Blogroll Me!

Friday, February 13, 2004

Roxio - Undervalued?

I've been watching Roxio for some time now and I believe that the company is severely undervalued at this point. I say this because I believe that it's Napster division will have substantial value going forward and add to the value being created by the CD/DVD burning side of the business. There's a small chance that the company could sell Easy Creator/Toast to another competitor, but I'm not sure they'll get a great price for it. Add all of this up, and I think this business is worth substantially more than the $63MM enterprise value that the company is currently fetching.

The reason for the low valuation is because everyone believes that Napster will continue to burn through substantial amounts of capital in the near future. This would be detrimental as competitors (iTunes and Rhapsody) are spending large amounts of capital promoting their services and it's not clear that Napster will be able to keep up. The data that supports this is management's guidance of approximately $15MM cash burn next quarter (as far as I could ascertain). This would imply that their cash falls from the $64MM to $49MM, which implies that enterprise value actually increases to $78MM.

I think that $78MM for the Napster business alone at this stage of development is a steal. The division did $3.6MM in two months of operation in Q304 (calendar Q4). Why will Napster remain competitive and grow? Because it's the only music service of the top 3 that utilizes Microsoft's WMA standard, allowing Napster's service to be used with 66% of the players in the market. RealNetworks and Apple's platforms are proprietary, and while there are work arounds to port the music to other players, I just think that Napster will grab a lot of the Windows market share. Additionally, I think now is a good time to buy because Napster announced a marketing partnership with Target, Imation and Case Logic. The partners will be offering a packaged download kit that includes prepaid cards, Napster logo'd CDs and cases. I think Target's traffic will drive substantial sales of these products which will become apparent in the next quarter or two. Once the Napster division becomes profitable, then the valuation of this company will change dramatically as investors realize that this horse has legs. Think about it, download music is expected to do $300MM this year and grow to $4.5B in 2008. I don't normally use analysis firm's estimates, but I believe these numbers. As a top 3 service, Napster has big potential to become a $500MM+ business within two years. That's a 5x potential return.

I believe in assymetrical payoff profiles, and Roxio fits that to a "T". Roxio's valuation could fall another 30-40% depending on their competitive traction and/or the amount of time it takes the market to develop, but the valuation could also improve 3-7x within the next two years. I definitely see an opportunity to accumlate this stock over the next couple of quarters.

Lastly, I think the company makes an excellent acquisition target. It's clear that media channels are consolidating at the big scale (Comcast+Disney). I think this trend makes its way down to smaller players such as Roxio soon.

Catalysts that I expect to develop over the next couple of quarters:
- Reaching break-even faster than guided
- Beating consensus as conservatively guided
- Big numbers from the Target relationship
- Buy-out of the CD/DVD biz line (low probability)
- Buy-out of the company (medium probability)

Subscribe in NewsGator Online Blogroll Me! Subscribe with Bloglines Who Links Here

Email Me