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[July 02, 2006]

A future in 'oldies': IPO generated $33 million to fuel company's buying power

(Sacramento Bee, The (CA) (KRT) Via Thomson Dialog NewsEdge) Jul. 2--If you go to Apple's iTunes music store and download "Sugar, Sugar" by the Archies, you get a classic slice of bubblegum pop. Digital Music Group Inc. gets about 50 cents.


That's the approximate cut that Sacramento-based DMG nets for thousands of "vintage" songs sold for 99 cents on major online music sites such as iTunes, Yahoo Music, Rhapsody and Napster.

Making money a few dimes at a time may seem like a tough way to turn a profit, but DMG executives think their niche in the digital download business -- oldies -- can generate plenty of revenue for the year-old firm.

"That type of music is recognizable to many people," said Mitchell Koulouris, DMG's co-founder and chief executive. "People want to buy things they are familiar with, like what was popular in high school."

Since it was launched last year, DMG has been acquiring the digital rights to oldies such as "Sugar, Sugar," Fats Domino's "Blueberry Hill" and the musical oeuvre of '50s teen idol Frankie Avalon.

Flush with $33 million in capital from an initial public offering in February, DMG has bought up the digital distribution rights to more than 200,000 musical tracks -- some well-known, others obscure.

They're being distributed to more than a dozen top online stores that account for 95 percent of the U.S. online sales market, Koulouris said.

While online downloads are only a small chunk of the $12 billion U.S. CD market, Jupiter Research expects legal downloads will grow from an estimated $1 billion business in 2005 to more than $2 billion, about 15 percent of the market, by 2010.

While there are a number of digital music distributors, "DMG is differentiated because of their (oldies) focus," said Mike McGuire, an analyst with Gartner Inc. in San Jose.

At its spacious but sparsely furnished headquarters in a Natomas office building, a crew of DMG workers prepares tracks for transfer to digital music stores.

Sitting at his workstation, operations analyst Jon Radcliff can load up to 200 CDs into a $5,000 electronic box called a PowerFile. It takes about eight hours for the machine to "rip" all the tracks onto a hard disk, from which they're sent electronically to iTunes, Napster or other download sites.

Radcliff, one of 24 DMG employees, says most of the ripping takes place overnight.

Crucial to the process is the inclusion of so-called "metadata" -- information for each song that includes a title, artist, length and genre, as well as codes identifying in which countries the song can be legally sold.

Regardless of the music's previous popularity, DMG makes every track it acquires available for sale, said Anders Brown, a former Microsoft executive and DMG's chief operating officer.

"Our whole model is based on the premise that every track has some value to somebody," Brown said.

And there's really no limit to what the online stores will take, he said. Unlike traditional music stores where labels vie for precious shelf space for their CDs, online stores can carry an almost unlimited "inventory." And every track presents at least some potential revenue for DMG and the online stores.

DMG was originally conceived by Koulouris and his co-founder and brother, Peter, as a traditional record label -- signing artists to recording contracts, promoting their music and getting it played by radio stations.

But there was one crucial difference: All the music would be sold through digital sites rather than sent to traditional music stores in CD format.

But some musicians balked at that notion. "Most artists have the mentality of wanting to have their own CD," said Koulouris. "They place a high value on a physical product."

Koulouris said DMG subsequently abandoned the label approach. "It's just a tough row to hoe," he said. "The biggest labels ... just dominate the market."

Instead, the company focused on acquiring the rights to distribute thousands of oldies from existing labels and sharing the revenue. It also used funds from its IPO to buy up some labels outright so it keeps more of the sales revenue. It's also expanding its offerings into other specialized genres, such as Celtic and Native American music.

The company's IPO in February proved somewhat disappointing, with the stock closing its first day of trading at $9.25, down 50 cents from its offering price.

It has since fallen to as low as $4.60 per share, and closed Friday at $5.50, down 6 percent on the Nasdaq National Market.

Koulouris said the stock's decline was partly due to news in May that some 100,000 tracks were late in delivery to DMG. "That delayed revenues and is not necessarily good news for our shareholders."

In addition, because it's a relatively small company operating in a relatively new and unproven industry, DMG stock doesn't fit the investment requirements of many institutional shareholders, said Robert Hoffman, a principal in Candlewood Capital Management, a New Jersey investment fund that owns DMG stock.

"It's a very small company with a market capitalization of $46 million," he said. "A lot of funds won't look at anything under $1 billion.

Still, Hoffman said he's attracted to the business because of its basic premise: "You acquire the rights to music, you digitize it and you create an annuity stream," he said.

DMG lost $413,934 on revenue of $720,648 in the first quarter, which ended March 31. Hoffman said he expects the company to be profitable by next year.

In its most recent earnings report, the company said royalties and payments to record labels were $348,526, based on 1.01 million paid downloads during the quarter.

Jupiter analyst David Card said companies such as DMG can't wait for potential buyers to stumble onto its tracks among the millions for sale through digital music stores. "At some point, they (DMG) will have to promote their catalog," he said.

Koulouris said the company is trying that, getting editors at the music sites to feature DMG tracks and buying ad space on varied Web sites.

While it's uncertain how soon -- or even whether -- DMG will be a financial success, there's little doubt that buying and downloading music online is here to stay.

"I have four children and I can't remember the last CD they purchased," said Hoffman, the investment manager. "When I asked for a CD for Father's Day, I got a loaded iPod. I don't think anyone is debating the trend."

DIGITAL MUSIC GROUP INC. AT A GLANCE

What it does: Acquires the rights to distribute music to online music "stores" such as iTunes, Rhapsody and Napster.

Headquarters: Sacramento.

Founders: Brothers Mitchell and Peter Koulouris. Number of employees: 24. Ownership: Publicly traded (ticker symbol DMGI) on the Nasdaq National Market.

Competitors: The Orchard Enterprises Inc., Independent Online Distribution Alliance, Digital Rights Agency.

A sampling of the artists that DMG distributes: Frank Sinatra, Fats Domino, the Archies, Louis Armstrong, Bob Marley, Johnny Cash, Ray Charles, Roy Orbison, Maria Callas.

Source: Digital Music Group

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