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Why Can't They Be More Like Apple?

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Digital music is quickly becoming a matter of separating the Apple (Nasdaq: AAPL  ) from the Apple-Nots.

Music-subscription service Napster (Nasdaq: NAPS  ) and digital-music specialist Orchard (Nasdaq: ORCD  ) announced their quarterly results last night. The numbers weren't pretty, particularly for Napster.

Take a lap, Napster
Everyone remembers Napster as the renegade peer-to-peer file-swapping network, but music fans may be forgetting about its subsequent rebirth as a legal subscription service. Revenue fell by 6% to $30.3 million during the quarter. Napster's net loss came in essentially flat with the $0.10-per-share deficit it posted a year ago.

The upside is that Napster has now been cash flow-positive for five consecutive quarters. The company points to new mobile initiatives and May's launch of its MP3 store as incremental developments. Getting its subscribers to buy more a la carte tunes is also paying off, with the average subscriber buying 10% more now than a year ago.

So why is the bottom line fading despite all of these improvements? You guessed it -- the subscriber base is shrinking. The company now claims 708,000 paying subscribers, less than the 770,000 it had a year ago.

Where did all of the Napster heads go? Well, Apple is still growing. Sirius XM Radio (Nasdaq: SIRI  ) has had no problem growing its premium satellite-radio subscriber rolls, either. The appeal of digital music is expanding, it seems -- just not at Napster.

Investors can take comfort in knowing that Napster is trading for less than the $1.60 a share in cash on its balance sheet. So while renegade music buffs turned to Napster several years ago for free music, investors today can get Napster itself for free. As long as the company remains cash flow-positive, there should be some kind of floor. However, if Napster can't grow, there's no point in talking about the ceiling.

Harvesting losses in the Orchard
Unlike Napster, Orchard is growing nicely. Revenue grew 111% to $13.4 million in its latest quarter, and its deficit narrowed. That top-line spurt includes a little padding from last year's combination of Orchard with Digital Music Group, but even on a pro forma basis, the combined company's revenue would still have climbed by a hefty 41%.

Orchard isn't trying to take on Apple as a digital storefront, the way Napster and RealNetworks' (Nasdaq: RNWK  ) Rhapsody are. It would rather ride Apple's coattails. Orchard has a growing catalog of music and videos, with which it can collect royalties through sales on Apple or digital video streaming on Netflix (Nasdaq: NFLX  ) .

Orchard is aggressive in grabbing content, too. But is aggressive always good? It recently swooped in to buy bankrupt indie record label TVT Records, home of crunk pioneer Lil Jon. Now, expanding a collection of moneymakers is commendable, but labels don't go under without a reason. Orchard has skills in digital monetization, yes, but investors have been burned before. ARTISTdirect, for example, was an online-music specialist that tried to make it as a record label. It has moved on, but the scars linger: A handful of nickels will get you a handful of those shares today.

Being both a label and a digital distributor may be a way for Orchard to double-dip in Apple's coffers, but it's also quite a risky endeavor. Live Nation (NYSE: LYV  ) has successfully moved into label mode with its head-turning deal with Madonna, but that's because Live Nation is a masterful concert promoter. The learning curve is steeper for everyone else.

There's only one Apple
Low-priced digital-music companies such as Napster and Orchard could sway investors, but until either company discovers the secret to profitability, investors will be listening to a tune of little more than hopeful speculation.

Looking for the next Apple? Why can't the current Apple be the next one? Apple is growing, it's profitable, and it's the only company that has excelled at chasing its own tail in digital music.

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Netflix and Apple are Motley Fool Stock Advisor recommendations. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz has bought more digital downloads than CDs this year, but that's not saying much. Howns no shares in any of the stocks in this story, save for Netflix. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

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10/28/2016 12:03 PM
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