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Loss-making OD2 and Loudeye join... er... forces

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US digital music distributor Loudeye has acquired On Demand Distribution (OD2) for $40.5m in cash and shares.

Loudeye is buying OD2's European customer base and music licenses, saving it the effort of setting up a competing operation from scratch, and doubling revenue at a stroke. OD2 is only pulling in $2.5m a quarter - and making a loss, Loudeye reveals. So the buyer is clearly banking on considerable growth going forward, not only to reverse the downward trend in Loudeye's own revenues, but to justify the cost of the transaction.

This is the big question: is that growth there? There are certainly plenty of bullish predictions as to the size of the global digital music market. Loudeye notes that $11bn worth of recorded music were sold in Europe last year, and that researcher Forrester anticipates European digital music sales of $1.6bn come 2007.

But who will take the lion's share of that total? OD2 has built up a big customer base in the five years since its foundation in 1999 and the launch of its music service in 2001.

But As we've noted before, the company's customers are primarily ISPs. It has three partners with music-oriented brands: MTV Europe, Virgin and HMV.

Muscle beached

Virgin is expected to desert OD2/Loudeye in due course, following the formation of Virgin Digital, which will resell songs sourced from Loudeye rival MusicNet. Sources familiar with MTV's plans claim the company will soon partner with MusicNet in the US, a deal that could be matched in Europe now that MusicNet is operating over here.

MusicNet will say only that it is preparing to announce UK deals with "big name" partners, in addition to Virgin. In the US, its key customer is AOL, though that partnership does not (yet) extend to the UK.

HMV will soon announce a revived digital music offering, a move which likewise could see the high street retailer change distribution partners - possibly signalled by its decision to start selling iPods.

OD2's key European partner is Coca Cola, which uses OD2 to feed its UK MyCokeMusic store. Coca Cola is important because it's one of the few operations with the brand familiarity and - crucially - marketing muscle to promote its music service in the face of what Apple is doing with iTunes, of what Virgin is going to do with Direct and what Sony may well do with its upcoming digital music service, Connect.

To date, OD2's partners have not been particularly big marketers, and it's hard to see the likes of Tiscali, MSN and Wanadoo devoting large proportions of their marketing budgets to tout one, small aspect of their websites. Their money is going on promoting broadband subscriptions. Music downloads may be a part of this service, but not big enough to match what Apple is doing.

Going forward, OD2/Loudeye's big challenge will be to find partners who can match the big guns' marketing muscle and match the pricing bar put in place.

In the short term, they will need to consider how they will align their respective technology offerings: OD2's own Windows-based system and Loudeye's MusicStore Platform. The same goes for the two companies' workforces. OD2 CEO Charles Grimsdale will now become head of Loudeye's international business, and the rest of the OD2's "senior executive team" will stay on in their current roles, nbut nothing has been said about either companies' other workers. OD2 employs 80 people.

The acquisition will have an upfront impact on Loudeye beyond the actual cost of the purchase: it "expects to incur increased expenses from integration costs (and) non-cash amortisation charges required in connection with the transaction" not to mention the fact that OD2 is losing money - as is Loudeye.

Loudeye lost $2.8m during Q1 2004, on sales of $1.9m, down from $3.3m in the year-ago quarter.

Loudeye said it would begin taking a hit on the purchase from fiscal Q3, commencing 1 July, onward. It will pay $20.7m in cash ($2.3m) and shares ($18.4m), plus a further $17.5m over the next 18 months. ®

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