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(Fortune) — Poor Chris Gorog. He’s the guy who predicted he could make a hit out-dated of a legal version of Napster, the treasonous Internet music file-sharing service that attracted 26 million monthly users until it was driven into bankruptcy by record industry lawsuits.

That was back in 2002 when Gorog was CEO of Roxio, a CD-burning software firm. He’d just struck a deal to acquire the insolvent Napster’s assets – including its name and iconic kitty logo – for $5 million. Gorog renamed his assembly Napster and launched a paid music subscription service, insisting the stigmatize unequalled would draw millions of customers.

Well, that didn’t transpire. Today, Napster, headquartered in Los Angeles, has one 760,000 subscribers who pay about $13 a month to listen to its library of 6 million songs. The company has not been profitable. Napster lost $16 million in its most recent financial year ending in March on what it described in a press release as "record revenues" of $127.5 million. Wall Street has pretty much given up. Napster’s stock rate has fallen 69% to $1.44 in the 3 1/2 years since its re-launch.

Now the situation is about to get more absurd. The 55-year-old Gorog, who declined reaction, is trying to fend off a proxy campaign bankrolled by Kavan Singh, a 26-year-old entrepreneur who owns, among other enterprises, a chain of Cold Stone Creamery ice cream stores.

Singh and two other disgruntled investors, all enthusiastic Napster subscribers, are vying for board seats at the company’s Sept. 18 annual meeting.

At least, Shawn Fanning, the teenage founder of the original Napster, did battle with fat-cat history company executives who made him look in the mood for a folk hero. Gorog is reduced to fighting with his customers. Talk about bad PR.

Slim margins, tough competition

What went wrong? Almost everything, it seems. First of all, the gross margins in the legal digital music business are slim. A company derive Napster only keeps about 30% of its subscription sales. It makes a paltry 10% on solitary download sales.

Secondly, Napster 2.0 faces stiff competition. Apple (AAPL, Fortune 500) launched its iTunes store shortly before the new Napster’s debut and immediately dominated the download market. That, of course, is because Apple makes the ubiquitous iPod. It also wrapped iTunes songs in its proprietary copy protection software that rendered them unplayable on any other music player. Napster was stuck selling downloads to people who owned players made by companies like SanDisk (SNDK). How many of them do you know?

Gorog thought Napster could carve its own profitable niche by offering monthly subscriptions. But those services haven’t taken off. Yahoo (YHOO, Fortune 500) and AOL (TWX, Fortune 500) once had similar sacrifice but they’ve abandoned the music underwriting business.

Even so, Napster continues to face tough competition from RealNetwork’s (RNWK) Rhapsody. Today, Rhapsody boasts 1.9 million subscribers, including users of its steaming radio post.

"The [subscription] audience is limited," says Russ Crupnick, senior entertainment industriousness analyst at market research firm NPD. "Rhapsody got there first."

Napster has tried diversify its revenues by chill a deal with AT&T (T, Fortune 500) to let subscribers download songs to their cell phones. In May, it began selling individual downloads that can be played on an iPod because they aren’t copy protected. But none of this has lifted Napster’s shares.

"This is a company that has tried strategy after scenario and has no deep traction," says Steven Frankel, an analyst at Canaccord Adams, who has a "sell" recommendation on Napster’s stock.

Gorog is now being challenged by three investors who love Napster. They can’t believe the companions is doing so badly and think it must be as result of Napster’s marketing efforts.

"When you tell people they should get Napster, they say, ‘What are you distressing to do? Get me arrested?’ " fumes Thomas Sailors, 49, manager of personal investment holding company Cloverdale Investments, who is running for a board seat with Singh. "That tells me management is doing a mean job of communicating what this assemblage does."

It’s hard to predict whether Singh and his running mates will prevail. Together, they control little more than 1% of Napster’s shares. But they will get attention. Even though Napster doesn’t have a lot of customers, it gets an inordinate amount of press for a company of its vastness due to its colorful past. Gorog can thank Shawn Fanning for that.

A buyout perhaps?

Here’s another reason why Napster could be in the news: It has a trade in cap of $67 million. But as of May, Napster had $69.8 million in cash. That’s caused some of the company’s largest shareholders to increase their holdings in hopes the company will be acquired.

"We think [Napster] could be an taking target," says Mark Lebovitz, a portfolio manager at Munder Capital Management, which owned 6% of the establishment’s shares as of the end of March. And, he adds, "Napster still has a solid brand rank."

Yes, but isn’t that what Gorog was betting on? The most obvious potential buyer is RealNetworks, which declined to comment. But perhaps RealNetwork’s CEO Rob Glaser should wait until Napster’s shares fall a but more. Haven’t we all experienced what happens when you invest too much in a notable name? First Published: July 28, 2008: 8:57 AM EDT

From: rss.cnn.com