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Does iLike price show cost of Facebook dependence?

Sources say iLike's dependence on Facebook is partially to blame for music service's small valuation. Is this a warning for third-party platform developers?

Music service iLike is dependent on Facebook for 80 percent of its traffic and revenue, and that fact has suppressed iLike's value, say sources close to the music service.

MySpace has offered about $20 million to acquire iLike, a music recommendation site and provider of Facebook's most popular music application, sources with ties to iLike said. They added that the deal could close at any time. TechCrunch first reported the acquisition talks.

Some in Silicon Valley have speculated that MySpace isn't willing to pay more for iLike because it fears Facebook will boot iLike once its main rival takes control of the service. But that doesn't go far enough in describing the situation, said one of the sources. What has pushed iLike's valuation down is a problem with control. The company's managers have no way to prove to potential acquirers that their business model has a bright future because they can't predict from one day to the next which direction Facebook's Platform will go. The source said that leaders at iLike, or any other company on the platform, are not truly in control of their fate--Facebook's Mark Zuckerberg is.

"The cash flow of any company doing business on Facebook's API, or Facebook Connect, or Facebook platform is inherently at risk," said the source. "The multiple that an investor can place on that cash flow is not that much greater than 1, because you never know at which point Facebook could change the terms of the relationship or change the technology and cut off that cash flow."

There is no question that plenty of other factors may have contributed to iLike's meager sales price, but the questions raised by the music service's predicament may be a warning to companies that have banked on the developer platforms created by Apple, Twitter, and Facebook. It only makes sense that potential buyers of these pilotfish start-ups would demand a price that reflects the risks. After all, what happens if Facebook or Apple decides they want to compete in your sector? Click, off go the lights.

Facebook representatives did not respond to an interview request. Ali Partovi, iLike's CEO, on Tuesday issued a terse statement: "Twitter and the iPhone are the platforms of the future."

At the very least, this apparent snub of Facebook indicates that the once friendly relationship between Facebook and iLike has seen better days. The brothers Partovi, Ali and Hadi--iLike's co-founders--were chummy enough with Zuckerberg, Facebook's CEO, to throw him a party in 2007. The celebration was intended in part to show the Partovis' appreciation.

The brothers had plenty to be grateful for. Out of iLike's then 11 million users, 7 million came from Facebook. Critics of iLike will no doubt point out that the ad-supported music company acquired most of its now 50 million registered users from Facebook. They will also likely note that even with all that traffic, iLike wasn't exactly a cash machine. Ali Partovi told me last week that after running the company, in some form or another, for the past six years, it was cash flow positive for just the past eight months.

The company didn't license full-length songs from the four big record companies, so it didn't have the same large overhead of some of its rivals. But it also wasn't generating much revenue, the source said.

"Twitter and iPhone are the platforms of the future."
-- Ali Partovi, CEO, iLike

The company also competes in one of the biggest underachieving sectors in digital entertainment. Ad-supported music is still in its earliest stages of development, but the sites that have crawled out of digital music's primordial ooze don't look so good. Some of the pioneers, such as Ruckus and SpiralFrog, are already dead. Others, such as Imeem and Qtrax, have wrestled with financial setbacks. MySpace's own music service has failed to live up to expectations since launching nearly a year ago, according to music industry sources.

And news reports indicate iLike was searching for a buyer as far back as last year. Certainly, all of that could have helped drive down a valuation.

And there's yet another twist: a source close to MySpace said Rupert Murdoch's social-networking site is interested only in iLike's technology and couldn't care less about the music service's traffic. The source said many of iLike's users have downloaded its app but don't use it very much. Mike Arrington at TechCrunch wrote that iLike has built a tool to help users make recommendations and artists publish their work. The technology can be used as well for videos and games.

Murdoch has said that he intends to remake MySpace into more of an entertainment hub. Since MySpace already offers music and video, it might be a good bet that MySpace would dive into gaming.

One thing is for sure: MySpace would not buy iLike to obtain the company's download licenses for MySpace Music. Last week, iLike began testing a download store where it will sell MP3s from all four major labels. But MySpace Music already owned licenses to offer song downloads. For some reason it has yet to offer them, according to music industry sources.

At the same time MySpace tries to get its music house in order, the iLike situation throws the spotlight on Facebook's music aspirations. For a long time the company seemed content with allowing iLike to be the site's de facto music offering.

In March 2008, The Financial Times reported that Facebook was in talks with the largest major labels about launching a music store. Nothing ever came of it.

One can only wonder that if MySpace buys iLike, will that send Facebook back to the negotiating table with the big labels.