Trading at seven times my fiscal 2009 (ends August 31st) earnings estimate, Destiny Media with its 90% plus gross margins and recurring revenue stream is a undiscovered gem for both technology and value investors alike. Through its contracts with music labels such as Universal Music Group, Destiny securely and digitally transfers songs from record labels to radio stations over its Play MPE network. After offering their service for free while in its testing phase, revenue is about to explode higher now that the labels are starting to pay for Destiny’s service. Besides Universal Music Group, Destiny signed another major label at the end of December and the last two should sign soon. With no analyst coverage and with no one following the company, investors have the opportunity to invest in a company that I believe could soar to $4 a share, or a whopping 500% in the next 18 months as investor discover the company. And that is the value of only one of their businesses, as its video software player, Clipstream could have tremendous value as well.

 

How do music labels send new music to radio stations? As ridiculous as it sounds, record labels are still printing CDs and then overnighting via courier those CDs to radio stations. For some radio stations, labels will send multiple copies of the same CD and single versions of songs on an album. Estimates are the music business spends around $100 million on this wasteful process. Enter Destiny Media (DSNY).

 

For over three years, DSNY has been hooking up labels and radio stations to its Play MPE service. DSNY allows record labels to digitally and securely upload songs through its service and then radio stations download the songs they need and want.

 

DSNY locks the music to recipient computers so that recipients can access the song at only the authorized work PC, but not on their home PC.  If the user is given additional export rights, the song is unlocked and can be copied, but Destiny applies a digital trace or watermark that identifies that user.  The mark appears in every copy of the song, so illegal copies can be traced back to their source.

 

DSNY’s current library of songs is over 67,000, nearly double from 2006. However, one song will be sent hundreds if not thousands of times. For example, a country song by George Strait would be sent to every country station. That is why since its launch in 2004, Play MPE has delivered 92 million tracks of music. In 2007, 60 million tracks were sent compared to the 92 million tracks sent since inception. Mass adoption of the Play MPE service has begun and accelerated in 2007.

 

DSNY had been offering its Play MPE service for free until the beginning of 2007 when it started negotiations with the major labels to start paying for the service. All of the radio stations were hooked up and most if not all of the bugs in the system had been worked out. Universal Music Group was the first major label to sign a paying contract in March and near the end of December another major label signed up as well (DSNY will let us know which of the four majors signed sometime in January). The company has also signed up hundreds of independent labels to contracts in December.

 

I expect the other two major labels to sign by the end of the May quarter of 2008 and after that Destiny will continue into 2008 with all of its customers paying for the service most of them were receiving for free in 2007.

 

Beyond domestic distribution of music, there is a substantial opportunity to sign up music labels in other countries around the world for digital distribution of music. DSNY recently launched in Canada this past spring and in early December entered into Sweden, Australia and New Zealand.

 

 

DSNY’s value proposition is that it can lower the North American music industry’s distribution cost of music to radio stations from around $100 million to around $10 million a year. DSNY estimates that the international opportunity is double the size of the domestic industry. So, the total spent is around $300 million and DSNY thinks there is a $30 million opportunity in which it saves the industry substantial money and carves out a niche for itself.

 

For an industry that has major problems with expenses and plunging revenues, this is a life saver of cost savings. It is simply stunning that they haven’t all switched already to this service.

 

What is also interesting is that some labels think of the Play MPE as a superior service to sending a CD, due to being able to send it instantaneously with email notification, as opposed to waiting a day or two for mail delivery.

 

Further, radio stations love the service because they can get all of their music instantly and have to deal with none of the labor and inventory issues of CDs and burning CDs and keeping track of them. This is truly a win-win for all sides involved.

 

So why have labels been so slow to adopt this until now? Well, many of them have had tremendous turnover in staff and others have been taken over by private equity shops and been in a state of turmoil with plunging sales. Also, labels are notoriously slow to adopt new technologies and innovation in general. But with an opportunity to cut a major cost by 90%, labels are now leaping at the opportunity.

 

Beyond labels sending music to radio stations, there is also a burgeoning opportunity to use Play MPE service to send music to the media, retail buyers, and other influencers of choice and taste. For example, the labels send CDs to reviewers at Rolling Stone magazine and to music buyers at Best Buy. The labels are transitioning to send music to these people digitally. This should be a driver of growth for Play MPE in the future.

 

 

DSNY has partnered with Mediabase, a subsidiary of Clear Channel Communications (NYSE: CCU). Mediabase is a real time reporting software that radio stations use to monitor what other radio stations are playing, in a way spying on each other. For example, smaller radio stations love it, because they can see what new music is really hot in big markets and then start playing that song.

