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THE DAY AHEAD: Amid slide, CDNow reprices its stock options

CDNow (Nasdaq: CDNW) is quite busy these days explaining how the company has enough cash for now, how accountant concerns are old news, and how the company should be appreciated for its customer accounts and traffic growth.

Maybe CEO Jason Olim and company would like to explain why CDNow repriced its issued and outstanding stock options at $5.625 on March 20. Employees, officers and members of the CDNow board hold the options, which are supposed to be an incentive to boost performance. If an employee has options with a strike price of $10 and the stock is at $20, that option holder pockets the difference. If an option strike price is above the actual share price, the options are worthless.



CDNow: Who are the most likely buyers?



CDNow execs were holding a lot of worthless options. So, instead of boosting company performance and the stock price, CDNow chose to lower the options bar.

A passing mention about the repricing was found in CDNow's annual report. It wasn't immediately clear where the options were initially priced, but the company said they "were set at an exercise price greater than the closing price of CDNow common stock on March 20."

Repricing options, which has had shareholder activists screaming for years, is the equivalent to a pat on the back for failure. Typically, a stock crumbles and a company reprices options so high-level execs can still cash in. Most repricing moves don't require shareholder approval.

The repricing means CEO Olim will make out as long as CDNow shares break the $6 level. Not bad for a guy who has seen the company fall from an April 1998 peak of more than $35. Not bad for a guy who was stood up by Columbia House after the AOL-Time Warner merger. And not bad for a guy who is the leader of the company that will be best known for being one of the first dot-com casualties.

Shareholders would be peeved about the options repricing if there wasn't a touch of black humor to the whole thing. CDNow execs can't reprice options fast enough. At Thursday's closing price of 3 13/16, CDNow’s repriced options are still underwater.

What's CDNow really worth?

Although the CDNow deathwatch is on, a few investors have concluded that CDNow shares may be a bargain.

These investors think like this: CDNow has 3.5 million customers, a strong brand and lots of traffic. Given those stats, CDNow has to be valuable to somebody.

In a serious case of damage control, CDNow said Thursday it reported 5.7 million unique visitors in February, and added that it attracted more visitors than Barnesandnoble.com (Nasdaq: BNBN).

So what is CDNow really worth?

CDNow has no warehouses or hard assets that can be easily valued. Instead you have to value the company based on customers, traffic and brand. Robertson Stephens analyst Lauren Cooks Levitan sums it up well. "High site traffic and a large customer following are not sufficient to drive a successful business," she said.

We'll acknowledge that CDNow has a good brand in the music business. But a company could buy CDNow and do away with the brand. Does the buyer want to inherit all the public relations -- not to mention investor relations -- baggage CEO Olim has wrought?

That leaves the CDNow customer list as the main asset. We reckon CDNow's 3.5 million-customer list may be worth the company's $115 million market capitalization. These customers are also loyal and drive traffic.

Counting customers

But valuing CDNow's database is tricky. Amazon.com (Nasdaq: AMZN) has the lowest customer acquisition costs in e-tailing, paying just $19 to acquire a customer. Using Amazon.com's figure, CDNow customers would be worth $66.5 million. Toss in what's remaining of CDNow's cash and brand, and the company might not get a premium even at its depressed market cap.

That's admittedly a lowball offer. The problem with basing a takeout price on customer acquisition costs is no one can agree on what a customer is worth. Jupiter Communications said it doesn't track the figure because it can be skewed through fancy accounting.

Merrill Lynch reiterated Jupiter's comments. Most analysts, however, agree that average customer acquisition costs probably hover in the $40 to $50 range. Analysts said $100 for a customer is very high and Amazon.com's tally is very low. Using the $40-a-customer figure, CDNow's customers are worth $140 million.

The big question is whether music customers are more valuable than, say, book customers and toy customers. And just because CDNow spent heavily to acquire customers doesn't mean its buyer will.

Friedman Billings Ramsey analyst Robert Martin, who has been watching CDNow shares, figures CDNow will get $10 a share, or $300 million, in a best-case scenario. Judging from my e-mail, that figure will disappoint those loyal CDNow shareholders, especially those investors who failed to bail in time.

The more likely scenario is that some company will buy out CDNow for $6 to $8 a share. As for the potential buyers, online e-tailers such as Barnesandnoble.com may be interested in CDNow to broaden its reach. Brick-and-mortar retailers such as Tower Records could also bankroll CDNow. Content sites such as MTV.com could use CDNow to add more e-commerce. Toss eMusic (Nasdaq: EMUS) and MP3.com (Nasdaq: MPPP) into the mix too.

"CDNow is a top five brand on the Web," said Martin. "You would think that would account for something."

You'd think.