Napster is beginning to ramp up its ad-based business

Piper Jaffray analyst Gene Munster maintained an "outperform" rating and $6 price target on Napster, expecting the Street to shift its focus from subscriber additions to the company's new Napster.com initiative over the next few months.

Napster shares have declined 15% over the last four weeks and, excluding cash, shares are trading at 0.4 times Munster's revenue estimates for calendar 2006.

"Clearly, Street sentiment is negative on Napster, given little faith that the company can materially add to its sub base in calendar 2006," said the analyst in a research note Monday.

However, "even under the assumption that the Napster music service faces a significant headwind for new sub adds in calendar 2006, the overall business will not be materially impacted. Meanwhile, the company will be beginning to ramp up its Napster.com ad-based business in mid-calendar 2006, which will likely lead to increasing interest from the Street."

Munster is currently modeling for Napster music service net subscriber additions of 237,000 in calendar 2006. If he cuts his estimate in half, to 119,000, revenue for 2006 goes down by only 10% and EPS declines by 5%.

The premise of the Napster.com initiative is to leverage the brand and take advantage of the two to three million visitors to Napster.com every month through an advertisement-based business model, according to the Piper analyst. In time, Napster believes this new business has the potential to be bigger than the existing music service.

"We believe the company is taking the right steps to continue to take advantage of one of the most recognized brands in online music," Munster said.

The music downloading industry's dominant player continues to be iTunes from Apple Computer, with more than three-quarters of all audio downloads. Napster, Yahoo!, Microsoft unit MSN and RealNetworks are fighting for the remainder of the pie.