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Digital Rights Management – An Emerging Market
Ben Johnson, Analyst First Securities Northwest
April 26, 2004
Digital media distribution and content delivery over the Internet is a burgeoning market,
driven by the increasing uptake and advances in broadband service as well as the growing
number of people online. Worldwide, the number of Internet users has grown to about
600 million at the end of 2003 (IDC) and is expected to reach about 1.4 billion by 2010.
Moreover, it is estimated that one out of every three households in the U.S. has
broadband service making consumption of Web content easier and faster. The number of
online households with broadband access is expected to grow to close to 60 percent
penetration by 2006.
The combination of more users online and more users with improvements in broadband
access has created an unprecedented demand for Web content. It has also given rise to
file sharing applications such as KazaA, Grokster, Morpheus and ShareMonkey, which
have been widely embraced by the Internet community. The primary activities associated
with these applications are sharing of music and video files. The music industry estimates
that it is losing as much as $4 billion annually to online piracy. Meanwhile, movie piracy
is costing the movie industry an estimated $3 billion annually as about 500,000 movies
are downloaded illegally over the Internet every day. Broadband access enables the
transfer of full-length movies in less than 40 minutes time, and this is expected to
increase to as little as 45 seconds with next-generation technologies on the horizon.
Exhibit 1. CNET Top 10 Downloads, Week Ending April 25, 2004
Rank Service Weekly Downloads Total Downloads Weeks on Chart Description
1 KazaA 1,471,089 346,014,103 104 P2P file sharing program
2 Ad-aware 1,317,297 37,114,958 75 Spyware/adware protection
3 ICQ Lite 1,186,297 47,522,332 81 Instant messenger program
4 Spybot 539,407 16,208,108 61 Spyware/adware protection
5 WinZip 525,680 117,179,917 393 Zip file software
6 iMesh 422,358 71,651,521 209 P2P file sharing program
7 ICQ Pro 2003b 230,890 245,221,883 344 Instant messenger program
8 Morpheus 198,497 122,484,952 156 P2P file sharing program
9 LimeWire 191,983 20,882,140 40 P2P file sharing program
10 Avant Browser 182,832 4,206,062 38 Ad/pop-up blocker
Despite copyright laws, and lawsuits from coalitions such as the Recording Industry
Association of America and the Motion Picture Association of America, as well as
through legislation in Washington, illegal file sharing is not going away. According to the
RIAA, computer users are downloading more than 2.6 billion copyrighted files (mostly
recordings) each month. At any given moment, there are more than 5 million users online
offering well over 1 billion files for copying through various P2P networks. The ease
with which consumers can download copyrighted content is fueling a pervasive
environment wherein consumers can find any content they want, and download it with
relative anonymity. This is further exacerbated by casual attitude that consumers have
towards the illicit aspect of the activity (see Exhibit 2 below). The existing P2P
marketplace is home to more than 80 million users in search of content.
Exhibit 2. P2P Network ShareMonkey User Poll
Below you can find all of ShareMonkey's polls since version 3.0 of ShareMonkey was released.
Do you think P2P will damage the movie industry?
(Added 23-02-2003)
37.54%
No, the same fuss was made when recordable video tapes were released
23.37%
No, they will always make millions
9.91%
Maybe, if enough people download their movies
13.43%
Yes, and P2P movie downloads should be regulated
15.76%
Yes and I don't care
Total Votes: 25,146
Source: ShareMonkey website, March 2004
Given the distributive nature of the Internet and the increasing sophistication of P2P
networks, the challenge for the entertainment industry is to find ways to deliver content
over the Internet that is both easy to use and secure while simultaneously supporting their
business models. To address that challenge, Digital Rights Management (DRM)
technologies are gaining wide acceptance with both the RIAA and the MPAA as an
effective and preferable means of protecting copyrighted content that is distributed over
the Internet. In addition to its ability to manage and control access to content, DRM
provides businesses with the flexibility to support a broad range of business models. In
April, 2003, we saw the first broad commercial implementation of DRM when Apple
moved to sell songs over the Internet for the iPod with iTunes (wherein songs purchased
from Apple’s online store can be burned onto CDs and played on up to three computers,
but are transferable only from the iPod).Thanks to DRM, the online music store market is
starting to get crowded with the likes of Walmart, Virgin and Napster 2.0 jumping in.
Not only has the entertainment industry broadly accepted DRM, it has become a priority.
