RealNetworks and MTV Networks formed a joint venture called Rhapsody America to compete in the online music streaming market. They each contributed assets and agreed to governance terms. RealNetworks contributed its Rhapsody streaming service and held a 51% stake, while MTV contributed marketing capabilities and held 49%. They structured exit options like put/call options to address risks, but have since spun Rhapsody off as its own independent entity, conceding so far it has failed to compete with iTunes.
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Deals slides team 1 (1)
1. A Joint Venture Between RealNetworks & MTV Networks Team 1 Kevin Barnett Chelsea Childs Charlotte Lange Joe McVicker OleksandrPankiv
2. How Rhapsody Works Catalog of over 8 million full-length songs Choose from 2 plans: Rhapsody Unlimited ($12.99/mo.) Rhapsody To Go ($14.99/mo.) MP3 Store
3. Basics of the Deal Joint venture announced in August 2007 Limited Liability Company (LLC) Rhapsody America = 51% RealNetworks + 49% MTV Managed by Michael Bloom, Vice President of Digital Music for MTV Alliance with Verizon Wireless
4. Cash Current Rhapsody subscribers Third-party contracts Personnel Rhapsody.com domain Rhapsody brand license Music content License of Rhapsody IP Cash URGE subscribers Third-party contracts Personnel Brand licenses Music content $230 million five-year note for advertising Contributions to the Joint Venture
6. About RealNetworks, Inc. Founded: 1994 Headquarters: Seattle, WA Industry: Internet software & services Products/services: Rhapsody, RealPlayer, SuperPass, GameHouse Revenue: $604.8 million Net Income/Loss: -$243.9 million Employees: 1,993
7. RealNetworks’s Role in the Deal Venture partner with 51% ownership stake Expertise in Internet and software technologies Experience running a subscription-based service
8. About Viacom International Founded: Established in 1971 by CBS, spun-off in 1973 Headquarters: New York, NY Industry: Cable TV, motion pictures Businesses: MTV Networks, BET Networks, Paramount Pictures Revenue: $14.6 billion (2008) Net Income: $1.25 billion (2008) Employees: 11,500 (3/09)
9. About MTV Networks Founded: 1981 Headquarters: New York, NY Owner: Viacom International Industry: Music, TV Channels: Over150 worldwide, including MTV, VH1, CMT, Logo, Nickelodeon, Nick at Nite, Noggin, Comedy Central, TV Land & Spike TV
10. MTV’s Role in the Deal Venture partner with 49% ownership stake Most recognized music brand Rhapsody featured at MTV Video Music Awards Access to TV networks and websites for marketing MTV channels (e.g. VH1, CMT) will be Rhapsody playlists so consumers can download new music featured in the TV shows Popular with key demographic of potential Rhapsody users
12. Verizon’s Role in the Deal Direct marketing through Verizon retail locations Verizon’s V CAST Music service allows customers to: Download music to phones Upload music from PC to phone Access ringtones, etc.
