Looking at Loudeye

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Back in December, a little digital-media company named Loudeye (Nasdaq: LOUD) made a big splash when it announced a partnership with Microsoft. The relationship would allow just about anyone to start an online music store and compete with the big dogs like Wal-Mart (NYSE: WMT), Dell (Nasdaq: DELL), Amazon.com (Nasdaq: AMZN), Sony (NYSE: SNE), Hewlett-Packard (NYSE: HPQ), and Roxio, which are slavering over the online-music pie. The fourth-quarter and year-end numbers recently released by this small cap (I'd call it a penny stock if not for the daily dollar volume) provide a good opportunity to assess its progress and prospects.

But first, you might wonder what the company does. At its core, Loudeye operates what it says is the world's largest digital music library, with eight times more ear candy than can be had at Apple's (Nasdaq: AAPL) iTunes store. The primary business is providing content and content management to third parties for distribution via a variety of enterprises such as online music stores, cell phone networks, or Internet radio.

Like many frightful new technology companies of the past, Loudeye continues to have a bright red bottom line, and the cash it needs to operate is being generated through stock offerings. (Earlier this month, it sold nearly 11 million shares in a private placement valued at $1.85 per stub.) But the firm sees light at the end of the tunnel. This year's losses came to $0.39 per share, with a $0.03 loss for fourth quarter. That's a significant improvement over 2002's $0.75 loss, where $0.25 came in the fourth quarter.

Loudeye's been cutting costs and shedding underperforming operations (like its media-restoration unit). This yielded gross margins of 40% for the year, against -5% for 2002. Management said it hoped to bring the company to profitability by the end of fiscal 2004. Yeah, I know on the surface that sounds like wishful thinking, but Loudeye's aggressive moves toward containing costs has a ring of enthusiasm (dare I say honesty?) and is worth noting.

At around $2.30, shares are up nearly 65% from the December low of $1.40. Make no mistake, they represent a gamble, especially until Loudeye can deepen its shallow pool of customers. But this is one small cap that may be worth a second look and further investigation.

Is Loudeye an eventual Hidden Gem? Take a free test ride of Motley Fool Hidden Gems to find out.

Balding grunge holdout and Fool contributor Seth Jayson says he'll never buy into the whole conformist online music scene, man. He owns no stake in any companies mentioned above.