IDC expects that the DRM market will grow rapidly over the next few years, climbing
from $96 million in 2000 to $3.57 billon by 2005. Consequently, we believe that the
DRM sector is timely from an investment standpoint, and will name a few companies that
are best positioned to see steady revenue growth as they provide DRM technologies to
counter online piracy that pervades the increasingly sophisticated and expanding P2P
networks.
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What exactly is DRM?
Digital Rights Management restricts the use of digital files to protect the rights of
copyright holders. These technologies control file access (number of views, duration of
views, pay-for or free), altering, copying and saving. DRM technologies can be contained
within the operating system, program software or in the actual hardware of a device.
There are basically two aspects to DRM: (a) content is encrypted in a shell that can only
be accessed by authorized users (“containment”) and (b) the content is “marked” or
“tagged” as a signal to a device that the media is copy-protected.
The DRM Intellectual Property Land-Grab….Who is Grabbing?
Despite the widespread acceptance of DRM in the fight against online content piracy and
file-sharing, it is still a new and evolving technology that lacks standardization.
Consequently, the jockeying for position amongst several DRM firms has created an
unsettled environment, fragmented by incompatible formats and copy-protection
schemes. Ultimately what is needed for universal adoption of DRM is standardization
and interoperability that will allow consumers to access protected content and view or
play it on any number of proprietary platforms.
In the middle of the fray are bellwethers such as Microsoft, IBM, Sony and Phillips
(Intertrust), Apple, RealNetworks and Sun Microsystems. Ultimately, most of these
companies are fighting over who will control the software that controls the content. Here
is a brief overview and how we see them positioned in the marketplace:
The Key Players - Publicly Traded
• Microsoft (MSFT – Nasdaq) – The likely 800 pound gorilla in the DRM space is
promoting Windows Rights Manager, which is currently being held in check by a
legal challenge from Intertrust over patent infringements on Intertrust’s
technology. Microsoft has been widely accused of unfair dominance in digital
media. In December, RealNetworks sued the juggernaut for more than $1 billion,
accusing it of illegally monopolizing the market by requiring Windows users to
accept the Company’s media player. While the Company is, on the face of it,
driving standards to push towards interoperability through establishing the
Content Reference Forum (see www.crforum.org) with Macrovision (MVSN –
Nasdaq), ContentGuard, Universal Music Group, NTT, Verisign (VRSN-Nasdaq)
and ARM, the UK silicon house for mobile phone chips, its core specification 1.0
is clearly based on the work of ContentGuard – of which it is a shareholder. Last
week Microsoft announced that it is getting ready to release “Janus”, a copyprotection
software that will add a clock function to portable music players that
run on its Windows Media Audio (WMA) format. The Janus “app” would allow
downloaded tracks to be programmed to expire creating “rentals” of subscriptionbased
music libraries.
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• Apple (AAPL – Nasdaq) – Given the huge popularity of iPod, Apple has been
able to pull ahead of Microsoft and RealNetworks in the DRM race. Recently, HP
announced that it is joining forces with it, reselling a variation of the iPod. This
means that a significant amount of Windows users will be pushed toward Apple’s
proprietary DRM scheme based on its AAC format and Fairplay (as opposed to
Microsoft’s WMA format). The importance of this cannot be overlooked since the
DRM land-grab really boils down to a format race. Whoever’s format reaches
scale first will likely be the one that the majority of copyright holders and
manufacturers go with. In the last quarter, Apple shipped 807,000 iPod units,
blowing away the Street’s consensus forecasts at about 500,000, and has a
backlog of iPod orders that it does not anticipate catching up with until at least the
4th quarter of this year. The iPod/iTunes component of Apple’s business is clearly
its strongest division and we think that if management at Apple can just stay out
of its own way, the iPod could eventually become a catalyst for users to switch
from Windows to the Mac. However, that is a big “if”. Pace Real Network’s
recent attempt to reach out to Apple for an alliance that would allow Real’s media
format to work on the iPod in an attempt to fend off steep competition from
Microsoft which plans to launch an online music store later this year. We think
this is a mistake on Apple’s part in that the key for any real growth in the industry
is allowing consumers to play downloaded music on any device. Instead, by
isolating itself, Apple is playing the same “tune” all over again that it did in the
1980’s when it lost dramatic market share to Microsoft by not effectively
establishing channel partners.
• Sony/Royal Phillips - Last year Sony and Royal Phillips got into the DRM game
through establishing a joint venture to purchase an interest in Intertrust
Technologies, which owns several DRM patents and technologies. The
Companies took Intertrust private in the transaction. The Intertrust JV is
developing a DRM system which Phillips plans to launch by June this year that
will allow consumers to play digital music and video on any player. Recent
rumors are that Sony is eyeing Apple’s iPod as an acquisition candidate. Sony
also plans on launching its own MagicGate DRM later this year. This week,
Microsoft is paying $440 million to InterTrust as a settlement to patentinfringement
claims. By the way, InterTrust is reportedly working on a DRM
interoperability layer that is, among other things, supposed to make Apple’s
iTunes play on other non-iPod devices.
