Yahoo's Music Rivals Sing the Blues


On May 10, Web portal Yahoo! (YHOO) unveiled Yahoo! Music Unlimited, a service that allows users to access and play more than 1 million songs over the Internet for a monthly subscription fee of $5, after a free seven-day trial.

But while the music service's opening day was free for users, it cost its competitors dearly. RealNetworks (RNWK) and Napster (NAPS), two companies that offer similar music subscription services, saw their stock fall by 20% and 27%, respectively, by the close of trading the following day. Meanwhile, Apple (AAPL), the leader in online music with its iTunes MP3 downloading service, saw shares drop by as much as 7% before finishing the day off almost 3%.

Is the situation really so dire for Yahoo's competitors? To find out, BusinessWeek Online staff writer Burt Helm spoke with Scott Kessler, director of information-technology equity research at Standard & Poor's. Here are edited excerpts from their conversation:

(Scott Kessler is an S&P Equity Research analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this article. All of the views expressed in this article accurately reflect the analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this chat. For required disclosure information and price charts for all S&P STARS-ranked companies, go to spsecurities.com and click on "Investment Research" and then on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts.")

Q: How does Yahoo's entry affect the digital music market?

A: The headline everyone is talking about today is that Yahoo is now going to become a formidable competitor to say, Apple, which has the iPod MP3 player and the iTunes music service. But the first thing is that there are two segments right now in online music: Pay-per-download, like Apple's iTunes, and subscription services, like what Yahoo is about to offer. The reality is that they are moving into a different segment in online music than Apple. It's one that is occupied primarily by two other players, Napster and RealNetworks with its Rhapsody service. Those two are going to be much more seriously affected.

Q: Both Napster and RealNetworks have seen shares fall drastically. Do you think those price drops are justified?

A. Napster is really at risk here. While it's widely acknowledged that they have a well-known brand in online music, what they do is not substantially dissimilar from what Yahoo is now offering. They have the same kind of compatibilities, and I think they even use the same standard for the file formats. What's worse, online music is really Napster's only business.

Q: And RealNetworks?

A: RealNetworks is slightly different. It is a company that has a lot more in the way of assets than Napster. But this is going to challenge them, and online music made up 29% of Real's revenues last quarter, so it's significant.

One advantage of RealNetworks' Rhapsody service is that it has a service tie-in to Comcast Broadband, which is one of the biggest Internet service providers in the U.S. With that said, Yahoo will have a lot of power to attract users and convert folks to subscribers. Here at Standard & Poor's we're cutting our price target on RealNetworks's stock from $9 to $8. We still have it rated as "buy."

Q: How do you think this news affects Apple and its music distribution model?

A: Steve Jobs and Apple have made it pretty clear that they think people want to own and not rent music, and Apple has stuck to its downloading model. A successful Yahoo entry might result in Apple reconsidering their business model, and adding a subscription offering. But presently, I highly doubt that someone with an iPod is going to subscribe to Yahoo music. The MP3 player plays a strong part in determining what service people use. The reason that iTunes is the leading download service right now is because of the iPod.

Q: Why is it that Apple's stock took a sharp drop in value as well?

A: In this market, it's not really about current users. Yahoo is a big competitor, and at the end of the day, a new customer might say, "This iPod is too expensive, maybe it's cheaper to go with this cheaper alternative that Yahoo is offering."

I think the market is reacting to uncertainty over whether there will be less robust growth of MP3 sales for Apple in the future with this new entrant. This isn't any new entrant. Yahoo is the proprietor of the most visited Web site in the country.


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