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Beats Electronics takes a crack at digital music

by Eric Vermilya  |  Published January 15, 2013 at 4:19 PM
Within the notoriously unstable and oftentimes desperate music industry, everyone is searching for the corporate equivalent of Adele, a business model that produces hits, makes a profit and has staying power. That formula has been more elusive than an Agnetha Fältskog sighting.

Want examples? Clamp on a pair of headphones, crank the volume and listen up.

A few years back, young, urban types and their suburban wannabes began laying out some serious change for big, colorful, design-heavy headphones from the likes of Beats Electronics LLC and Skullcandy Inc. Investors enthusiastically jumped in behind them, figuring if youthful consumers can fill their iPods or smartphones with free music, they're bound to spend money on something.

Now, Skullcandy is the object of growing takeover speculation, but for all the wrong reasons. Its stock has plummeted in value by almost two-thirds since a July 2011 initial public offering, amid only modest gains in sales and a rash of analyst downgrades.

Meanwhile, Beats is diversifying and creating some serious industry buzz in the process.

Last week, Beats announced that it has hired Ian Rogers, the high-profile CEO of successful digital music marketer Topspin Media LLC, to head a digital music service Beats has just christened Daisy. Daisy's creative director is the indie music darling and film composer Trent Reznor, Beats revealed. Beats also announced what is being called a "substantial strategic investment" in Topspin, although the amount wasn't disclosed. Bob Moczydlowsky, Topspin's senior vice president product and marketing, subsequently said that while Beats is taking equity in Topspin, it won't have voting rights or a board seat.

In a press conference, Rogers and Beats co-founder Jimmy Iovine, the hip-hop impresario and chairman of Interscope-Geffen-A&M records, said the new music service will be launched during the second half of this year. They were short on any particulars, according to media outlets present at the conference, although Topspin itself announced that its artists marketing products will be integrated into Daisy.

That Beats, whose other co-founder is the rapper and producer Dr. Dre, is pursuing music subscription isn't a bolt from the blue. In July, the company announced that it had purchased Mog, one of many struggling streaming music services formed during the past several years and funded largely by venture capital. While details of that acquisition weren't revealed, Beats paid substantially less for Mog than the $25 million VC firms and major recording labels had invested in the company, according to a number of industry insiders. The Los Angeles Times reported a $10 million price tag.

Beats carries enough cash to sprinkle money around the industry, at least to a point. In August 2011, Taiwanese smartphone maker HTC Corp. bought a 50.1% stake in Beats for $309 million, with promises of an aggressive product and marketing tie-up. Eleven months later and in a far less publicized move, Beats bought back half of that stake for $150 million. A dazed HTC is too preoccupied how to fend off Samsung Corp.'s mobile phones arsenal to worry too much about headphones, although a current line of HTC phones features Beats. At the time of the divestment, HTC said it would lend Beats about $225 million, a kind of "get out of my face, kid" gesture.

Digital music subscription services have attracted all sorts of investors and substantial capital, but have proven a particularly treacherous siren call. Several have gone bust or shut down, including now-forgotten names such as Beyond Oblivion, Lala and Wahwah. Turns out, it's easy to attract millions of listeners as long as they don't have to pay. As the labels licensing the music demand large, up-front fees, the math simply doesn't add up, no matter how well-heeled investors may be. (Rogers, himself, knows how difficult the terrain can be. He once headed Yahoo! Inc.'s music service, another failed effort.)

Despite a long list of failures, the money still keeps coming. In October, the French service Deezer announced a €100 million ($133.7 million) funding round, led by Access Industries Inc., the Russian owner of Warner Music Group Corp. Deezer claims to be in 100 countries and boasts a user base of 20 million, although only 1.5 million subscribers. It has yet to venture into the United States.

Spotify Ltd., another European-born and bred subscription service, is the current king of the hill. It claims 20 million subscribers, as of the end of 2012. Only 5 million, however, pay either a $5 or $10 monthly fee.

In 2011, Spotify notched revenue of $245 million, but lost $59 million. Last November, Tech Crunch, citing "confidential financial information," projected annualized revenue of $500 million for the year ending this January.

That kind of growth sounds impressive, but is disappointing, considering that the industry was projecting Spotify would turn $900 million in revenue last year. Put in perspective, Spotify's revenue numbers aren't even twice what Skullcandy is expected to sell and look where it's headed. According to The Wall Street Journal, Spotify raised money from new investors including Goldman Sachs Group Inc. late last year, valuing the company at more than $3 billion. Skullcandy's current market cap is about $191 million. The day it began trading in July 2011, the market cap neared $600 million.

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Tags: Beats by Dre | Beats Electronics LLC | Beyond Oblivion | Bob Moczydlowsky | Daisy | Deezer | Dr. Dre | HTC Corp. | Ian Rogers | Interscope-Geffen-A&M | Jimmy Iovine | Lala | Mog | Skullcandy | Skullcandy Inc. | Spotify Ltd. | Topspin Media LLC | Wahwah

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