Digital Picks the Orchard

Yes, you can pick up somebody who's bigger than you. Digital Music Group (Nasdaq: DMGI  ) , a company that has earned its keep by licensing music and video for digital distribution, just proved that. It will be acquiring indie-record-label enabler The Orchard.

It's a good deal all around. The all-stock deal will give The Orchard a 60% stake in the new, combined company. It will also place The Orchard CEO Greg Scholl at the helm.

The move gets validation from more than just today's share-price pop. Going by last year's financials, The Orchard generated a gross profit of $4.2 million on $14.9 million in revenues, and it will account for 60% of the revenues and 64% of the gross profits at the combined company. In other words, offering up a 60% stake for a larger rival with fatter margins is a no-brainer. DMGI also brings a green balance sheet to the table.

The Orchard is a golden brand in digital distribution. The indie labels respect it. It gets obscure artists into online hubs such as Apple's (Nasdaq: AAPL  ) iTunes, Napster (Nasdaq: NAPS  ) , and RealNetworks' (Nasdaq: RNWK  ) Rhapsody. It's a shoehorn into more than a hundred different digital-music stores. And it helps set up ringtone deals with several more wireless providers.

DMGI is a force on many of the same fronts. It's also been a shrewd dealmaker on videos, having brokered revenue-sharing deals with sites such as Time Warner's (NYSE: TWX  ) AOL and Google's (Nasdaq: GOOG  ) YouTube.

However, most investors think of DMGI as a broken IPO. The company went public at $9.75 last year, and even with today's pop, it is still trading at half of its debut price. The makeover it's now getting should give the combined company a clean slate in the minds of burned investors. Clearly, there are many opportunities waiting to be milked in digital distribution. Now with The Orchard on its side, DMGI has some good chances to finally produce a worthy harvest.   

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Longtime Fool contributor Rick Munarriz thinks it's cool that DMGI is helping give Gumby and Mr. Bill some online loving. He does not own shares in any of the companies in this story. He is part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.