 

DSNY is also partnered with Allaccess.com, a news and information site for the radio industry, and Allaccess.com helps market DSNY’s service to radio stations.

 

DSNY has also partnered with Scott Studios, which is owned by Google (NASDAQ: GOOG) which provides radio automation software. Scott Studios’ software lets a DJ pre-record his comments, set up all the songs in advance and then in 15 to 20 minutes have a four hour program ready to go.

 

All of these partners allow DSNY to have a real economic moat that makes them the de facto standard for radio stations and others to get their digital music from.

 

 

Beyond the niche of digital distribution of music to radio stations, there are also other opportunities for DSNY to send radio advertisements, TV advertisements, movies and TV shows.  Tiny DSNY has its hands full locking up the digital distribution business first, and then it will focus on what other opportunities are out there. However, don’t think that distribution of music is the only avenue the company has to pursue with its technology.

 

 

Clipstream is a video player based on Sun Microsystems’s JAVA programming language. It is a competitor to Adobe’s (NASDAQ:ADBE) Flash and Microsoft’s (NASDAQ: MSFT) Windows Media Player.

 

The advantages to Clipstream are that it can use up to 90% less bandwidth than its comparable video players and works on 98% of computers without additional software to be downloaded. Further, there is no external video player that pops up to use the software, the video plays straight from the web page.

 

Clipstream offers tremendous advantages over Flash, especially for Banner ads. First you reach 10% more people, as Flash is not compatible with all operating systems and computers. Second, you don’t need a streaming server. Finally, you save up to 90% on bandwidth.

 

DSNY is initially targeting marketing survey firms and ad agencies to use the product and results of these efforts should be seen in the first half of 2008.

 

There are a myriad of potential applications of Clipstream, including Internet TV (IPTV) and banner ads that once you move your mouse over the banner ad, digital music or voices play and when your mouse moves away, the sound goes away.

 

While I am currently assigning little or no value to Clipstream, it does have the potential to be very valuable. Management of DSNY thinks that Clipstream could bring in more revenue than Play MPE one day. Consider that Sun Microsystems has no video player to offer as part of JAVA and that they may want to license the technology to help promote JAVA. That is just one potential monetization or value enhancer to Clipstream.

 

 

Another interesting part of DSNY is its’ online music store turnkey solution called PODDS. Anyone who wants to set up their own online music store, a la iTunes can download PODDS and you are soon in business. Currently, PODDS is generating revenue from several customers and is a licensor of iTunes’ iPod license.

 

Much like Clipstream, there is an opportunity to grow PODDS into a much bigger business as well, but currently I’m assigning it little value.

 

 

 

DSNY filed a patent for their state of the art watermarking technology on October 18^th, 2007. Watermarking adds a digital imprint that allows for the tracking of a digital file.  DSNY’s watermarking survives compression, survives changes of the file to other formats such as mp3, and survives broadcast over the radio or copying.

 

Normally, watermarks are easy to see and find, but the music labels have told DSNY that its watermarking technology was the best that they found and that the watermark was hard to find and created no disturbance to the quality of the song.

 

Consider that Digimarc (NASDAQ: DMRC) has an $180 million market cap and is losing money and claims a ton of technological value from its watermarking technology and tiny DSNY may have tremendous value just from this soon to be patented technology.

 

 

With all of the potential upside to the company, its not surprising that insiders stepped up and bought shares in November. The CEO bought more than 167,500 shares and the CFO bought 75,000 shares. While these share amounts may not sound like much, consider that the CEO’s salary was just $113,000 in 2007, which is a little higher than 2006’s $84,000. Buying 114% of your after tax salary in stock in the open market despite owning almost 21% of the company as a whole is incredibly bullish.

 

Further, there have been a few 13G filings by institutions indicating that the executives are not the only ones who are picking up on the potential mammoth upside.

 

 

The way DSNY gets paid is on a transaction basis. When a new song or album comes out, DSNY gets paid a small fee for delivering this track or album to every person or entity connected to its system.

 

If everyone who used the Play MPE system last year paid DSNY for its service, the company would have around $10 million a year in revenue.

 

Right now, DSNY has two major labels (out of four majors) and hundreds of independents signed on to pay. Most of this will not kick in until the May quarter, as the contracts were signed in December, many with January 1^st start dates. Also, December and January are seasonally very slow months for the record labels.

