MusicBank Opts to Play Ball With Recording Industry

As online companies Napster and MP3.com (MPPP Quote) feud with the record labels in courts on both coasts, Pierce Ledbetter has avoided the copyright battles that have been engulfing the Internet music industry.

Ledbetter, 33, is the co-founder and chairman of MusicBank, a privately-held online music service formed with more than $20 million in venture capital money and set to begin operations in September. As far as the big recording companies are concerned, Ledbetter has opted for cooperation instead of confrontation.

The popularity of such programs as Napster, the file-swapping software that allows users to download music for free from the hard drives of other users, has forced the record labels to confront the future of music, many in the industry say.

Rather than simply taking the online renegades to court, the recording industry is beginning to make its own efforts at offering secure music over the Internet -- meaning impossible to store and distribute to users that don't first buy the compact disc -- and at the same time getting paid through licensing fees.

The beneficiaries appear to be upstart companies like MusicBank.

Unfettered by Legal Situation

"We've watched Napster closely, but we've maintained our outlook," Ledbetter said. The Napster court battle, along with the MP3 file format that allows unsecured downloading of music, has "galvanized the industry to act," and helped MusicBank secure licensing agreements with some of the major labels, he said.

"It created an awareness within the industry that they needed a secure model," Ledbetter said. He said licensing were "part of our business plan from the start."

San Francisco-based MusicBank's service, which is similar to My.MP3.com service, allows users to assemble their own digital jukeboxes. MusicBank's technology can read a user's CD-ROM drive to ensure ownership of the music, and then place it on a personal home page, where it can be "streamed" from the Internet rather than downloaded to a user's hard drive. The goal is to create portable music, enabling users to access their tunes from wireless phones and handheld devices wherever they go. Users gain access to the music by going to their personal homepage, and in the cases of both companies, listeners must first buy the compact discs.

Ledbetter said MusicBank's revenue will be a mix of advertising dollars and money from anticipated revenue-sharing agreements with retailers. The company has reached a deal with Virgin Megastores in which every time someone buys a compact disc the music is automatically put online at MusicBank for the user to access over the web. Other link-ups with retailers are likely to follow, he added.

As long as MP3.com's lawsuits go on -- delaying its ability to offer popular songs online -- MusicBank has an advantage, according to a recent research note by Phil Leigh, an analyst at Raymond James & Associates who covers MP3.com.

"Since it was first introduced in January, we have been optimistic about the prospects of the My.MP3.com service as a business concept," Leigh wrote. "The progress that MP3.com can make in reaching settlements may well have an important bearing on the potential investment rewards of the stock."

"Meanwhile," he added, "it will be important to monitor the progress of companies like musicbank.com who are unfettered by the legal situation at MP3.com."

Another analyst, Malcolm Maclachlan, who covers the online entertainment industry for independent research firm IDC, described MusicBank as "MP3.com without the baggage, without the legal baggage, without the [public relations] baggage," referring to MP3.com's initial tactic of throwing bombs at the record industry rather than extending an olive branch.

"Depending on how many companies get licensing agreements to do this, they could be very lucrative," he said. In a recent research report, Maclachlan estimated the market for digital music downloads to reach about $1.2 billion in 2004 from an estimated $6.5 million in 2000.

Labels May Take Further Equity Stakes

MusicBank has secured licensing agreements with Bertelsmann's BMG Entertainment and Seagram's (VO Quote) Universal Music Group, which also took a seven-figure equity stake in the upstart. In an interview, Ledbetter said he is confident he will secure similar agreements with the other three major labels -- EMI, Sony's (SNE Quote) Sony Music Entertainment and Time Warner's (TWX Quote) Warner Music Group. Other labels may also acquire equity stakes in the company, he added.

Meanwhile, MP3.com has reached settlements with three labels, but it has yet to settle with Sony and Universal.

A person at Sony said talks with MP3.com are continuing. But on July 28, Sony and Universal asked a federal judge to award damages. The judge denied the motion at the time, and the case is scheduled to go to trial Aug. 28.

In the Napster case, seen as a benchmark for establishing how copyright law applies on the Internet, the company was granted a temporary stay July 28 after a judge ordered the service shutdown. The company is scheduled to deliver its opening brief in the case on Aug. 18.

"One of the things that was attractive to us about MusicBank -- and we realized that people want online solutions to manage their music libraries -- is that they are clearly supporting secure formats," said Andrew Lipsher, senior vice president for worldwide corporate development at BMG Entertainment.

But he cautioned that is too early to predict who will be successful once the nascent online music industry begins to mature. "What we are doing is supporting a couple of legitimate players in the space," he added. "But we are not clairvoyant, we don't know who is going to win at the end of the day."

The key question is pricing. Neither MP3.com nor MusicBank will reveal details of their licensing agreements, but analysts believe the companies are paying around 1.5 cents to store a song initially, and then three-tenths of 1 cent for ever time a user streams a track, according to Nitsan Hargill, an analyst at Kaufman Brothers. With an average of 10 songs per CD, this equates to about $20 per 100 CDs, a cost that MusicBank must pay up front, and hope to recoup later, mainly through advertising, he said.

"You multiply that by 10 million users, and it can get really expensive," he said. "The question is, how do you pay for it? My main problem is with the upfront cost."

MP3.com said it will not begin offering popular content from the labels it does have agreements with unless it settles with all five. Musicbank, however, will go live Sept. 14, regardless of the licensing situation.

"We won't wait," Ledbetter said. "We would be willing to go ahead. Part of this is our confidence that we will have all the labels. We will only offer licensed content.

"We could have launched earlier," he added. "We had the technology. But we prefer to take the high road."

Ledbetter's experience running EveryCD.com, one of the first online CD retailers, led him to start MusicBank. "There's tons of competition in terms of retail on the Web," he said. "I realized all margins would tend to zero in retail."

He has aboard former top executives from E*Trade (EGRP Quote) and Levi Strauss, as well as the former manager of the band Blues Traveler and board member of the H.O.R.D.E. festival, a long-running annual music festival.

As for a possible initial public offering , Ledbetter demurred. "Right now, we are focusing on our launch," he said.