Napster's Growth Spurt

My, how you've grown, Napster (Nasdaq: NAPS  ) . The on demand music subscription service is on a roll, closing out fiscal 2007 over the weekend with more than 830,000 paying accounts.

If that sounds like a whole lot more than the 566,000 subscribers that Napster watched over just three months ago, you're right. Most of the gain came from 225,000 new subscribers that came over from AOL. Time Warner (NYSE: TWX  ) decided to end its AOL Music Now service back in January, brokering a deal with Napster. In exchange for dropping its AOL Music Now subscribers on its doorstep, Napster would pay Time Warner based on how many of the roughly 350,000 AOL Music Now subscribers switched over to Napster.

I don't know about you, but I think landing nearly two-thirds of those orphaned accounts is pretty good. Both services had similar pricing ($9.95 a month for unlimited streaming through the PC and $5 more for the ability to make the tracks portable to other music devices), but handoffs rarely go this smoothly.

It wasn't all AOL for Napster. The company did land 40,000 net organic additions, too, for the quarter ended in March. As it stands now, Napster has 785,000 premium accounts and 45,000 discounted university-student accounts.

As small as Napster has been, it knows that it can't do it alone. The company has a knack for landing big partners like XM Satellite Radio (Nasdaq: XMSR  ) and, more recently, AT&T (NYSE: T  ) to help spread the word.

Napster believes that it has now lapped RealNetworks' (Nasdaq: RNWK  ) Rhapsody in terms of paying accounts in the on-demand music subscription space. We'll see about that. RealNetworks had nearly 2.6 million music subscribers at the end of December, though that is spread across all of its music-based offerings.

Napster now expects to report more than $28 million in revenue for the quarter that ended in March. Wall Street analysts were expecting just $26.6 million on the top line. Prognosticators will also likely lift their June quarter revenue target of $33.4 million. It is a sequential improvement, sure, but keep in mind that the AOL Music Now subscribers weren't brought on until mid-March. As premium subscribers, they will contribute plenty over the course of the next three months.

Napster didn't disclose its bottom-line performance this morning. You will have to wait until May 16 for that, but don't get your hopes up. Despite the heady additions, Napster is going to be in the red for some time. Analysts don't expect a profit out of Napster until fiscal 2009 at the earliest. It does have a cash-rich balance sheet to see it through until then, but let's hope that the cash burn slows once it pays off AOL and begins to cash in on its organic -- and non-organic -- popularity.

Jam on with some blasts from Napster's recent past:

• Napster had just 566,000 subscribers at the end of December.
• 225,000 more came over from AOL Music Now.
• Maybe someone else will profit from the popularity.

Digital music is a high-growth industry that is often explored as part of the Rule Breakers newsletter service. XM is a former recommendation there. Time Warner is a Motley Fool Stock Advisor pick; AT&T is a former recommendation of that newsletter. 

Longtime Fool contributor Rick Munarriz isn't a subscriber to any digital music service, even though he does have satellite radio. He does not own shares in any of the companies in this story. He 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.