 

The company is due to report its November quarter’s numbers in mid January, and it will show some growth, but not amazing growth. Here is where the opportunity is, and this is why it is not hard to understand why those executives and institutions are buying. The company at some point in calendar 2008 will be on a run rate of $10 million in revenue, once everyone is signed up. And it could be more depending on when international contracts start getting signed.

 

Assuming $10 million in domestic Play MPE revenue in fiscal 2009 (ends August 31^st) and $1 million of international Play MPE revenue and further assuming a 90% gross margin and $4.5 million of expenses (a 50% projected increase from 2007) gets you $0.10 per share in pre-tax profits.

 

And this includes no revenue benefit to Clipstream and a very slow uptake in international revenue. The investment thesis in DSNY really is not an “if” revenue explodes but exactly “when” it explodes. I think the May quarter is when revenue really takes off, and by year end it should be very clear where DSNY’s revenue is going.

 

 

The company currently has a market cap of around $30 million. Assuming my revenue estimate of $11 million is correct, the company will earn $0.10 in pre-tax profits in fiscal 2009. The company should probably be valued at a multiple of 15 to 20 times that number. That would give you a valuation of $1.50 to $2 per share.

 

Using a price to sales measure on $11 million, 10 times price to sales for a 90% gross margin, highly recurring business seems fair, giving the company a value of $2.11 per share.

 

The upside to the valuation comes from how successful the Clipstream business is, how successful the company is in getting International labels to sign on, and what new ways the company is able to monetize its watermarking technology.

 

If the company can continue to grow to my revenue estimate of $16 million in 2010, it will earn $0.20 per share, making $4 per share an easy target in 18 months.

 

 

The main competition for Play MPE is physical distribution of CD’s and the secondary competition is distribution of unprotected MP3 files.  There are also other smaller online services in niche markets like in Canada, but none has been able to achieve even 2% of Destiny's transaction volume.  The main competition for Clipstream is player based video solutions such as by Microsoft, Apple and Real Networks and Adobe Flash, which is the current standard for web video.

 

One interesting comparison is the one already mentioned, Digimarc (NASDAQ: DMRC), a company that specializes in watermarking technologies. Another interesting comparison to DSNY is the much larger DG Fastchannel (NASDAQ: DGIT) which distributes advertising to television and cable networks. DG Fastchannel uses more of hardware solutions than software in distributing content. DG Fastchannel sells for around 25 times 2008 earnings.

 

 

One of the primary risks is the ever changing music industry. There is an element of risk in the uncertainty in how music will be distributed in the future and how radio stations and others will receive that music.

 

I’m confident that music will continue to need to be given to radio vendors to give listeners a chance to listen to music before deciding to buy and that music publishers will need to send that music to those radio vendors, whether they are on the Internet or not. And DSNY should be positioned perfectly to act as the middle man, making sure that the music is securely sent to the rightful parties.

 

 

 

Another risk is that DSNY is an illiquid Bulletin Board microcap stock. The stock could act very volatile for no apparent reason. The stock is closely held with management and large holders. News and additional interest could make the stock extremely volatile and investors need to be prepared.

 

DSNY has a few legal actions outstanding against Yangaroo (Toronto:YOO), including an invalidation of YOO’s patent and a suit for defamation. DSNY initiated the action after YOO was making false claims in the market place and generally bad mouthing DSNY. Since DSNY’s lawsuit YOO has stopped its previous conduct and YOO has quietly dropped their previous counter claim against DSNY.

 

The only interesting part of YOO is how easily it was able to raise $10 million on the basis of the idea of digital distribution of music and advertising. Too bad for its investors it doesn’t have the technology or ability to break out of its tiny Canadian base. Also too bad they have already burned through $4 million of their money, on very little revenue.

 

The final risk as I see it is whether DSNY can adequately handle the transition for barely making $1 million in revenue to more than $10 million in revenue. Can the company maintain its financial discipline and not squander its new found wealth? Can the company also grow judiciously in headcount? And can it maintain its technological edge and its place in an ever changing music industry?

 

Investors hung up on historical revenues are going to miss out on an excellent investment. With no one following DSNY, no analysts, very few investors of any kind, DSNY afford discerning investors an opportunity to invest in a high margin technology company at ridiculously low valuations right before the company’s revenues explodes. With numerous catalysts to occur in the first quarter and revenue and earnings poised to make eye popping increases due newly signed contracts, DSNY offers tremendous upside. Whether the stock goes to $2 or $4 is really a moot point with the stock at $0.68 per share.