The shareholders, seeking board seats, want the digital music service to turn around its stock slump or pursue a sale.

Napster Inc. has struggled to catch the ear of enough customers. Now the company is out of tune with some of its big shareholders.

With its stock trading at $1.34 and subscribers leaving its digital music service, the Los Angeles company is facing a proxy battle with three investors who together own about 1.5% of the company. They each want a seat on the board and are pushing Napster's management to turn around its stock slump or pursue a sale.

The company, which bought its name from the defunct file-sharing network, said Friday that it was continuing to look for suitors through UBS Investment Bank. But its executives are fighting back, dismissing the three shareholders as a musician, an ice cream franchisee and a middle-management banker who are unqualified to run a digital music business.

The dissident group has put forth "no substantive plan for how its nominees will enhance value for our stockholders if elected," Napster said in a letter to shareholders Friday.

The three shareholders are attacking in advance of the Sept. 18 annual meeting.

In its current incarnation, Napster has been a high-profile example of the challenges faced in finding a winning business model in the uncertain world of digital music, which Apple Inc. dominates with its iTunes store.

Napster has begun several initiatives, including a download store to complement its subscription service. The efforts have done little to lift the stock, which is down 31% this year, but executives say they are poised for a comeback.

"The fundamental strategy is absolutely, unequivocally unchanged from Day 1," Chris Gorog, Napster's chairman and chief executive, said in an interview. "Unlimited access to the world's music catalog any time, anywhere. That's been our vision, our mantra. Everything else along the way are milestones toward achieving that."

Napster was the name of a free music-sharing service used by more than 60 million people before lawsuits filed by the recording industry shut it down. From the ashes of the 2002 bankruptcy filing, Napster's name, its kitten-face logo and some of its technology were acquired by Roxio Inc., a CD-burning-software firm. Roxio adopted the name in 2004.

The new Napster Inc. created a music subscription service and now has more than 700,000 subscribers paying $13 a month to listen to a library of more than 6 million songs. It has a free music streaming service called FreeNapster, which is ad-supported. And it opened its digital music store, which sells songs without copyright protection, in May.

Napster has also pushed to be the mobile music service on cellphones worldwide. Its U.S. carrier partner is AT&T Inc.

Despite being an innovator in a burgeoning field, the 145-employee company has struggled. It recently posted a quarterly loss and said its subscriber base shrank to 703,000 from 760,000. Revenue fell 6% to $30.3 million.

Adding to its challenges, Napster has another competitor in the music subscription space -- Rhapsody America, a joint venture of RealNetworks Inc. and Viacom Inc.'s MTV Networks. It boasts nearly 3 million subscribers, opened its own music retail store in June and recently announced a mobile service deal with Verizon Communications Inc.

Napster's "confidence in the mobile initiative has led them to continue on a do-it-ourselves strategy," said Michael Olson, a senior research analyst with Piper Jaffray. "That's the one glimmering sign of hope. The subscription music model has hit a brick wall."

In its letter to shareholders, Napster called the three dissidents inexperienced with the digital music business and public boards.

Leading the fight are Perry Rod, a professional investor based in Encino who has sung in a band in the Los Angeles area; Tom Sailors, a Dallas investor and former manager at Banc of America Securities; and Kavan Singh, a St. Louis healthcare entrepreneur who also owns and operates 10 Cold Stone Creamery franchises in California and Michigan.

"Napster has been going on a road to nowhere," Rod said in an interview. "It's certainly no surprise that the current board and management are defending themselves so vigorously. They are defending their entrenched positions."

The board members whose seats are up for election are Richard Boyko, a former senior executive at advertising firm Ogilvy & Mather; Philip Holthouse, a partner at an accounting firm; and Robert Rodin, a management consultant.

Gorog, who was CEO of Roxio when it acquired the Napster assets, said he would encourage shareholders to study the current board members' biographies and expertise. But he said he was sympathetic to shareholder concerns.

"We understand their frustrations," he said. "It makes us more committed to increasing the share price."

By Michelle Quinn, Los Angeles Times Staff Writer
August 30, 2008