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Subprime-like Mortgages Forcing Music Companies Into Bankruptcy

Subprime loans have caused pain and foreclosures in the housing markets and the same phenomenon is hitting digital music companies like imeem, Pandora, Last.fm and Playlist.com. With subprime loans, home owners are enticed by a teasingly low introductory rate. Within the first several years, the initial start rate zooms up making it difficult for the owners to pay the higher rate. The result is financial calamity usually ending in foreclosure.

Online music companies have fallen for the same financial trickery by agreeing to contracts to pay record labels, hoping to resolve pending litigation. The euphoria is short-lived upon realization that the new contract rates will eventually bankrupt their company.

Online Music Streaming Companies
  Happened Prediction
Shutting down SpiralFrog, PluggedIn, Yahoo radio, AOL Radio imeem, Pandora, Playlist
Reduce offering Youtube, Last.fm, ilike Slacker, Myspace Music, MTV, VH1, Yahoo Video
Shift business to paid subscription Last.fm (in all but 3 markets) ??

To illustrate, let's look at imeem, a popular online music company. Amid great fanfare, this digital music purveyor entered into licenses with the major record labels. Top news outlets touted this as a pivotal moment in the music industry, citing that outstanding litigation had been resolved with the labels agreeing to "share revenue". The announcing press release was cheerful, with both sides disbursing public hugs of congratulation. Unmentioned, however, was the fact that imeem had been forced to agree to the license, or face a lengthy legal battle and partner intimidation. Also undisclosed were the specific terms in which imeem agreed to pay a bit less than 1 cent for each song played on their site, and while that may not sound like much, it adds up quickly. Imeem has publicly stated that they are now doing more than 1 billion streams per month. At just 1/2 cent per play, imeem must pay $5,000,000 per month to the record labels, equaling an enormous $60 MM per year in royalties.

The numbers don't look any better when examining an individual user's behavior. Assume a visitor to imeem listens to music for 45 minutes, and assuming a song is 3 minutes in length, that equals 15 songs, which translates to 7.5 cents owed to the record labels. Online ads currently sell for approximately1/3 of a cent, which means the user is bombarded with 25 paid ads during their visit. And this assumes imeem sells all their ad inventory, which of course is nearly impossible to do.

$60 MM per year, or 25 ads per visitor might seem a bit high, but remember - these are ONLY the royalty costs. Imeem, like any other business, incurs many other costs such as management, sales force, engineers, bandwidth, servers, office space, plus royalties to publishers, all of which may be charges separate and above the record label fees.

Imeem is not alone. Every other well known online music company that streams music from the major labels is in a similar predicament. Playlist.com was recently faced with lawsuits, and the record labels intimidated large partners like Facebook and Myspace into blocking them and agreeing to similar deals such as imeem. Their royalties are quickly amassing with the two labels they have settled with.

2009 is seeing a radical shakeout of the online music space as companies come to grips with the underlying economics. Without the easy source of new money from investors or parent companies that will tire of subsidizing online music ventures, businesses must either shutdown, change their business or cut back and only stream music from companies that offer more reasonable rates.

Subprime loans seem like a good idea at the time, because they resolve a near term financial issue. However, as the financials are fully adjusted, the pain hits. Most online music companies hope to sell to a big company like Youtube did, or change their rates like Pandora is trying to do. The current economic malaise limits the number of potential buyers, and to date, record labels have not shown willingness to enter into true revenue sharing deals without a per-stream limit. And unlike the metal shapers in Detroit, digital music companies are not sympathetic bailout candidates so expect short sales and foreclosures.

--MR
michael@michaelrobertson.com



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