Start-ups lead push to manage digital rights

This week, the little-known sheet-music retailer saw its stock jump from $12 a share to more than $28 in its initial public offering before cooling to around $19 at the market close.

Internet stocks have moved the bar considerably higher for eye-popping first-day gains, making 50 percent spikes routine. But the movement behind Sunhawk, a small-cap stock below the radar of most analysts, spotlights a hot niche in the new economy: digital rights management (DRM).

The past year has seen a series of high-flying stocks rocket from the DRM launchpad. InterTrust, which provides security for digital content, went public in October and climbed 202 percent in its market debut. That offering was followed in December by competitor Preview Systems, which spiked 299 percent by the close of its first day of trading.

Industry giants such as Microsoft, Sony and Adobe Systems are closely involved in DRM. But that hasn't squeezed out a host of smaller players, such as privately held Reciprocal, which recently lined up some heavy corporate backers.

The promise for such companies is simple: Freely reproducible digital formats, notably the MP3 format, have blazed the trail to the Net and have sent industry groups scurrying to court to stem a growing tide of piracy. Whether those legal efforts succeed, new digital content on the Net must become less susceptible to unauthorized copying before companies will embrace online distribution, according to analysts.

International Data Corp. says the retail market for electronic software distribution will increase to $14.9 billion by 2003 from an estimated $351 million in 1998. Without promising absolute security, DRM could unleash that market by offering encryption and other services, such as assessing royalty fees and tracking sales for marketing purposes.

A key tool DRM firms offer, dubbed "persistent security," allows anti-copying features to follow a given music recording offline to portable music players and personal computers, for example.

"This is pretty key to the whole concept of digital delivery of content," said Jeremy Schwartz, an analyst at Forrester Research. "This is clearly the direction the industry must go in the next few years."

That air of inevitability has been a key factor in driving investor interest in the DRM market. But the complexity involved in securing digital content--and the numerous competing platforms emerging to take care of the job--means that widespread adoption could be years away.

Irv DeGraw, research director at financial information firm WorldFinanceNet.com, warned that high-flying stock prices can be misleading indicators of the strength of individual companies in a hot segment.

"What's driving these valuations is that these are early companies in an industry that is still in an early growth phase," he said. "Institutional investors buy them because they want to be in the sector, but it's too early to pick the winners from the losers, so they pick them all. They're (the equivalent of) options."

In addition, DeGraw said DRM stocks have not performed well in the aftermarket relative to other Internet stocks, pointing out that both InterTrust and Preview Systems have fallen well off their highs amid a general market swoon.

"On average, stocks in this sector at year-end were up about 50 percent from the first-day close," DeGraw said. "That's lousy."

Still, he said that such companies--including numerous pre-public ventures queuing up for IPOs--are well-positioned to take advantage of a strong, if not spectacular, market for protecting and paying for copyright-protected works online.

Enabling digital distribution
Companies like InterTrust and Preview Systems are in effect laying the groundwork for the Internet as a commercial digital distribution channel, according to Soundview Technology Group analyst Kris Tuttle, who recommends both stocks.

"The year 2000 will be a big market development year, during which the infrastructure for digital commerce will be deployed," Tuttle said. Although some digital content transactions are getting done, he said, the market "won't begin in earnest until 2001."

While this is happening most prominently with music, numerous companies hope to offer security across the spectrum, from text to pictures to video.

Other DRM players include Canada's RightsMarket.com and Digimarc, which offers something slightly different: a patented digital watermark technology to discourage, rather than bar, illegal copying. Alchemedia offers protection for digital photographs.

Next month, San Jose, Calif.-based Vyou (pronounced "view") plans to launch its first product, Vyoufirst, which could place tolls on activities Internet surfers have come to expect for free.

"We want to let Web sites determine their own content access policies for any part of their site," explained CEO Pete Levy. He said the software would enable a site to set variable fees for increasing levels of access, from viewing to sharing and printing. "You might charge 50 cents to read the article online, a dollar to email it to a friend, and three dollars for a printout that could then be photocopied and shared around the office," he said.

With so many competing platforms and services, interoperability looms as a serious issue for would-be contenders.

The music industry, for one, has sponsored a standards project known as the Secure Digital Music Initiative (SDMI) to provide a framework for compatibility. But that has not guaranteed cooperation, and some have criticized the group for moving too slowly. This fall the SDMI missed a key deadline to set standards for portable MP3 players, for example.

Rather than being an impediment, the lack of standards is being viewed as an opportunity by one company.

Reciprocal is looking to become a middleman in digital content transactions by streamlining the process and offering interoperability among multiple security platforms.

"The core of our business is processing transactions," said Ghada Hammouda, the company's chief marketing officer. "We want to make security invisible to the consumer and make buying digital products as seamless as possible."

Hammouda added that media companies need to implement procedures sooner rather than later.

"If the industry doesn't deal with this quickly, it will lead to trouble," she said, flagging a potentially unwelcome fallout of DRM for consumers. "Young consumers are getting used to the notion of free digital music, and it may become more difficult to enforce payment down the road."