16. The Competition: Apple’s iTunes $2.5 billion in net sales revenue from music-related products/services Catalog of over 12 million songs (4 million more than Rhapsody) Over 10 billion songs downloaded
19. Pre-Contractual Risks and Costs Addressed by Joint Venture Form Adverse Selection Expensive, inefficient information gathering process Protracted, difficult contracting process resulting in inflexible or overly-specific contract terms
20. Adverse Selection Adverse Selection risks exist where informational asymmetry permits opportunism Parties may exploit informational asymmetry in contract or acquisition negotiations
26. Not a discrete exchange: parties must “cooperate to an extent that cannot be specified by contract”
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28. Transaction Cost Economics Field of study that examines the comparative costs of planning, adapting, and monitoring task completion under alternative governance structures Underlying assumption = opportunism Transaction costs occur when parties to a transaction do not operate in unison
29. Asset Specificity Concept of transaction cost economics Creates risk of opportunism at the expense of the party who developed the specialized asset Leads to poor performance in a joint venture Formal contracts can mitigate asset specificity
30. Article IX:Management of the Company Section deals with actions on behalf of Rhapsody that either MTV or Real need permission from the other to take: Changing Rhapsody’s budget; Incurring indebtedness; Making loans; Transferring Rhapsody’s brand name; Committing Rhapsody to merger or sale of its assets; Beginning any litigation; and Neither party may amend the LLC Agreement
31. Business Plan Parties must follow the Plan for 5 years Includes operating budget, target capital contribution schedule, strategic outlook, etc. Provides for cases where parties cannot agree on operating budget
33. Four Exit Opportunities MTV’s Put option RealNetworks’sCall option Drag-Along / Right of First Refusal Tag- Along
34. MTV’s Put Option The put allows MTV to force RealNetworks to buy its 49% interest Not at will; only exercisable in two ways: If RealNetworks undergoes an “extraordinary transaction” without MTV’s written consent If an “impasse” exists
35. Types of Extraordinary Transactions Special cash or non-cash distribution or dividend Extraordinary repurchase, redemption or acquisition Incurrence of debt Direct or indirect sale or disposition
36. RealNetworks’sCall Option Allows RealNetworks to force MTV to sell its 49% interest to it according to specified valuation techniques Not at will, only exercisable if an “impasse” exists
37. Impasse Both the put and the call vest if an impasse occurs According to the definition, an impasse can only occur if, for two consecutive Fiscal Years, there has been a Budget Approval failure and any of the Impasse Financial tests have not be met
38. Drag- Along / Right of First Refusal RealNetworks may transfer its interest to another party and ‘drag-along’ MTV’s interest Option requires MTV to sell its interests on same terms to a prospective purchaser of RealNetworks’sinterest MTV reserves the right of first refusal
39. Tag-Along MTV may ‘tag-along’ its interest into sale to the potential bidder if RealNetworks decides to transfer its ownership Tag-along sale is on the same terms
41. Rhapsody America’s Results Spent roughly $119 million on advertising Subscribers in 2010 are down from 2009 by 100,000 to 700,000 Apple’s iTunes is still the dominant player, even without a subscription-based offering
42. The Spin-Off Press release announced spin-off to independent entity RealNetworks to contribute operating capital MTV to contribute advertising Both RealNetworks & MTV will retain slightly less than 50% interest
43. Conclusion Rhapsody America failed (so far) to compete with iTunes Parties faced pre- and post- contractual risks when structuring the deal Joint venture form meant to address these risks Spin-off concedes failure, but demonstrates parties’ commitment to the venture’s potential
Rhapsody is a music service that can be compared to cable TV: customers pay a flat monthly fee and get unlimited access to Rhapsody’s catalog of music.The Rhapsody catalog includes all genres of music from major label artists to indie bands.Rhapsody Unlimited: Listen from any computer and some compatible home audio systems.Rhapsody To Go: Listen with mobile apps for your iPhone/iPod, or transfer songs to compatible MP3 players.MP3 Store: Option to purchase individual songs to own forever – even after subscription ends
The joint venture intended to launch Rhapsody as a competitor to Apple’s iTunes.Michael Bloom was appointed to manage Rhapsody. As MTV’s CEO for URGE, he had experience running an online music service, but he didn’t have experience running a successful one. URGE was a flop, so we found it surprising that the parties agreed to give him a second chance by running Rhapsody.Joint governance.Long-term alliance with Verizon Wireless to integrate Rhapsody into V CAST music service on cell phones
Both companies contributed cash for operations and the subscribers of their respective music servicesURGE: MTV’s URGE service was a partnership with Microsoft, launched in 2006. The partnership dissolved, in part, because Microsoft “betrayed” MTV by launching its Zune Marketplace (MP3 store) for the Zune player.The brand licenses that MTV contributed include MTV, VH1, and CMT, among others.
