-       warning this is an illiquid one –

MakeMusic is a quirky little software business with an embattled board of directors and a revolving door at the CEO position.  The company is cash rich and trades at a cheap valuation for a decent niche business.  Additionally, the largest shareholder has made a serious cash offer to purchase the company for a price just a nickel under the current market price.  The board has lost the confidence of shareholders -- each director had significantly more votes withheld than voted in favor, and no director received over 16% of the votes represented at the meeting – youch!  It has little choice but to negotiate with the largest holder and/or try to find another buyer for the business.  

MakeMusic is a music software company with two products, Finale and SmartMusic.  Finale is a powerful program that allows professional composers to notate their music by computer rather than suffer through the arduous process of writing scores by hand.  Orchestral scores are very complicated and the program automatically handles the most confusing rules of musical notation (such as dealing with notehead placement on chords and stem direction of notes).  Finale allows composers to notate music in a variety of ways including entering parts with a MIDI (musical) keyboard, and the program lets users hear their work-in-progress performed by a very high-quality virtual orchestra. 

Finale has become a worldwide industry standard and is one of only two significant competitors in the space.  Competition between the two notation software companies is very rational and Finale is the market-share leader in two of the largest markets, the US and Japan (where Finale has a 75% market share).  Because composers want software that is compatible with their publishers, copyists, and collaborators, there are high costs of switching and the industry features very stable market shares.  Finale is used by Hal Leonard, the largest publisher of sheet music in the world, as well as prestigious music schools such as the Juilliard School, Berklee College of Music, and the New England Conservatory.             

MakeMusic’s second product, SmartMusic, is an ingenious program that allows music students to practice band and orchestra parts at home to virtual accompaniment.  The software highlights mistakes and missed notes, lets students loop difficult sections at various speeds, and records performances that can be automatically transmitted to teachers.  SmartMusic has no meaningful competitors and the company’s large and growing music library, which would take years to replicate, provides a high barrier to competitive entry.  SmartMusic is growing at a 15%+ rate despite steep budget cuts in school districts across the country.  The software is currently used by over 185,000 subscribers.

MakeMusic has a $19 million dollar market capitalization and about $6 million in cash with no debt.  While Finale is a mature product with limited growth prospects, it historically generates about $5.5 million in segment income.  Over the past year, which has been marred by late product launches, Finale has made $4.4 million.  After years of investment into SmartMusic’s development and music library, that segment is finally profitable as well.          

Okay, so that was the good news.   

While MakeMusic’s valuation is attractive, the company faces several challenges that have required it to tap its large cash balance over the past year.  Finale remains a powerful program that is essential to its users, but the software is frustrating to use.  Like many long-dominant software programs (Finale was introduced in 1988), recent updates have been weak and the overall customer experience is unsatisfactory.  Users of Bloomberg might be familiar with this dynamic:  Without a do-or-die incentive to innovate and improve, Finale has languished and is currently in need of a makeover. 

Additionally, current management cannot get out of its own way.  Finale’s annual update (which drives revenues), has been late several years in a row and this year’s annual upgrade will likely be just a partial upgrade.  The company has been through 6 CEOs in 7 years, and has not been able to bring anyone in to polish Finale, MakeMusic’s crown jewel.      

MakeMusic’s largest shareholder, LaunchEquity Partners, filed an angry letter to the company’s board this July and offered to purchase the company:

“While we have considered remaining a large minority owner, the reality is that we have not seen enough evidence that the rewards of such a strategy outweigh the risks . . .  we cannot sit idly by any longer.  The lack of material revenue and profit growth, the steep decline in the company’s notation product line, the recurring turnover of senior leadership and the accelerating level of spending during the six years that LaunchEquity has been a shareholder has led us to conclude that MMUS is in need of aggressive strategic leadership.”

To navigate around MakeMusic’s poison pill and the Minnesota Share Control Act, LaunchEquity structured its initial hostile proposal as an asset purchase.  LaunchEquity proposed to buy MMUS’s assets ex-cash and assume all its liabilities for $13.5 million.  At the last reported cash balance, this values the company at about $3.94 per share.

I think LaunchEquity’s offer materially undervalues MakeMusic.  The board has lost the confidence of shareholders after installing a poison pill earlier this year.  I believe the company either forges a better deal with LaunchEquity (or another buyer), or we see shareholders overhaul the board and stop the crazy parade of inept CEOs.