It’s No Napster; It’s a Sleeper

Can an Internet music company become a financial success without relying on pirated songs?

So far, the evidence isn’t encouraging.

Napster Inc., whose song-swapping service has made it the poster child for music piracy, faces a crippling lawsuit from the recording industry. Earlier this month, multimedia search site operator Scour Inc. was forced to lay off most of its staff after lawsuits from the Motion Picture Assn. of America and the Recording Industry Assn. of America scared away potential investors. And just last week, a federal judge ruled that copyright violations by MP3.com Inc. would cost the company at least $117 million, a penalty that could put it out of business.

None of that has discouraged Launch Media Inc.

For 6 1/2 years, the Santa Monica company has used technology--first CD-ROMs and then the Internet--to introduce music fans to new artists. Slowly but methodically, Launch has built a music library with more than 120,000 songs and attracted a user base of 4.3 million. And it has done so without the flagrant copyright violations that have landed so many Internet music ventures in hot water.

“We believe artists should get compensated for their work,” said Launch Media Chief Executive Dave Goldberg, a former management consultant and lifelong music enthusiast. “If they can’t get compensated, then they’ll stop making music, and that’s bad for us.”

Instead of offering digital versions of copyrighted songs--as MP3.com did--or writing software to locate pirated music on other people’s computers--as Napster and Scour did--Launch obtained licenses for songs and videos from music publishers and record labels.

Launch also produced its own versions of songs and videos, which don’t trigger any licensing fees. The company installed a studio in its sprawling office--as many radio stations do--to record artists ranging from Sarah McLachlan to Run DMC. Launch also sends crews on location to record performances at concerts and in other venues.

All that original content certainly wasn’t free. Since its inception, Launch has spent “a couple million dollars” producing its own songs and videos, Goldberg said. It also spent about $100,000 in its most recent fiscal quarter on licenses.

But analysts expect increased advertising revenue will carry Launch to profitability. As new users continue to flock to the Web, Launch’s audience will grow, and that will help the company rake in more advertising dollars, said Bill Lennan, an analyst with WR Hambrecht & Co. in San Francisco. What’s more, the radio- and TV-style commercials that are possible with broadband Internet connections will command even higher prices, helping Launch to collect three out of every four revenue dollars from advertising, he said.

“We’re still in the early days of Internet growth, and certainly in the very early days of broadband penetration,” said Lennan, who considers himself one of the most conservative analysts following Launch. He expects the company to become profitable in early 2002. “They’re going to make money someday, there’s no doubt about it.”

Launch has won plaudits from analysts, but the company isn’t close to breaking even yet.

Last year, Launch Media posted a net loss of $37.5 million on revenue of $16.6 million. In the first half of 2000, Launch lost an additional $24.1 million on revenue of $14.3 million.

Though analysts agree the company will become profitable, investors are still wary. After closing at $6.50 on Friday, down 25 cents on Nasdaq, Launch shares are off about 70% from the $22 of its initial public offering in April 1999.

But Goldberg insists that Launch can make money, even if it plays by the copyright rules.

Launch has enough cash to fund the company until the end of 2001, when Goldberg hopes revenue will begin to outpace costs. As of June 30, the company had about $50 million in current assets, including $3.8 million in cash and cash equivalents.

“They have a very viable business model,” said Chase H&Q; analyst Paul Noglows. “Launch provides what we think is an excellent [online] marketing platform for all the major [record] labels.”

Indeed, Launch has more in common with radio stations and MTV than with online music retailers. Although the company’s Web site, https://www.launch.com, allows visitors to buy compact discs and cassettes through a partnership with Wherehouse Music and CheckOut.com, Launch isn’t really competing in the $14-billion music retail industry, Goldberg said. Instead, Launch is helping consumers find new music they might like.

Although radio stations reach far more listeners than Launch, “the labels are better off having people listen to us,” Goldberg said. “On Launch, they can see the title of the song they’re listening to, they can click the ‘Buy’ button and buy it right there, and we’re paying them royalties.”

