A tiny company in Sacramento, Calif., with a pittance in revenue caused an outsized stir this month when it filed for an initial public offering. The buzz started when a few tech blogs crowned the company, Digital Music Group, as the first "long-tail" IPO. But even if DMG, essentially a digital music wholesaler to online music stores, is a clearly undercooked IPO candidate now, it's worth considering simply because it represents a business model that investors will be confronting more and more in the next few years. But what is long tail? Because it's still a new, if influential, idea, there's no clear consensus on it. But most agree that it's a gradual reshaping of the demand curve for digital music and other media -- in this case, from an overweening "head," comprising a handful of music megahits, into a growing "tail" of niche-catalog properties, whether hits of yesteryear or new works from garage bands. In other words, new technology is bringing about changes in media commerce that allow songs, books and movies to keep selling -- modestly, but in aggregate, profitably -- long after their shelf life. So what's the effect of this new technology? First, there are more tools to produce content, such as Apple's ( AAPL) Garage Band software, which can remix and create digital music, blogging software, and so on -- all of which puts more niche content out there. Second, the cost of buying media is cheaper, whether through peer-to-peer software or through Web sites such as eBay ( EBAY). So it's both easier and more convenient to buy this stuff. Finally, content that used to be frustratingly hard to find is much more accessible now, thanks to search engines, online user-created reviews, and content-oriented social networking sites such as News Corp.'s ( NWS) MySpace. Of course, so-called long-tail businesses aren't anything new. In fact, the most successful ones are well-known, and many tech investors already own them. eBay, with its site allowing you to connect with people selling all kinds of weird stuff, is a clear example, as is Amazon ( AMZN) with its user reviews, Netflix ( NFLX) with its recommendation software and Google ( GOOG), whose sponsored links allow many a niche site to draw in revenue. But none of these companies actually set out to exploit the long tail. None of them launched an IPO to tap into the realization that this is a busy intersection of media and technology that is going to make a few smart people much richer than they may already be.
And so DMG's IPO plans are worth noting for two reasons. For one thing, it's a clear announcement that the long tail is no longer simply a buzzword describing an idea that everyone only sort of understands. It's quite possibly a lucrative business -- and investing -- venue that startups are building around. For another thing, it's a clear warning that not every long-tail investment is worth investing in right now. DMG is pitching itself as a growing catalog of songs, currently around 17,000, that are available only through downloads on online music stores such as Apple's iTunes, Yahoo!'s ( YHOO) music site and Napster ( NAPS). In fact, 80% of its revenue to date has come from iTunes. In the first six months this year, it brought in $234,000 in revenue from such sales. The company is smart enough to see there will probably be a huge land grab for the rights to songs as more people grow comfortable buying music online, and as they cultivate an appetite for songs outside the mainstream. Take a look at DMG's best-selling titles in June: Fats Domino's Ain't That a Shame, The Tams' Be Young, Be Foolish, Be Happy and The Foundations' Build Me Up, Buttercup. None of these will ever again be bestsellers, but there's pent-up demand to buy them online, because buying them on a CD usually means buying a dozen other songs you probably don't want. Add up enough of these microsales, and you can end up with a megafortune. So that's one way to view this IPO: as a tool to carve out an inexpensive foothold in what could prove to be a lucrative market.
By raising $36 million through this offering, DMG will expand its catalog while the getting is plentiful and relatively cheap.However, there's another view that emerges as one digs into the actual filing. In DMG's case, it seems, the devil lurks in the niches of its prospectus. Most telling is that the company, in less than two years in business, has racked up $1.5 million in losses, or more than five times the revenue it has brought in. Wall Street has frowned on those kinds of numbers for several years. But who knows, maybe the whiff of the long tail will overcome such stinginess. After all, with the right managerial crew, a good idea can take a company far. But the executives at DMG still seem to be in the process of choosing a business model. Last year, the company said it planned to beef up hiring so it could sign, promote and market undiscovered artists. In May, it abruptly shifted gears, laying off seven of its 15 workers, and decided to focus on buying the rights of golden oldies. Also in the second quarter, the company took a $75,000 writedown for a non-recoverable advance it made to an unnamed recording artist. For their hard work, executives are pulling in salaries of $120,000 or more and, along with directors, issuing themselves stock that will see its value surge exponentially on the IPO. Over the course of this year, the company has sold 2.4 million shares of its stock to eight insiders for a grand total of a penny a share. Given all that, DMG's planned IPO looks as much like a long shot as it does a long tail. But why should that stop it? Let the buzz build up this buttercup to be young, foolish and happy before it's time to sing "Ain't that a shame."