Products/servicesRealPlayer: A media player that allows you to download video from thousands of Web sites and transfer them onto mobile phones and portable devices, such as smartphones, iPods, Sony PSPs, and Microsoft Xbox.SuperPass: A monthly package that includes 10 MP3s, one casual game, and hours of exclusive premium content.GameHouse: Real is the largest creator, publisher and distributor of casual video games. Some popular Real games include Scrabble, Uno, SuperCollapse, and Sally's Salon.The figures shown on this slide are reported as of Dec. 31, 2008 and were taken from Real’s 2008 Annual Report.Revenue: Real had an increase in net revenue from 2007 to 2008. In 2007, net revenue was $567.6 million.Net Loss: Real had a net loss at the end of 2008. The previous year (ending 2007) Real’s net income was $48.3 million.Employees: Of the 1,993 employees, 1,774 are full-time and 219 are part-time.
Real’s 51% ownership stake comes from it’s previous 100% ownership of Rhapsody (after purchasing it in 2003) and then selling MTV its 49% interest at the start of the joint venture in 2007.Experience running subscription-based service: RealNetworks originally purchased Rhapsody (Listen.com at the time) in 2003 for $36 million and ran the service independently until contributing it to the joint venture in 2007.
Revenue: Up from $13.4 billion in 2007.Net Income: Down from in $1.63 billion 2007.
Viacom acquired MTV Networks in 1985.MTV reached approximately 96 million US households; and in more than 520 million households in 160 countries and territories worldwide. (As of December 31, 2007)
MTV committed to prominently displaying the Rhapsody brand at its marquee event — the Video Music Awards in Las Vegas on Sept. 9, 2007.
V CAST allows customers to:Download music instantly to their V CAST Music-enabled phones, over the air, at any time and from anywhere in the V CAST service areaFill their phones directly from their PCs with music from their Rhapsody subscription Access an extensive catalog of ring-back tones, ring tones and other music-related content
Source: PricewaterhouseCoopers’ Global Entertainment and Media Report, 2008After video games, recorded music is the second greatest revenue-producer in online entertainmentGames = 35%Recorded music = 20%Newspapers = 4%Films = 4%Magazines = 1%Other = 36%
Industry analysts expected revenues from online music services in the US to grow from $814 million in 2005 to nearly $3.4 billion in 2010Worldwide, revenues are expected to reach $5.5 billion in 2010, up from $1.2 billion in 2005.Figures shown include online, mobile and subscription trade revenues. 2008 figures are estimates. Figures rounded and expressed on a fixed exchange rate.
As of Sept. 2007, Apple had $2.5 billion in net sales revenue from music-related products and services (including iTunes Store sales, iPod services, etc.) Considering that digital music revenues for 2010 are expected to reach roughly $3.4 billion, Apple is clearly the dominant competitor in the industry.iTunes Store sells 90% or more of digital downloads in the U.S., according to people in the music industry. (WSJ article)Users have downloaded over 10 billion songs as of Feb. 2010The 10 billionth song downloaded was “Guess Things Happen That Way” by Johnny Cash
We all know that Napster faced numerous lawsuits regarding illegal file-sharing that allowed users to listen to copyrighted music for free. Napster’s brand name and other assets were bought out of bankruptcy in 2002 and new, legal, and subscription fee-based Napster service was launched the following year.LimeWire is a P2P service, similar to the old Napster. Legality is questionable.Pandora creates “radio stations” based on music that you choose (for example a Britney Spears station) and you can listen over the internet on your PC.Last.fm is similar to Pandora – it is an internet radio site that bases the music played on your tastes.Emusic.com is subscription-based, like Rhapsody.Spotify is similar to Rhapsody, but has a free “lighter” version available by invitation from existing users. It also allows you to create and share playlists with your friends.
