If you're going to cover the gamut of music alphabetically, you're going to need a little Zappa. However, landing the eclectic works of Frank Zappa isn't the only thing behind Warner Music Group's (NYSE:WMG) announced acquisition of Ryko. It's a dirt-cheap opportunity to teach old alternative-rock classics some new-economy tricks.
As a disc jockey at WVUM, the campus radio station at the University of Miami, I put some mileage on many of the Ryko artists in the late 1980s. As Righteous Rick -- that's the on-air name that I went by until I warmed up to Rick Regardless -- I went through a healthy balance of Cocteau Twins, The Flaming Lips, and Ministry. For a spell, I would end my set with The Dead Milkmen. But these bands weren't all on Ryko at the time. It's where their catalogs eventually came to fade away.
That's probably why all it took was $67.5 million in cash for Warner to win the Ryko handshake. There's a little irony there. There's also some tremendous opportunity for Warner.
We'll get to Warner in a second. Let's start with the irony.
Ryko caves in to the Man
Go to the Rykodisc website, and you will see a company description that is bound to be tweaked soon.
"In an industry where the big fish have swallowed the little fish at an alarming rate, Rykodisc remains an anomaly," reads an entry in the site's FAQ page.
Yep. Those are famous last words for a little fish about to become money-shark supper.
As one of the best-known indie labels, Ryko certainly didn't seem like the kind of company that would sign on any dotted line. The company was founded nearly two dozen years ago, sensing an opportunity in the nascent compact disc market. It was mostly a classical music format for high-end audiophiles at the time. Ryko figured that it wasn't long before modern music would migrate to the more attractive platform. As lore has it, the four founders scribbled away the business plan on cocktail napkins at a music conference in France, and an indie was born.
With value in reissuing classic vinyl releases on CD, Ryko tapped in to the alternative-rock market. Its biggest early catch came in 1986, when it signed a licensing deal to release three dozen Zappa titles on CD.
In that sense, it's almost fitting that Ryko should wind up on Warner's arm. It was the company at the forefront of the rock CD movement. Now it will be part of the one music company that is at the forefront of the digital-music revolution.
Warming up to Warner
As far as music debuts go, Warner Music Group's IPO wasn't exactly No. 1 with a bullet. The company went public a little more than 10 months ago, and even though it had hoped to price its offering as high as $24 a pop, it wound up fetching just $17 a share at the time. Two months later, the stock bottomed out at $14.50.
Since then, Warner shares have inched their way out of the teens. It's actually a few trading days away from living up to the $24-per-share springtime hype from last year. Why has Warner won back some street cred? Because Ryko gets what digital music is all about. That's also why snapping up a company like Ryko in a depressed prerecorded-music industry is a brilliant move.
CD sales have stalled for the labels. They have fallen every year -- save one -- on this side of the millennium. The industry's initial reaction was to go after peer-to-peer networks because it believed that song-swapping pirates were at the root of the medium's demise. It hasn't given up on that front, only now Warner has embraced the same digital-delivery format that was once set to do the sector in.
Dust just about any bold initiative in digital music, and you will find Warner's fingerprints all over it. Warner's R.E.M. chose to launch a new CD in 2004 with a viral marketing campaign on social networking-heavy MySpace.com, and now other bands are following suit. This past fall, Warner launched Madonna's new CD in a breakthrough manner by peddling high-priced ringtones for its first single before its actual release. This is an unheralded market despite the fact that companies such as InfoSpace (NASDAQ:INSP) have announced that ringtones are generating twice the revenue of standalone digital song downloads. It's no surprise to see Warner be the first major label to strike a deal with Skype.
Warner didn't stop there to revive Madonna's career. It also brokered a deal with Motorola (NYSE:MOT) to feature her in its televised Rokr phone ads. In Europe, it offered the debut single to folks who preordered the digital CD.
Then came the CD's rollout at the iTunes Music Store. Having sold more than a billion digital downloads, Apple Computer (NASDAQ:AAPL) is clearly the market leader in this booming industry. Apple's pricing strategy has been dressed to the nines for the most part, with individual tracks fetching $0.99 apiece and entire albums priced at $9.90. That's why it was so impressive to see Warner bundling Madonna's Confessions on a Dance Floor with a digital booklet and a Hung Up video on iTunes at a $12.99 price point. It packaged Depeche Mode's latest disc with digital goodies that included the ability to order choice concert tickets before the general public could. In trying to duplicate the U.K.'s success of James Blunt stateside, Warner turned to Google (NASDAQ:GOOG) and used an AdWords account to buy related keywords to make sure that the curious get directed right to the source.
It was also a trendsetter last year, when it broke a new band using a viral video, active online marketing, and no physical CD release. Yes, Warner gets it.
Maybe CD stands for "continuously digital"
Digital music is going to save the music industry. The margins are significantly higher, so the companies can get by on less. A perfect example would be Warner's latest quarter, during which earnings improved significantly despite flat sales growth. Digital sales soared 176% during the period, though, so one can only imagine how Warner's financial picture is going to improve as digital downloads grow from its present stake of just 7% of overall sales at Warner.
The digital-music revolution is something that investors can cash in on. It's not just Warner looking to make a mint as it gives Ryko a digital makeover. The opportunities are everywhere. The Rule Breakers newsletter service has already singled out a few players. Last year, the ultimate growth stock research service recommended shares of satellite-radio provider XM (NASDAQ:XMSR) and mobile-browser software specialist Openwave (NASDAQ:OPWV).
XM is creating opportunities in the music industry by broadening the reach of bands with its dozens of niche commercial-free music channels and deep playlists. And Openwave is powering the phones that will serve as more than just ringtone enablers in the future.
Yes, these are exciting times in the music industry. Don't let the worrywarts tell you otherwise. It was an industry ripe for a disruptive technology like digital downloads. Companies spent far too much in pressing CDs, shipping them out, and taking in returns. Now, online delivery frees up the inventory hassles. It also is creating new outlets for savvy labels to sell music videos and digital perks.
As an analyst on the Rule Breakers team, I can assure you that I'm digging as deep as possible to find great investing ideas in this booming space. If you're the kind of person who doesn't mind taking on some risk to pursue great rewards in areas like digital distribution, you may want to consider a free 30-day subscription offer to see whether you, too, can hear the sound of tomorrow, today.
It's going to be quite the concert. I'll save you a seat.
Longtime Fool contributor Rick Munarriz once had his band signed to Sony's Columbia Records label. It didn't exactly pan out. T he Fool has a disclosure policy. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.
