music licenses (which now appear unobtainable) implies that ATRN’s shares (which have recently traded in the $2 - $6 range) should be worth more than $15. Forget being poised to triple…based on this metric, shares of ATRN could be poised to quintuple.
3. Every other publicly-traded player involved in this space is worth hundreds of millions or more. These include:
- Viacom (VIA): $33 billion
- Best Buy (BBY): $11 billion
- Sirius (SIRI): $8.5 billion
- Pandora (P): $3 billion
- CC Media (CCMO.PK): $650 million
- RealNetworks (RNWK): $500 million
Privately-held players are also fetching premium valuations. For example, Spotify (the on-demand license holder I alluded to above), received a $15 million investment last year from Sean Parker, the former CEO of Facebook and co-founder of Napster (played by Justin Timberlake in “The Social Network”). This investment valued Spotify at $300 million. A similar valuation would send ATRN’s shares rocketing to $50, a 15-bagger from here.
As eye-popping as that move would be, it would come as no surprise to some -- ATRN’s shares were over $50 in 2008 before the market collapsed (they got as high as $68 in 2007). A lack of institutional coverage has contributed to ATRN's failure to head back toward those highs. However, with Pandora’s IPO and increased attention in this space, that could change very soon.
FYI, Spotify reportedly raised another $100 million in March, valuing the company at $1 billion, more than triple its prior valuation.
4. Facebook is in the process of rolling out its Music Dashboard. The anticipated structure of Facebook's Music Dashboard greatly favors on-demand license holders. Appropriately, ATRN has already invested R&D resources to integrate Kazaa with Facebook. Considering that music addresses a much larger audience than games, the Music Dashboard promises to have a much bigger impact. The takeaway is that the eventual winners will be much more valuable.
That's saying something. Thus far, Zynga has been the big winner on Facebook and its IPO is expected to value the company in the range of $10 billion. Meanwhile, Popcap Games, a second-fiddle to Zynga, was recently acquired by Electronic Arts (EA) in a $1 billion+ deal. This suggests that there could be several $1 billion+ winners in the Facebook music battle. However, ATRN is one of only a few players with the necessary licenses. This sways the odds heavily in their favor.
5. ATRN’s entire business is turning around. On its Q1 earnings call, management informed investors that its new affiliate platform (Internet advertising) is being met with great success. Enhanced tracking, distribution, and brand-protection capabilities have helped to attract 1,400 advertisers and 9,000 new publishers, more than tripling its total from Q4. It was almost needless to say, but ATRN's CEO stated that incremental revenue growth is expected for Q2.
The timing of all this couldn’t be better. Management spent much of 2010 shedding unprofitable revenue (which contributed to its lower sales last year). As a result, margins in its agency business have rocketed to 26% from 6% a year ago. With much of the revenue and margin restructuring done, new investors get to participate in a reinvigorated company without dealing with the months of pain involved.
Investors close to the situation seem to agree. Most recently, Trinad Management, a major shareholder in ATRN, disclosed to the SEC
that it acquired an additional 145,264 shares during a 2-week period in June. FYI, Trinad’s co-founder, Robert Ellin was an ATRN board member until a few months ago. It is suspected by many that he resigned from the board to eliminate any conflict of interest associated with Trinad’s growing ownership in ATRN. The obvious implication is that Ellin saw more value in ATRN's stock than he did in being a member of its board.
6. Meanwhile, Kazaa is moving forward with some exciting enhancements and innovations. In Q1, it released its optimized mobile browser in March, enabling users to stream music to their mobile devices, a critical step toward competing on the same level as Pandora. Not surprisingly, management indicated that this new capability instantly resulted in a “significant improvement” in virtually every important user / usage metric.
In fact, subscriber-growth accelerated to an annualized rate of nearly 50%. With its new Pandora-like radio functionality, Kazaa appears well-positioned to show continued accelerated growth...and in this economy, accelerated growth stories don’t go unnoticed by Wall Street for long.
Most notably, we believe that ATRN will soon offer Kazaa via an iPhone / iPad app. When Pandora released its iPad app, in 2010, sales growth went through the roof. After posting 35% growth in 2009, Pandora’s sales nearly tripled in 2010. They're on pace to do so again this year. If ATRN follows suit, sales could hit $230M 24-months from now.
That may sound like a stretch, but Pandora has already proven it can be done (did you know who Pandora was 2-years ago?). Besides, even if ATRN “only” grows to $100M over the next 2-years, it would be nearly as big as Pandora is today. A comparable valuation would be $2 billion or $300 per share, 100x today’s levels.
7. The company recently raised cash and landed the heaviest-hitting CEO I’ve ever seen such a small public company attract. His name is Stuart Goldfarb and until recently he was the President and CEO of Bertelsmann Direct North America. For those who don’t know, Bertelsmann is a $20 billion giant, described by Wikipedia as “the most international media corporation in the world”. As ATRN’s press release states, Goldfarb built Bertelsmann DNA into “the world’s largest direct marketer of music, DVDs and books (with over 20 subscription and membership “club” businesses including BMG Music Service, Columbia House, Book-of-the-Month Club, Doubleday Book Club and yourmusic.com), serving over 14 million members with revenues of over $1.2 billion”.
Yes, $1.2 billion...with a "B". With a track record like that, growing ATRN’s revenue to a couple hundred million dollars doesn’t seem far fetched at all.
Conclusions: ATRN exhibits classic characteristics of a company with grossly undervalued shares. Its most coveted assets are not reflected on its balance sheet. These assets will cushion investors from losses if management fails to execute. Also, being early to the Internet music game resulted in lumpy result and significant losses. As a result, investors abandoned the stock, sending it to incredibly low levels.
Most importantly, ATRN's market is now getting hot (in this case, red hot). Yet the shares remain under the radar because institutions and retail investors have yet to rediscover it.
Looking at ATRN's 5-year chart, it’s clear that the stock has been forming a base over the last year. This tells us that buyers have been accumulating shares without forcing sellers to accept a further discount. In fact, the stock is now starting to rise, indicating that sellers are no-longer be willing to sell at a discount (or at all). This could lead to sharp gains in a short period of time, because most of ATRN's shares are in the hands of insiders or large buyers like Trinad Management. Any such move is sure to hit traders’ screens for daily gains. Soon after that, the cat will be out of the bag.
In the meantime, for a few dollars per share investors get a company that paid $15 per share for music licenses which much larger companies are now desperate to obtain. With success, ATRN’s stock could rise by 5x, 10x, or even 100x. With failure, investors could still profit handsomely, as AAPL, AMZN, GOOG, P, or another eager company swoops in for the ammunition (licenses) it needs to compete against Pandora.
Disclosure: I am long AAPL, ATRN, GOOG, RNWK, P.