• RealNetworks Inc. (RNWK – Nasdaq) – The Company’s Helix DRM 10
platform makes it possible to deliver secure media content to PCs and non-PC
devices including mobile devices and home appliances. Real Networks recently
announced its own online music store with improvements to its RealPlayer that
lets customers play music purchased through Apple’s iTunes store without
licensing Apple’s FairPlay DRM scheme (chances are that Apple will have
something to say about this in court sooner than later). RealNetworks is pursuing
a strategy that offers greater flexibility than Microsoft and Apple through
supporting each of the competing encoding formats, as well as the MP3 format.
This will enable consumers to be able to use a single media player on their PCs to
play and organize music purchased from all of the major online music sites.
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However, songs downloaded from Real’s music store are encoded with Helix and
cannot be transferred directly to an Apple iPod. The Company has about 1.15
million paying subscribers for its premium players and streaming services.
• IBM (IBM – NYSE) – Big Blue’s Media and Entertainment group has launched
in initiative called extensible Content Protection (xCP) that includes encryption
software that allows media providers to give consumers to ability to view content
on any xCP compliant device. The Company provides DRM functionality through
its Electronic Media Management System (EMMS). Last week, IBM unveiled
xCP at the National Association of Broadcasters convention in Las Vegas, adding
to an even more fragmented marketplace for choosing a DRM scheme to go with.
• Macrovision Corp. (MVSN – Nasdaq) – Macrovision has rolled out a number of
application specific DRM solutions. Last October, it released a DRM technology
for the CD gaming market called Fade, which initially allows pirated games to
function normally, but gradually disables the game features over time. The idea
here is to get the gamer “addicted” to the game and then make it slowly
unplayable. This past week, it announced shipment of its FlexNet Publisher, the
cornerstone of its next-generation DRM system, which allows software publishers
to maximize their revenue by tailoring custom licensing packages in addition to
preventing piracy. The Company is working closely with Microsoft in the
development of its technology, as its latest music protection product – the CDS
300 – features Windows Media Digital Rights Management. It shouldn’t surprise
anyone then that Macrovision has received notice in January from the U.S. Patent
and Trademark Office of a second patent interference proceeding with InterTrust.
Menwhile, Macrovision has brought suit against 321 Studios the same week that
321 Studios has infringed on its patent on DVD copy protection technology. The
Company has more than 160 domestic patents issued and more than 850
international patents either issued or pending.
Private Co’s to Watch
• ContentGuard – Has developed XrML, which will likely become the common
platform for DRM in the entertainment industry given the fact that it has been
adopted by Microsoft and it is a very rigorous language with lots of flexibility.
Could be an acquisition candidate at some point for Microsoft or Sony, a licensee.
ContentGuard’s XrML is also endorsed by Hewlett Packard (HWP – NYSE),
Adobe Systems (ADBE – Nasdaq), Portal Software (PRSF – Nasdaq) and
Xerox Corporation (XRX – NYSE). In fact, in early April, Microsoft and Time
Warner (TWX-NYSE) both announced that they has become strategic investors
(Xerox already had an equity interest).
• Digital Containers Inc. – The Company has patented key content security,
authentication, e-commerce and media playback technologies suitable for use in
P2P networks and DRM. DCI’s DRM technology enables content to be played on
Microsoft, Apple and RealNetworks’ systems.
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DRM Coalitions to Watch
• Project Hudson – Made up of Intel, Nokia, Samsung, Toshiba and Matsushita
that is focused on an Internet-based wireless DRM protection scheme that would
make it possible for users to share digital files on a limited basis or for files to be
shared for promotional purposes.
• Content Management License Administrator – An industry group set up by
Nokia, Intel, RealNetworks, mm02, Matsushita, Samsung and Warner Brothers
focused on providing vendors and service providers with processes and guidelines
for delivering digital content to mobile handsets and other devices that use the
Open Mobile Alliance (OMA) Digital Rights Management version 2.0 spec.
RealNetworks and RSA Security have recently announced plans to support
version 2.0.
