Better To Sink Napster Than Sell It -- Ask Management

Almost 90 percent of the market valuation of Napster Inc (NAPS-$1.41) evaporated since 2004 as investors fled the digital music company, tiring of management’s inability to wrestle away any market share from rival Apple Inc or Internet piracy.

Three shareholders, who beneficially hold 1.7 percent of the company stock, are waging a proxy battle for seats on the board.

Shareholders Perry H. Rod, Thomas Sailors and Kavan P. Singh said that Napster shares would be worth at least $1.79 in liquidation—and probably $6.47 a share based on comparable valuation benchmarks in the digital music space.

A buyout of the company, however, may depend on how the company's 2008 proxy statement is voted on come September.

One of the proposals brought forth this year is to not remove any extensions of the company's shareholder rights plan. As company policy stands right now, stated in the current proxy: "no provision exists in the Company's Bylaws requiring management to solicit proxies on behalf of challengers to the incumbent board."

Management believes it serves the best interest of all shareholders to maintain the status quo, noting that "takeover attempts frequently include coercive tactics, such as partial or two-tier tender offers that do not treat all stockholders equally."

The Board previously approved the Rights Plan in order to deter tactics that unfairly pressure stockholders, squeeze them out of their investment without giving them any real choice, depriving them of the full value of their shares.

Management wants to throw up obstacles, making it more difficult to take out the company; whereas, shareholders on the other side of the proposal would like to make it even easier for the company to be taken over.

In order to have better insight into the rational behind each side of the proposal, it makes sense to understand the incentives driving each party’s behavior, whether to sell or not to sell the firm.

CEO William Gorog and President Bradford Duea beneficially own approximately $4.43 million and $688,576, respectively, in company stock.

Gorag currently owns approximately 1.95 million shares (fully vested) in outstanding equity awards exercisable between $3.87 a share and $15.25 a share.

Duea is sitting on about 235,000 equity options (fully vested) exercisable between $3.87 a share and $15.25 a share, too.

If a change in control of Napster occurs, and his employment was terminated without cause, all of his outstanding stock option and restricted stock awards would immediately become fully vested—although worthless!—and Gorog would be entitled to severance of $1.87 million (with no tax “gross up”).

Under Mr. Duea’s employment agreement, he would receive an estimated $300,00 in cash payments upon severance for good reason after a change in control.

I'm sticking with you'
Cos I'm made out of glue
Anything that you might do
I'm gonna do too ~ Velvet Underground “I’m Sticking With You” YouTube video

Named Executive Officers have nothing to gain by selling the company—even for twice the current market cap of $67.87 million.

In the meantime, the company is struggling to turn a profit, shareholders want out, and the vulture funds are circling.

Editor David J Phillips and Columnist Eric I. Schleien do not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.