ATRN Update – Kazaa Changes Everything

October 20, 2010 at 4:54 pm Leave a comment

Given the 50% gain in ATRN’s share price since we recommended it, one might expect that we would take this opportunity to recommend that our community members sell some or all of their ATRN stock.  A 50% gain in just a few weeks is a pretty nice return in any market.  Another approach we could take is to recommend that our members sell 2/3 of their position.  At yesterday’s closing price of 45 cents, they can book a 50% gain on 2/3 of their position and be left playing with only “house money” (gains) invested. The bottom line for our community members is that we believe the deal to buy the Kazaa assets is a game changer and that our investors should not sell any shares, quite the contrary.  Investors who bought on our first recommendation at 30 cents should give serious consideration to investing additional capital in light of what we believe to be a transformative deal to purchase Kazaa.

We believe the potential for Kazaa is enormous and the deal announced at the end of last week has been overlooked by investors and the media due to the small size and stature of Atrinsic – a micro-cap company with a penny stock valuation approaching negative enterprise value that was heretofore known best for its search engine optimization and affiliate marketing expertise – a company that on its face seems like an unlikely acquiror of digital music assets. We will offer more commentary on this aspect of the ATRN/Kazaa tie up in the near future, but suffice it to say for now that we believe the strengths and assets brought together with this marriage will be very rewarding for shareholders.

In our original due diligence on Atrinsic, we noted that an outright acquisition of Kazaa was a strong possibility and that we believed such a deal would be a catalyst that would eventually bring many new investors to the story.  The trading in ATRN stock since the deal was announced suggests to us that shares are being acquired by saavy traders in anticipation of the deal’s closing and that we should see substantial gains from current trading prices as more details emerge about the combined company’s plans and the online streaming music space gets more attention from investors. We believe that there will be a significant increase in investor interest in the online/streaming mobile music space over the next few quarters if the anticipated services by Apple and/or Google materialize, there is an IPO by Pandora and/or Rhapsody or if we see continued consolidation of the smaller players by larger technology companies. We believe that most if not all of these events will play out over the next 3 – 6 months and that this will cause investors to begin to look at relative valuations in the space, highlighting the latent value in ATRN/Kazaa shares. To gain some context for valuations in this space, consider the deal flow over the last couple of years –

>>Apple acquired the Lala streaming music service for a reported $80 million (though some outlets reported the price was as low as $27 million). Lala had taken in $35 million in venture capital and was valued at $180 million in its last round of funding, though it did not have as many paying subscribers as Kazaa currently does.

>>NewsCorp/MySpace paid $8 million for a practically bankrupt start-up called Imeem when it failed to attract further venture funding and it could not continue to cover the costs of debt incurred in building out its content and delivery system.

>>NewsCorp/MySpace paid $20 million for social music service iLike.

>>Napster – acquired by BestBuy for $121 million. Napster had $67 million in cash at the time, so the net price was $54 million.  However, Napster was losing subscribers, burning cash at a rapid pace and had generally very bleak prospects for independent survival.

>>HP acquired Melodeo streaming music service for a reported $30 – $35 million.

>>Last.FM was acquired by CBS for $280 million

>>Spotify and Pandora have each achieved valuations well in excess of $250 million in multiple rounds of venture funding

Obviously, there is a very wide range of valuations in this space, from $8 million for a nearly bankrupt iMeem to valuations in excess of $250 million for companies that are growing and seemingly on the verge of achieving profitability (Pandora,Spotify and Last.fm). When you consider that the existing Kazaa (still in beta) has already attracted over 80,000 subscribers without the marketing push that we expect to see when all the tweaks to the service are complete, you begin to get an idea of its potential.  When you further consider that Kazaa in its original form was downloaded over 800 million times and had over 50 million daily unique visitors at its peak, it is easy to see how Kazaa could turn out to be one of the big winners in this space.  If the new ATRN/Kazaa can get just 1/2 of 1% of those previous users to come back and subscribe, the company would be solidly profitable on its existing expense base. Given that ATRN’s legacy revenue/expense sharing deal with Kazaa had them footing the bill for Kazaa’s far flung operations for the last couple of years, we believe that the consummation of this merger will allow them to consolidate many of these operations, cut costs and create an expense structure that would allow them to be profitable with even fewer subs – perhaps as little as 125,000 or just 50% growth from what they have achieved while in Beta status.  We believe what transpires here over the next 3 – 4 months will make Kazaa among the first profitable players in the online music space and until one of the IPO’s mentioned above actually comes to market, the closest thing to a publicly traded pure play.

In summary, we view ATRN’s current cash adjusted (no debt) market cap of of just over $2 million as somewhat remarkable given the potential for Kazaa and believe that it represents one of the more striking examples of a valuation disconnect that we have seen.

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