Yahoo! Plays the Right Note

Its digital music player may prove a worthy competitor to the iPhone.
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It was the kind of story that should have had stocks hopping higher: Two market leaders -- one in Internet media and another in storage -- join forces to plunge into a hot market growing the only way it can when sparked by disruptive technologies.

But that wasn't all: The companies come up with a technological twist that could give it a quick edge against the 800-pound gorilla dominating the market. So investors should have been excited, right?

Well, not quite. On Monday, those two companies --

Yahoo!

(YHOO)

and

SanDisk

(SNDK)

-- unveiled their new product: an MP3 player with a WiFi connection that can stream Internet radio stations and browse photos on Yahoo!'s Flickr site.

Yahoo! and SanDisk timed the announcement for the wee hours of Monday morning, when the business press was hungry for news after a sleep-filled, three-day weekend. The problem was the 800-pound gorilla -- the

Apple

(AAPL) - Get Report

iPod. You're not supposed to challenge the iPod.

To make matters worse, the new product announcement coincided with news that Apple had just sold its 100 millionth iPod.

That cast an unflattering light on Yahoo!, which looked like it was a late, late entry to the race. It's like being on

American Idol

in the sixth season; people can't help but wonder what took you so long to get there.

For Jim Cramer's take on this topic, click here

.

Following the news, Yahoo!'s stock dropped 1% on Monday to $31.64. SanDisk moved in sympathetic tandem, falling 1% to $44.03. (Yahoo! shares gained back that 1% in recent Tuesday trading, while SanDisk shares were up fractionally.)

Nothing says welcome to the MP3-player market quite like an indifferent shrug of the shoulders. The silver lining, if you can call it one, was that the stock price of the 800-pound gorilla also slipped Monday. (Apple shares were flat in recent Tuesday trading.)

But while it will be some time before another music player even starts to eat into the iPod's market share, it's a little unfair to lump the Yahoo!-SanDisk player, with the refreshingly untrendy name of itsSansa Connect, into the scrap heap where the

Microsoft

(MSFT) - Get Report

Zune resides.

The Sansa Connect appears to be more about sticking a toe into the waters of the media player of the future than playing catch-up in a race whose victor was declared a long time ago.

Microsoft thought its "killer application" was the ability to let Zune owners beam their favorite songs to other Zunes. But that overlooked a few crucial realities: Zune needed a critical mass of users in a given school or office to make said beaming worthwhile, and one of the beauties of social networks (and P2P networks) is that they connect you with kindred souls across the city, the country and the globe.

Then there was DRM, or digital-rights management software, which is designed to staunch music piracy. Consumers have rebelled against DRM, but Yahoo! and SanDisk's player is debuting at a time when labels, led by

EMI

(EMIPY)

, are starting to offer DRM-free music tracks at a 30% premium.

It took Apple to break that logjam, but its competitors are likely to benefit as well. Apple has paradoxically profited from DRM, since it used it as a pretext to lock its iTunes music store customers into playing purchased songs only through its proprietary software.

So up until now, if your iPod up and died and you had bought music through iTunes, you had little choice but to buy another iPod -- which, quite frankly, a lot of iPod owners were happy to do.

But now that Apple is offering to retroactively strip out its DRM protection to songs that were also bought years ago, that may change.

It opens the door to a music player that offers much more than the iPod -- which is where the Sansa comes in. The Sansa offers the same music-beaming feature as the Zune, but it doesn't regard the feature as a killer app, just as an ancillary feature.

The intriguing thing about the Sansa is that it treats your music player as a mobile device that can access key features that Yahoo! members are accustomed to using on the Web: LaunchCast radio, Flickr photos and Yahoo! instant message.

By using your Yahoo! account on the Sansa, you can potentially listen to radio stations on your music device (a long-cherished dream of many music lovers) and view photos already posted on Yahoo!'s quintessential photo-sharing site.

What Yahoo! is attempting here is both bold and devious: It's importing its well-established portal to an iPod-like device. If it were able to add email and cell-phone capability to the music player, it would back into being a worthy competitor to Apple's iPhone.

And that, should it ever happen, would be news that would make Yahoo! shareholders sit up and take notice.

Provided, of course, that Yahoo doesn't wait until the 100 millionth iPhone is sold first.