EMI's Digital Decision

A Qtrax linkup could open the doors to online gains.
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As the one-year anniversary of the Grokster decision rolls around, music companies are still looking for ways to make money through digital music.

Witness music big

EMI Group

, which has struck a deal to offer its catalog online. London-based EMI says it is the first major music company to make its catalog available via what will be the "world's first advertising-supported, legal peer-to-peer music distribution service."

For this new advertising effort, EMI has signed a licensing deal with Qtrax. Qtrax was developed by New York e-commerce software maker LTDnetwork. Revenue will be split fifty-fifty between the two sides. Advertising is likely to come in the form of voice, Internet banners, video and other mediums.

The music industry has suffered greatly at the hands of file-sharing pirates. But services like

Napster

(NAPS)

, once a source of countless losses, now sell music legally.

Yet piracy concerns persist in the minds of investors. The International Federation of Phonogram and Videogram Producers, which represents the industry, says that at the end of 2005 there were 335 legal file downloading sites, up from 50 in the previous year.

And while physical music sales declines continue to bewilder investors, sales via the Internet and other platforms kicked in $1.1 billion in 2005, up nearly threefold from the previous year. For its part, EMI says that digital sales in publishing and music hit $211.2 million for its full calendar year, up from $88.4 million.

Indeed, digital sales are now largely mitigating physical declines, though online sales still make up a smallish fraction of total revenue. At Sony BMG, for example, digital sales in the U.S. are said to now make up 14% of total sales.

Warner Music Group's

(WMG)

digital sales are in the high single digits as a fraction of total sales.

When launched, the EMI-Qtrax partnership will allow consumers to listen to a chosen track a predetermined number of times. Each time a consumer plays a track, the Qtrax player will also offer the option to purchase songs. It will also provide people with a premium subscription option, and the ability to purchase songs and albums a la carte.

The Qtrax service is expected to enter a test phase later this year and will initially pilot the service in the U.S.

Last June, the Supreme Court ruled against file sharing service Grokster in favor of media companies in a suit brought by MGM. The Supreme Court ruled unanimously that Grokster could be held liable if consumers illegally exchanged songs and movies using its technology.

The online development comes as investors await a tie-up between EMI and Edgar Bronfman Jr.-led Warner Music Group. But by all accounts they could be in for a wait. EMI made a $4.2 billion cash-and-stock bid in April that was promptly rejected by Warner's board.

Since then there has been much speculation but little visibility on a potential deal. Sources have suggested that Warner Music might in turn bid for EMI, pending a decision by investors including Bain Capital, Providence and Thomas H. Lee Partners. Meanwhile, EMI Chairman Eric Nicoli is said to be playing a waiting game and has left the bid on the table.

Either way, investors are licking their chops at the prospect that the two companies will someday join forces, given the prospect of billions of dollars in cost cutting from operations and the prospect that the two companies would better compete with

Vivendi's

(V) - Get Report

Universal Music and Sony BMG, the world's two largest music companies. It would also help grow EMI's presence stateside, something the company has long wanted to do.

EMI stock was flat on Monday while Warner Music Group shares were up 4 cents to $27.01.