What if a digital-media company went public and nobody came?
The number is probably lower than you're thinking. Just 5,300 shares traded hands yesterday. Stack that up against trading volume of 53.1 million shares of Apple
I'm not just comparing the two companies because the names have a logical connection. The models do, too. The Orchard is a digital enabler for indie music labels, and it's an active provider on Apple's iTunes Music Store. In fact, when Apple announced last month that it had added premium tracks free of digital rights management to its virtual storefront, it singled out The Orchard as a key partner.
So how can The Orchard enter the market without the kind of buzz one would expect with a recognized brand in digital delivery? Well, instead of hitting the market with the accompanying flash of underwriters and other institutional investors, the company chose to sneak in through the back door.
Back in July, The Orchard agreed to acquire the smaller -- but publicly traded -- Digital Music Group. That strategy was similar to what the larger New York Stock Exchange used when it decided to combine itself with the smallish Archipelago Holdings. From there, it evolved into the company that we know as NYSE Euronext
Not exactly the next Euronext
The difference is that Digital Music Group was a bit of a stinker. It went public at $9.75 a share last year, and pretty much went downhill after that. Like The Orchard, Digital Music Group also licensed music through digital outlets such as Apple. Even though Digital Music Group also secured digital licensing deals for video clips, music is its lifeblood. Apple accounted for roughly 70% of Digital Music Group's revenue before it hooked up with The Orchard.
The combination was announced over the summer, and it looked good on paper. Digital Music Group was struggling financially, but it still had a ton of cash left over from last year's IPO. The Orchard generated a gross profit of $4.2 million on $14.9 million in revenues last year. Based on the 2006 financials, The Orchard would account for 60% of the revenues and 64% of the gross profits at the combined company. The Orchard would receive 60% of the voting power of the new company, with its CEO taking the helm.
The market eventually forgot about the deal. Digital Music Group's stock bottomed out last week at $2.13 a share, less than a quarter of last year's IPO price and less than half of its value after the acquisition was initially announced.
To help soften the blow and keep its listing intact -- and also out of the penny-stock gutter -- the new company preceded its Wednesday launch with a 1-for-3 reverse stock split.
Getting pumped yet? Of course not. On a split-adjusted basis, the company hit an all-time low on Wednesday.
These aren't exactly Granny Smith apples
Investors aren't necessarily holding a rotten bushel. Digital Music Group never caught on with the marketplace because its operating expenses far outpaced its revenue generation.
The digital-music market is still in its infancy. Helping artists achieve digital distribution through premium music sites such as iTunes, Napster
This model works better in scalable form. If it can keep its operating overhead stable, The Orchard will be able to milk more out of its distribution deals in the future. Oh, and now that it's public, it will have that much easier a time becoming a master consolidator in a very fragmented market.
The opportunities for digital delivery will also expand in the future. The Orchard is entering a favorable environment, with leading e-tailers such as Amazon.com
Investors may want to wait a quarter or two to assess the earnings power and cost-shaving synergies here, but don't walk away too far from The Orchard. This company won't be growing in the shade of obscurity for too much longer.
Amazon.com is a recommendation to Motley Fool Stock Advisor newsletter selection. Wal-Mart is an Inside Value selection. NYSE Euronext is a pick in the Rule Breakers growth-stock research service. All three newsletter services are currently beating the market, and you can find out why with 30-day trial subscriptions to any of them.
Longtime Fool contributor Rick Munarriz thinks an apple a day may not keep the doctor away, but it sure can please the orchard grower. 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.