Don’t Forget the Watermark
Digital watermarking is a pretty cool complement to DRM, allowing content to pass
through an analog environment (the “analog hole”) and over legacy equipment and while
still carrying information to identify usage rights, and then back to DRM. Richard
Parsons, CEO of Time Warner characterized the problem that the analog hole poses for
content providers, “Video content, even when delivered digitally in a protected manner,
must be converted to an unprotected analog format to be viewed on the millions of analog
television sets in consumer homes. Once content is ‘in the clear’ in analog form, it can be
converted back into digital format which can be then subject to widespread unauthorized
copying and redistribution, including over the Internet. This problem applies to all
delivery means for audiovisual content, from DVDs to pay per view to over the air
broadcasts.” Digital watermarking is believed by many to be the most promising
technology solution to blocking the analog hole.
• Digimarc Corp. (DMRC – Nasdaq) – Digimarc’s digital watermarking
technology enables DRM systems to connect content outside the DRM (in the
anolog domain) back the DRM. The Company has developed considerable
intellectual property, with more than 140 patents and an additional 350 pending.
The Company is effectively to digital watermarking what Content Guard and
Intertrust are to DRM. Digital watermarking is not DRM exactly, but worth
noting, as the technology will likely play a major role in DRM platforms moving
forward.
• USA Video Interactive (USVO – OTCBB) – Like Digimarc, USA Video
Interactive is a provider of digital watermarks. While considerably smaller, and a
relatively new entrant to the marketplace, the Company is developing some digital
watermaking IP of its own, which could make it a player to watch. In January, it
announced its first licensing customer and OEM partner, Tri-Vision International
(patent holder for v-chip technology).
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Parting Thoughts
With the demand for content and rich media over the Internet surging and the prevalence
of increasingly sophisticated P2P distribution networks, the clamoring over who will be
the winner in the DRM wars is anything but “much ado about nothing”. Who will win the
platform war between Sony/Phillips, Microsoft, Apple and Real Networks? Microsoft
just always seems to come out on top of races like this, but Sony/Phillip’s InterTrust is
the holder of key patents. The pending infringement case will likely tell the tale. And
who will win the format war between Microsoft and Apple? It has been interesting to see
Apple change its colors in this one. They used to go it alone, and just assume that
offering superior technology would be enough. This time they are partnering up with
channel technology vendors such as Hewlett Packard that can give them the scale they
will need to take on Microsoft and its channels. Can smaller niche players like USA
Video Interactive stake their place in the market? If they do, chances are pretty good they
will go the way of InterTrust through acquisition by one of the larger players.
So what investment makes the most sense? The bad news, as we have noted above, is that
given the early stages of the market it is still not clear who the winners will be. The good
news is that chances are the key players mentioned in this report will be around long after
the dust in the DRM market has settled as they are generally well-positioned with
diversified product portfolios and revenue streams. In fact, the real money is only just
beginning to be invested in the market.
In 2003, we saw entertainment companies finally start building business models that
accommodate the Internet, but 2004 will be the year in which digital media and premium
content drive the online distribution channel. This is good news for DRM.
Digital Rights Management Index
Company Ticker
Stock
Price
Mkt. Cap.
(mil) 52-Wk Range
FY03 Rev
(mil)
FY04E
Rev (mil)
FY03
P/S
FY04E
P/S
Apple Computer Inc. AAPL $27.53 $10,241 $12.98-$29.58 $6,207 $7,490 1.63 1.35
Digimarc Corp. DMRC $13.24 $267.7 $11.02-$17.48 $85.6 $93 3.05 2.80
Macrovision Corp. MVSN $18.34 $903.6 $16.00-26.93 $128.3 $140 7.76 7.12
Microsoft Corp. MSFT $27.54 $297,277 $23.59-$30.00 $32,187 $35,900 8.54 7.66
Real Networks Inc. RNWK $6.68 $1,127 $4.73-$9.29 $202.3 $240 5.74 4.84
* Price as of 4/23/04
For More Information Contact:
1st Securities Northwest, Inc.
Ben Johnson [phone]
18824 SE Mildred St.
Portland, OR 97267
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REGULATION AND CERTIFICATION
I, Ben Johnson, hereby certify that the views expressed in this research report accurately
reflect my personal views about the subject security(ies) or issuer(s). I further certify that
no part of my compensation was, is, or will be, directly or indirectly, related to the
specific recommendations or views expressed by me in this report.
The material herein is for informational purposes only and is not intended to, and does
not constitute the rendering of investment advice or the solicitation or an offer to buy
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Securities Northwest, Inc. is not responsible for the marketing or price performance of
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results are not necessarily a guarantee of future performance. The opinions expressed
herein reflect the judgment of the author at this date and are subject to change without
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The foregoing discussion and material contains forward-looking statements within the
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