Walking Through the MP3 Minefield

Yes, fortunes can be made in this new technology. But investors should proceed with caution.
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Editor's note: The MP3 phenomenon promises to change the music business forever and to create a new round of e-commerce fortunes. Jim Seymour, TheStreet.com's technology expert and a longtime professional musician, explores the curious world of downloaded music. Yesterday, Jim looked at the technology, the worries and the players. Today, he spots some likely hot prospects for investors among the companies leading this revolution and explores how you can sample MP3 yourself.

Sure, it's hot, and sure, there are fortunes to be made in this brave new digital-downloads world of recorded music on the Web. So how does an investor play the MP3 opportunity? Carefully, and with some of the same worries that afflict the record companies:

The big music companies are unquestionably going to get hurt by MP3, at least for the next couple of years, as the music industry gropes toward a workable secure-download standard. Most are significant but hardly dominant contributors of profits to the media-holding companies that own them, such as

Time Warner

(TWX)

,

Sony

(SNE) - Get Report

and

Bertelsmann

. So while you should keep in mind the impact of MP3 when you consider those stocks, other lines of business outweigh MP3 issues in their likely profitability and movement.

Implementers of MP3 and, soon enough, of

Secure Music Download Initiative

-compliant products will offer rich investment opportunities. The big gains are still some distance away though, and this remains a crapshoot: Which company's technology will win?

RealNetworks

(RNWK) - Get Report

is an obvious play right now, for example, coming off the buzz from its

announcement of

RealJukebox

at its annual conference last week. But it's wobbling now around 200 and has a 52-week range of 15 3/4 to 263 3/4, which many investors will see as a

big

caution flag. I'm a fan of RealNetworks, long term; I see its RealJukebox rollout as a major change of direction for the company, broadening its revenue opportunities and giving it a substance and security that, until now, have been in some question. I can't say RealNetworks is finally out from under the cloud of possible devastation by

Microsoft

(MSFT) - Get Report

, but it's very nearly so.

Among other players,

Liquid Audio

is promising, and with an IPO just announced, it offers an opportunity to get into one of the very few pure-play downloaded-music companies relatively early. The company has done deals with

Dreamworks SKG

,

Capitol Records

and a few artists, though those deals are for evaluation-level projects, not ongoing, full-line commitments. Liquid Audio uses the Advanced Audio Codec, or AAC, from

Dolby Laboratories

, which may give it a technical edge. And although it built its name and business around its proprietary format, it's now saying it'll support MP3 and Microsoft's new Windows Media 4.0 formats as well

CustomTracks

(CUST)

may also be a

winner, especially now that it has dropped its former focus on building and selling custom CDs full of customer-specified tunes and is working on download systems.

The .coms devoted to MP3 are flourishing, but very few of the tens of thousands of sites offering downloadable music are viable business propositions. Two, however, offer appealing near-term investment opportunities.

GoodNoise

(GDNO)

, which backed into public ownership by merging with an OTC shell and is presently

in the process of moving to a

Nasdaq

listing, has the rights to sell songs from the likes of

Louis Armstrong

and

Frank Zappa

. The stock has almost tripled this year and seems likely to head higher, perhaps much higher, when it's listed on the Nasdaq and as it secures more contracts with record companies. Today, GoodNoise has only

Rykodisc

under contract, and additions to that list are likely to be distinctly second- and third-tier indie labels for now. But GoodNoise is in the best position of any .com in the industry to move into the big leagues over the next couple of years. (I have a small indirect interest in GoodNoise, which recently received venture capital funds from the privately held Internet incubator,

idealab!

, in which I have a small holding.)

The other good bet is

MP3.com

, a hip, promotion-minded, privately owned company that has so far mainly been a mechanism for bringing previously unheard-of bands to the public eye -- uhh, ear. But consider a measure of MP3.com's determination to move into the mainstream of today's pop music: MP3.com announced in late April that it would be a co-sponsor of this summer's high-profile, 26-city tour by

Alanis Morissette

and

Tori Amos

. Many speculated that this meant Morissette and Amos would release the tour album or at least one new song in the MP3 format over MP3.com. Alas and alack, Alanis says it ain't so: She'll stick with her usual label,

Maverick

, and the CD format, though she

will

release one live single, but on a new site Maverick is developing. Ouch. Contrary to stories heard earlier this year that an MP3.com IPO would be along late in 1999, I think you should look for an MP3.com IPO sometime in the next quarter.