Where parties want to enter into a long-term arrangement, rigid contracts may not be the most efficient or effective form In a strategic alliance, parties typically want something akin to sustained best efforts from each other This standard is “necessarily vague” – defining each party’s responsibility too rigidly would be counter-productive: Increases complexity and cost of deal Would not allow for responsiveness to market or unforeseen operational challenges or synergies
Parties remain tied to the success of the ventureBecause both parties retain interest in JV, overvaluing assets makes little sense Information-Gathering Process may be deferred Once JV is under way, accessing information about other party is more affordable and efficientSince one party to a JV often ends up buying out the other, deferring informational costs increases overall value
Transaction costs result in delays, breakdowns of communication, and overall decrease in the dealGoal of parties is to decrease transaction costs and therefore increase the value of the deal
Concept of transaction cost economics: that describes the degree to which investments are specialized to a particular transactionLeads to poor performance in JV: Asset specificity is bad for joint ventures because both parties need to be pulling their weight; if one party devotes time and resources to engaging in opportunistic behavior, that means that correspondingly less time and resources are devoted to ensuring the deal’s success.Mitigation through formal contract: Formal K can mitigate asset specificity risks:It provides rules & procedures to apply in future situations, reducing uncertainty about behavior and outcomesThe punishments it sets out serve as a reference point to judge the extent of opportunismSince the K prescribes the nature of a transaction, partners can rely on it to resolve conflicts & disputesApplying this to Rhapsody JV, because the value of the parties’ initialinvestments depended on continuation of the relationship, they selected the structure and terms that best reduce asset specificity risks.
A starting point for addressing these risks is Article IX of the LLC AgreementThis list illustrates some of the more crucial decisions that should be made by both parties in order for the JV to be successful
Article IX refers to a “Business Plan” for the JV that both Real & MTV must follow for 5 years following the agreementIf there is a failure to approve the operating budget, Real has the option to adopt one on its own and fund it with an unsecured loan without MTV’s permission, as long as Real makes up for any operating losses that fiscal yearIf there is a failure to approve the annual operating budget for 2 consecutive fiscal years, an impasse resultsIf this happens, the CEO’s of Real and MTV must be notified of the impasse. The CEO’s then must make a good faith attempt to resolve the matter within 30 days. If the parties still cannot reach an agreement, the put-call provisions may be invoked.
2) Extraordinary repurchase, redemption or other acquisition of RealNetworks Parent Equity with a few qualifiers3) Incurrence of indebtedness: in excess of 20% or more of the revenues or assets of RealNetworks or its subsidiaries taken as a whole4) Direct or indirect sale or disposition: in one transaction or a series of related transaction, of assets or business that constitute 25% or more of the revenues, net income or assets of RealNetworks and its subsidiaries taken as a whole
-Drag along: If, after 5 years from the effective date, RealNetworks wishes to transfer its interest to another party, it shall be entitled, at its option, to require MTVto include all of its Interest into such sale- MTV’s RFR: Gives MTV the right to purchase RealNetworks’s 51% interests at the same terms it was offering to the potential buyer.
If, after 5 years from the effective date, RealNetworks wishes to transfer its interest to another party, it must notify MTV of the agreementMTV reserves the right, through the tag-along option, to require the potential bidder to buy its 49% interest upon the same terms agreed for RealNetworks’s 51% interest
Spent approximately $119 million spent on advertising since August 2007 – over half of the value of MTV’s $230 million five-year noteDespite the high advertising expenditures, subscribers are down.
RN’s press release of Feb. 9, 2010 announced plans to restructure Rhapsody America into a newly-formed corporation that will operate independently from the parent companies.No single majority owner will run Rhapsody.Real’s operating capital contribution is $18 million in cash.MTV advertising commitment of $33 million – this will also dismiss the remaining $111 million of the $230 million note originally contributed to the JV.Other shareholders will hold the small interest that remains after MTV & RealRNsaid the spinoff will allow the company to focus on its other businesses, including casual games and its RealPlayer software.The benefit is that it won’t consolidate Rhapsody’s financial results with Real’s consolidated financial statements anymore.
Pre- and post-contractual risks included information asymmetry, adverse selection, asset specificity, and moral hazard.Structuring the deal as a joint venture addressed these risks by attempting to align the parties’ interests, create incentives to ensure the deal’s success, mitigate the possibility of opportunistic behavior, and limit exit options.JV structure tied parties together so effectively that even exiting the deal required a joint effortMTV and Real reached an agreement regarding their exit much in the same way they agreed to enter the joint venture in the first place.
