Posted by Ablang on 07/13/07 01:30

Digital Music Group is merging with The Orchard
By Clint Swett - Bee Staff Writer

Last Updated 9:26 am PDT Thursday, July 12, 2007
Story appeared in BUSINESS section, Page D4

http://www.sacbee.com/140/story/268482.html

Digital Music Group Inc., a Sacramento-based pioneer in online music
distribution, said Wednesday it is merging with a larger rival as the
two companies scramble to become profitable in the nascent realm of
legal music downloads.

In effect, the $60 million deal with The Orchard Enterprises Inc.
means the privately held New York company will take over DMG, with
Orchard chief executive Greg Scholl at the helm. The combined company
will take Orchard's name but will retain DMG's listing on the Nasdaq
stock exchange.

While Orchard and DMG are the two largest independent digital
distribution companies in the U.S. with combined 2006 revenue of more
than $25 million, neither has been profitable.

Experts say that merging the two companies, with the combined digital
rights to more than 1 million songs and more than 1,000 hours of
video, will help it cut costs while increasing its clout with both
music labels and investors.

"They are two companies trying to gain traction," said Phil Leigh, an
analyst with Inside Digital Media in Tampa. "There may be too much
overhead for two companies, but one company could be successful."

It's unclear if DMG's 35 Sacramento employees will be offered jobs
with the combined company. Scholl said those details will be worked
out before the deal closes sometime in the fourth quarter.

Orchard has been especially strong in gaining the digital rights to
independent labels. In addition to providing tunes to online retailers
such as Apple and Rhapsody, it helps market and promote much of the
music produced by its artists.

DMG has specialized in oldies and some world music, and has recently
branched out into videos of older TV shows such as "Gumby" and "I
Spy."

"The Orchard is the biggest brand name in this area," said Rick
Munarriz, a Miami-based analyst with Motley Fool. "It's the label that
(musicians) want to be associated with."

He said the merger could help investors forget DMG's disappointing
initial public stock offering in February 2006, that saw its shares
decline almost immediately after it hit the market at $9.75 a share.

DMG stock has been trading in the $4 range and Wednesday's merger news
helped propel the shares up 49 cents to $4.48.

Dan Koellen, an early investor in DMG as a member of the Sacramento
Angels, said he has high hopes for the combined company, "From the
beginning we thought that the company with the most largest catalog
was going to be the winner," he said. "The idea is that together they
will have a much higher valuation."

Mark Leibovitz, a portfolio manager with Munder Capital Management,
which owns more than 342,000 DMG shares, said he likes the deal
because it gives DMG scale that it badly needed to grow.

"It seems like a sensible merger," he said. "Something DMG needed was
scale and this should help them by adding plenty of content and
distribution."

It also could help in terms of luring new investors. "This provides
DMG with a clean slate," Munarriz said. "They can say, 'Look at me.
I'm a whole new company.'"

Terms of the deal call for DMG to issue 9.1 million shares of common
stock and 4.5 million shares of preferred stock to Orchard share
holders. If both classes of stock were valued at Wednesday's close,
the deal would be worth about $61 million.

The deal gives Orchard about 60 percent of the voting shares of the
combined company. The deal could potentially give DMG shareholders a
piece of a stronger company with more profit potential and a more
attractive stock.

"They are saying (to DMG shareholders), 'Would you rather have 40
percent of a company that's worth more in a few years or all of a
company whose stock is stuck at $4 and change?'" Munarriz said.

While Scholl eventually will take over the merged company, DMG is
currently being run by Karin Davis, the company's chief financial
officer and interim chief executive.

DMG founder and chief executive Mitch Koulouris said he will leave the
company during the next month after he closes some deals.

"I'm stepping down from CEO because the company doesn't need two
CEOs," he said.

"This is a good time to be handing off the baton," said Koulouris, who
remains the firm's largest stockholder with 567,752 shares.

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