For now, MP3 as a business seems likely to continue to struggle, though MP3 as a format is clearly dominant. If and when an SMDI-backed (or imposed?) standard becomes widely available, the real explosion in downloaded music will begin.

Some companies, such as

Universal Music Group

, jointly owned by

Seagram

(VO) - Get Report

,

AT&T

(T) - Get Report

, Bertelsmann's

BMG Entertainment

and

Matsushita Electric Industrial

, have decided not to wait, believing they can go it on their own. Universal Music announced last week that it wouldn't wait for an SMDI-based industry standard, but was going ahead with a system under development by

InterTrust

, and expected to be selling its labels' products online before the end of the year.

Revolutions, someone observed, are always messy, and this one won't be different. It has already begun to change the relationships between artists and recording companies. It's also spurred frantic meetings and midnight alliances among the executives of those companies and brought to public attention a number of bands and solo artists who would never have been heard from in years past.

Digging In for Yourself

If you're interested in the MP3 tumult as a music fan, an investor or just an interested bystander, I'll tell you right now that this is one revolution you won't begin to understand without dipping your toe into the water. Fortunately, that's free or nearly free and incredibly easy.

First, download the beta of RealJukebox at

www.real.com. Install it, stick a CD in your computer, and let it transfer the songs on that CD to your PC's hard disk. Play a few cuts. You'll be amazed at how quick and easy this is and at the overall fit and finish of what is, remember, still only a beta release of the RealJukebox program. (The final version, coming soon, won't be free but will be cheap and will transfer music with even higher audio quality, so don't start transferring your entire CD library yet.) This is serious software, and it's carrying one of the big red flags in this revolution.

Second, go to both

www.GoodNoise.com and

www.MP3.com, poke around, and download a tune or two. On GoodNoise, you can buy for 99 cents a download of one of the great cuts on jazz pianist

Eddie Green's

new album,

This One's for You

-- it's plugged on the home page right now. Or buy the whole album for just $8 -- half the price, please note, of most new CDs. On MP3.com, try something else, maybe one of the cool kids' songs, for free. Again, listen to your downloads. You'll quickly see why MP3 is causing such an upheaval.

(You'll also see why broadband service is so important. With most song files running about 2MB, and some as large as 5 MB, downloads via dial-up modems are hopelessly long. With 800 Mbs cable modems, 500 Mbs or better ADSL connections or a 1.5 Mbs T-1 line, most take just a minute or two. Count downloadable music as yet another corner of e-commerce to be fundamentally enabled by the arrival of fast Web access methods.)

Third, use a couple of the popular search engines-cum-portals to look for MP3 music. On

Lycos

(LCOS)

, try the MP3 category listed near the top of the page: Lycos is into supporting MP3 buffs in a big way and has found and rated for reliability many thousands of MP3 download sites. (Unfortunately, many of those sites are unreliable, often down, slow or otherwise munged. Watch for three- and four-star sites. And ignore the "ration" sites (red marks) in the lists that come up onscreen: These require you to contribute to the gene pool, so to speak, by uploading some tunes yourself, before you're entitled to download any of theirs. Frankly, the raggedness and unevenness of the experience of searching for and downloading files this way will show just how ripe the downloadable-music business is for the organization and consolidation of a GoodNoise or MP3.com.

That little tour, which shouldn't take more than an hour, will give you something of the flavor and the fervor of the MP3 movement. You won't be an expert, but you'll be way ahead of most of the people who talk a good game about the pluses and minuses of MP3 -- including an amazing number of record-company executives -- but have never done this themselves.

A Look Ahead

A popular analogy holds that the impact of MP3 will be much like the impact of VHS videocassette recorders two decades ago: The industry will fear its arrival, scream and complain -- then notice, a few years later, that the once-feared device has, as with VCRs, tripled or quadrupled its markets and revenues.

I think that analogy is inexact and deceptive. It was never easy to copy and freely redistribute (read: pirate) movies on videocassettes, for example, and in an analog world, copies were never nearly as good as the original -- but the general drift is right.

I have no idea how the world of recorded music will look 20 years from now, but I'm positive that downloadable digital music will have been a force for the good and will have led to positive changes beyond today's imaginings for the "record" business.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, Seymour was long AT&T and GoodNoise, although positions can change at any time. Seymour does not write about companies that are consulting clients of Seymour Group, or have been in recent years. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.