Goldberg’s vision is to supplant radio by streaming digital music directly to listeners over the Internet. Using a single music and video library, Launch could serve up an infinite number of personalized music channels. Then he hopes to cash in by selling online advertising and facilitating e-commerce transactions.

So far, online advertising and sponsorships are Launch’s main sources of revenue. In 1999, the company took in just under $9 million in ad revenue, amounting to 54% of its annual revenue. In the first half of 2000, advertising and commissions from electronic commerce transactions brought in $8.8 million, or 62% of total revenue. AT&T;, General Motors, Coca-Cola and Procter & Gamble are among Launch’s blue-chip advertisers.

Syndication of music news and concert tour information to radio stations and Web sites is Launch’s second-biggest source of revenue, amounting to $5.4 million in 1999. Most of that comes from sales to advertisers of radio air time, which Launch receives in exchange for providing music and entertainment news.

Launch also took in $2.2 million in 1999 from selling its monthly CD-ROM music magazine to about 265,000 subscribers for $20 a year.

Goldberg, 32, is an unlikely music industry visionary. He took piano lessons and sang in an a cappella group while growing up in Minneapolis, but when he graduated from Harvard, he never considered a career in music. Instead, he worked as a management consultant for Bain & Co.

Then a former Bain colleague told Goldberg that Capitol Records was looking to bring a consultant on board to bolster the label’s strategic thinking. He spent two years working as Capitol’s director of marketing and strategic business development.

During his tenure at Capitol, he was responsible for finding “new ways to get music to people,” Goldberg said, and he came up with the idea for Launch. He and Bob Roback, a childhood friend and securities attorney, began sketching out plans for the company in the summer of 1993. They struck out on their own six months later, operating out of an apartment Goldberg shared with a roommate and living off credit cards while the business got on its feet.

Originally, Goldberg and Roback planned to offer music, videos, reviews and interviews on CD-ROMs, video game consoles, interactive television and commercial online services such as America Online and Prodigy. The first CD-ROM came out in May 1995, and the company attracted investments from Intel Corp., NBC Multimedia and Japanese Internet investor Softbank Corp.

Then the World Wide Web exploded. Today, the Web is Launch’s primary platform.

To build visitor traffic on its Web site--and increase advertising revenue--Launch has spent about $10 million in stock in the last two years to acquire companies with substantial music video libraries. Now Launch’s Web site boasts a library of more than 5,800 music videos, including offerings from Madonna, Britney Spears, Faith Hill and Ice Cube. Video viewing accounts for about 30% of the activity on Launch.com, Goldberg said.

Malcolm Maclachlan, a media e-commerce analyst for research firm IDC in Mountain View, said the video library should be a more compelling draw than Launch’s audio music offerings.

Launch also was aiming to boost ad revenue when it agreed to buy a live summer concert series called the Warped Tour in June. Because the 6-year-old tour and the Launch Web site target the same fan base, Launch can sell a package of online and offline ads, Goldberg said. He also believes Launch can sell more Warped Tour tickets because it already knows what kind of music its customers like and how close they live to concert venues.

Launch executives say their company’s stock is being unfairly punished by bad publicity surrounding companies such as Napster and MP3.com. Analysts agree.

“I think [Launch] will emerge as one of the leaders in Internet music, but that space today is still too messy and confusing for most people,” said Noglows of Chase H&Q.; “Sometimes the baby gets thrown out with the bathwater, and I think that’s the case for Launch.

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At a Glance:

Company: Launch Media

Business: Offers music, videos and entertainment news on the Web and through other media channels

Founded: 1994

Location: Santa Monica headquarters, with offices in New York and Chicago

1999 sales: $16.6 million

1999 losses: $37.5 million

Initial public offering: April 1999

IPO price: $22 per share

Friday’s closing price: TK

Number of employees: 280

Major investors: General Electric, Intel, NBC Multimedia, Sony Music Entertainment