Napster Faces the Music and Dances

If a turnaround happens and nobody notices does it make a sound?

That's the question that Napster (Nasdaq: NAPS) must be asking itself, fresh off its third consecutive quarter of generating positive cash flow, but with its share price perched barely above its balance sheet greenery.

It was a respectable quarter for the digital music subscription service provider. Revenues rose 15% higher to hit $32.8 million in its fiscal Q3. The loss narrowed to $0.06 a share after posting a deficit of $0.22 a share a year earlier.

Napster has certainly curbed its overhead. The company pointed out during last night's conference call that it has reduced its advertising spend by 85%, while still landing more trial subscriptions than it did during the same quarter a year ago.

"This means, quite simply, that our business model is working," CEO Chris Gorog concluded.

OK, but that's not entirely accurate. The company closed the quarter with 743,000 paying subscribers, less than the 750,000 members it had three months earlier. That, in turn, was also lower than the 770,000 paying subscribers it counted at the end of fiscal Q1.

This doesn't mean the model has sprung a leak. It just means that being cash-flow positive carries a price.

The Napster model is also evolving in real time. The company expects to move away from DRM-protected music tracks in the coming months. It plans to offer MP3 downloads for sale no later than June.

Selling MP3s is addressing the market demand for music that is freely portable on all devices, including Apple's (Nasdaq: AAPL) iPod and Microsoft's (Nasdaq: MSFT) Zune, that have closed ecosystems.

The downside is that Napster will be competing with a lot of big fish like Amazon.com (Nasdaq: AMZN), Wal-Mart (NYSE: WMT), and Apple that already sell high-quality MP3 downloads.

Will it work? Can Napster keep its positive cash flow streak going? The key is that these aren't critical questions for Napster. The company has $69.3 million in cash and short-term investments on its balance sheet.

That is not just a cash mattress at $1.59 a share, but it's a perpetual stay of execution. Nobody has to notice the turnaround. Napster has plenty of time to make a sound.