The True Potential of ATRN – Kazaa

1. With Facebook: Facebook is in the process of rolling out its Music Dashboard, which greatly favors on-demand license holders. Appropriately, ATRN has already invested R&D resources to integrate Kazaa with Facebook. Considering that music addresses a much larger audience than games, the Music Dashboard promises to have a much bigger impact.

Zynga has been the big winner on Facebook games and its IPO is expected to value the company in the range of $10 billion. This suggests that there could be several $1 billion+ winners in the Facebook music battle. However, ATRN is one of only a few players with the necessary licenses. Yes, $1.2 billion…with a “B”. With a track record like that, growing ATRN’s revenue to a couple hundred million dollars doesn’t seem far fetched at all.

As eye-popping as that move would be, it would come as no surprise to some — ATRN’s shares were over $50 in 2008 before the market collapsed (they got as high as $68 in 2007). A lack of institutional coverage has contributed to ATRN’s failure to head back toward those highs. However, with Pandora’s IPO and increased attention in this space, that could change soon.

Privately-held players are also fetching premium valuations. For example,  Spotify reportedly raised another $100 million in March, valuing the company at $1 billion, more than triple its prior valuation. A similar valuation would send ATRN’s shares rocketing to $50, a 20-bagger from here.

Conclusions: ATRN exhibits classic characteristics of a company with grossly undervalued shares. Its most coveted assets are not reflected on its balance sheet. There is a chance of the integration including Spotify, ATRN – Kazaa and other music service companies.

2. With Pandora: Pandora’s music rights are more common and limited in scope. Indeed, the market seems headed toward an end-game except Facebook music integration. There are two possibilities: 1) Pandora will acquire one of on-demand license holders. If Pandora chooses Kazaa, ATRN shares will jump a lot in a short term.  2) The remaining on-demand license holders will develop Pandora-like functionality. Kazaa has already made some major moves to become more like Pandora. Thus, ATRN has been thrust into the right place at the right time.

3. With other big company: Writing software to stream music is relatively easy. But entering the Internet music market against Pandora is not as simple as many believe. With the explosive popularity of Internet-based music, major record labels have become resistant to hand out new on-demand licenses to anyone. Just ask Apple (AAPL) and Google (GOOG) — they’ve tried for a long time with no luck. If these giants want a legitimate and significant foothold in the marketplace, they may need to acquire one of the existing on-demand license holders. However, Rhapsody and Napster’s owners are unlikely to sell at an attractive price. As for the private vendors, only two appear ripe for acquisition, but their VCs surely know the value of their licensing rights (value listed). Thus, ATRN may be the only underpriced asset left in the market.

• Viacom : $33 billion; Best Buy : $11 billion; Sirius : $8.5 billion

• Pandora : $3 billion; CC Media : $650 million; RealNetworks : $500 million

And here’s where it gets good…

Kazaa paid $100 million for those hard-to-get licensing rights. However, this value does not show up on ATRN’s balance sheet. As result, ATRN’s market cap has drifted well below those levels. At present the company is only valued around $15 million. A $100 million valuation for its music licenses (which now appear unobtainable) implies that ATRN’s shares (which have recently traded in the $2 – $6 range) should be worth more than $15. Forget being poised to triple…based on this metric, shares of ATRN could be poised to six times.

4. Management: The company recently raised cash and landed the heaviest-hitting CEO I’ve ever seen such a small public company attract. His name is Stuart Goldfarb and until recently he was the President and CEO of Bertelsmann Direct North America. For those who don’t know, Bertelsmann is a $20 billion giant, described by Wikipedia as “the most international media corporation in the world”. As ATRN’s press release states, Goldfarb built Bertelsmann DNA into “the world’s largest direct marketer of music, DVDs and books (with over 20 subscription and membership “club” businesses including BMG Music Service, Columbia House, Book-of-the-Month Club, Doubleday Book Club and yourmusic.com), serving over 14 million members with revenues of over $1.2 billion”.

5. Improvement: Kazaa is moving forward with some exciting enhancements and innovations. In Q1, it released its optimized mobile browser in March, enabling users to stream music to their mobile devices, a critical step toward competing on the same level as Pandora. Not surprisingly, management indicated that this new capability instantly resulted in a “significant improvement” in virtually every important user / usage metric. In fact, subscriber-growth accelerated to an annualized rate of nearly 50%. With its new Pandora-like radio functionality, Kazaa appears well-positioned to show continued accelerated growth…

Most notably, we believe that ATRN will soon offer Kazaa via an iPhone / iPad app. When Pandora released its iPad app, in 2010, sales growth went through the roof. After posting 35% growth in 2009, Pandora’s sales nearly tripled in 2010. They’re on pace to do so again this year. If ATRN follows suit, sales could hit $230M 24-months from now.

That may sound like a stretch, but Pandora has already proven it can be done (did you know who Pandora was 2-years ago?). Besides, even if ATRN “only” grows to $100M over the next 2-years, it would be nearly as big as Pandora is today. A comparable valuation would be $2 billion or $300 per share, 100x today’s levels.

Most importantly, ATRN’s market is now getting hot (in this case, red hot). Yet the shares remain under the radar because institutions and retail investors have yet to rediscover it.

Looking at ATRN’s 5-year chart, it’s clear that the stock has been forming a base over the last year. In fact, the stock is now starting to rise, indicating that sellers are no-longer be willing to sell at a discount (or at all). This could lead to sharp gains in a short period of time, because most of ATRN’s shares are in the hands of insiders or large buyers like Trinad Management. Any such move is sure to hit traders’ screens for daily gains. Soon after that, the cat will be out of the bag.

In the meantime, for a few dollars per share investors get a company that paid $15 per share for music licenses which much larger companies are now desperate to obtain. With success, ATRN’s stock could rise by 5x, 10x, or even 100x. With failure, investors could still profit handsomely, as AAPL, GOOG, P, or another eager company swoops in for the ammunition (licenses) it needs to enter hot music service field.