Loudeye acquires OD2, creates digital media giant

Digital media company Loudeye will acquire On Demand Distribution (OD2), Europe's largest online distributor of music, for at least US$38.2 million, the companies announced Tuesday.

The combination of America's Loudeye and England's OD2 will create the world's largest business-to-business digital media company with a combined client base of 200 customers in 15 countries, the companies said. Loudeye and OD2 both sell digital music to a number of partners including retailers, ISPs (Internet service providers) and large companies such as Microsoft that then brand the "while label" music service.

The deal comes on the heels of the launch of the iTunes Music Store by Apple Computer in the U.K., France and Germany last week and the Napster online music service in the U.K. in May. Sony is also expected to launch its Sony Connect download service in Europe later this year.

"OD2 provides the nuts and bolts for third parties that don't have the ways or the will to build digital music services themselves," said Mark Mulligan, senior analyst with Jupiter Research. "The thing to remember is that the OD2 business model is still very valid regardless of the competition from iTunes and Napster, as those companies simply do not want to dilute their brand. This coupling with Loudeye will give OD2 greater financial muscle in the European markets," he said.

OD2, which was founded four years ago by musician Peter Gabriel and its current chief executive officer, Charles Grimsdale, supplies music to a number of partners including Microsoft's MSN, Viacom's MTV and The Coca-Cola Co. In April, OD2 announced it had sold one million downloaded tracks in the first quarter 2004. That compares with the 85 million songs iTunes says it has sold since launching in the U.S. last year, making it the market leader.

According to Loudeye, the acquisition of OD2 will allow the company to expand its customer relationships and partner opportunities, not only in Europe but in other areas such as Australia. It will also allow the company to increase the range of services it offers customers, including antipiracy services that attempt to subvert peer to peer file sharing networks such as Kazaa, which remain popular in U.S. and especially in Europe despite efforts to crack down on "illegal" file sharing practices.

Under the terms of the deal, Loudeye will pay US$20.7 million for OD2 in a combination of stock (US$18.4 million) and cash (US$2.3 million), with an additional US$17.5 million to be paid in cash or stock over the next 18 months, for a total of US$38.2 million in guaranteed payments. More than 90 percent of OD2's shareholders have already accepted the offer, while the remaining shares are expected to be acquired on the same terms no later than October, the companies said.

According to Loudeye and OD2, the combined company will have the world's largest licensed music catalog, including 1.3 million tracks licensed for Europe from the five major labels as well as hundreds of independent labels.

"A significant part of the value proposition is the relationship OD2 has with the record labels. It is not easy to create those relationships that result in licensing agreements," Mulligan said. Loudeye and OD2 will also benefit from sharing similar business models, he added.

One weakness that a combined Loudeye and OD2 will face is in marketing, Mulligan said. "Because they aren't consumer facing brands and rely on retail partners for marketing, they will find it difficult to compete against the marketing campaigns of iTunes and Napster, which as a result will always be the bigger brands," he said.

Loudeye and OD2 may be able to push forward the issue of compatibility and standardizing the formats for storing compressed audio data. Currently players that support Microsoft's WMA (Windows Media Audio) format and Apple's iPod, which supports the AAC (advanced audio coding) format, are forcing consumers to choose between the incompatible formats. AAC is also supported by RealNetworks's media player but Apple's Fairplay digital rights management system keeps RealNetworks services from being played over an iPod.

Convincing consumers to pay for digital music through commercial online services requires a high degree of interoperability between the formats because playing different music on various devices will limit consumer appeal, Mulligan said. Apple has already indicated it has no interest in interoperability, having rejected overtures from RealNetworks, but a company offering an unbranded music service has an interest in pushing the issue of interoperability, though that will be a tough, long road. "For at least the next 12 to 18 months, incompatibility will remain the defining feature of the market," Mulligan said.

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