Small music label plans to raise money in penny stocks, but choice can be risky

Monday, July 2, 2007 at 1:21am

It’s an understatement to call Nashville Records unusual.

The young, small local record label went public nearly two months ago with Pink Sheet stocks, a strategy Row veterans say no legitimate company has used in at least 20 years.

According to Gene Sibbett, president of the company, the move makes sense only because Nashville Records has solid plans for management of artists as well as distribution deals.

“You have to have pretty powerful people and distribution in place,” Sibbett said.

Whether those plans will pay off for investors remains to be seen.

On Friday, Nashville Records announced distribution agreements with River City Movies & Music and Rock Bottom Distribution, which might get Nashville Records’ products sold nationwide at stores including Wal-mart, Borders, Best Buy and Amazon.com.

Also last week, Nashville Records issued a statement saying representatives of four “A-level” artists, according to Sibbett, are in final negotiations to perform songs written by Records’ songwriters for the upcoming USS New York project. The USS New York ship is being constructed with steel from the World Trade Centers, and associated projects will include a patriotic album.

But the company has also had trouble. Nashville Records was forced to buy back and return more than 25 million of it’s small, “penny stock” shares, which were then traded at about six cents each. The offering, which the company says came about due to a “breach of contract,” is being considered an unregistered underwriting by company securities attorneys, according to a statement from Nashville Records.

“While the company was founded on expert talent from the music industry, the unique risks associated with being traded on the public market will be minimized in the future by engagement of legal and investment banking advise [sic] before actions of this nature are undertaken,” the statement read.

The murkiness of the situation has a lot to do with the nature of the Pink Sheets. Recently called the “dark matter” of the business world by a Cincinnati Enquirer financial writer, Pink Sheet stocks can be confusing. Also known as over-the-counter stocks, the securities are not traded on the major exchanges. The “Pink Sheet” nomenclature has come about because many are listed daily in a National Quotation Bureau publication called the Pink Sheets.

Financial planners consider the stocks riskier because they are not as large or stable as shares on a major exchange. Sometimes companies choose the Pink Sheets because they’re raising money for an initial public offering, as Nashville Records says it’s doing. Others can’t afford to meet listing requirements. Nearly all the firms have in common a size small enough to be wiped out if a hurricane hits their office, for example, or if there are safety concerns about the one product the company sells.

It’s not always easy to find a broker with knowledge of over-the-counter stocks. Many consider the shares to be a few steps above blackjack on the risk continuum. But some local investors — not to mention publications including The Motley Fool and Business Week — believe that, when thoughtfully chosen and closely watched, over-the-counter stocks can be money well spent.

“The perception is, don’t touch them,” said Buzz Heidke, president of Heidke and Co., a Nashville brokerage specializing in small- to mid-cap stocks. “That’s when you make your money, when you have a lot of people who are afraid to get into a certain area.”

Heidke’s firm owns shares in about 20 of the companies, and these were up, on average, by about 45 percent last year, he said. Heidke said the shares trade infrequently, increasing the bid-ask spread. Also, research is more difficult to obtain on the companies.

But on the other hand, companies listed in the Pink Sheets have plenty of room to grow. When one pays off, it can really pay off. Pink Sheet companies aren’t required to adhere to the Sarbanes-Oxley act, Heidke said, and the stocks often come at about a 30 percent discount under what prices would be on a major exchange.

Heidke advises working through brokers with a knowledge of stocks and equities before purchasing any Pink Sheet stocks. He also advises to only invest in companies that are profitable, and to normally not pick a company with a PE above 15.

In the case of Nashville Records, Sibbett said he wouldn’t recommend the Pink Sheets to every record label, but his company has solid enough plans for artists and distribution that raising money publicly will actually be available more readily than in the heavily tapped music industry private investment circles. When seeking investors in the private sector, he said, companies have to raise money they will have to eventually pay back, in the form of loans or venture capital. By being public, they’re raising equity. The risks are higher, but they don’t have the same debts to pay.

“It was just so difficult, today, to raise any money in the private sector,” Sibbett said. “We wanted to do something to attract major artists to the label.”

The company went public in a reverse merger in April and Nashville Records acquired the legal “shell” of a small neuroscience company, Neuroscience Washington, then changed the name and ticker symbol. Terms of the merger were not disclosed. Nashville Records had looked for some time for an appropriate company to acquire in this manner, and worked with a consultant adept at taking companies public through the Pink Sheets.

The company was created to be an answer to what those involve in Nashville Records consider to be failings of the modern music industry, Sibbett said. Corporate strategy will be project-oriented. The songwriters, musicians and catalogues involved likely will already be somewhat established. Nashville Records leaders don’t intend to “drop millions of dollars on one artist and move on,” Sibbett said.

“It seemed like Nashville was selling out to all the big media corporations,” Sibbett said. “We just hoped we could get back to a more traditional way.”

Nashville Records leaders say they can move the company to a higher trading level in coming years. Sibbett said the average cost of an initial public offering on the NASDAQ is $1.5 million. Entering the market as a Pink Sheet company was about one-fifth of that cost, he said.

According to those in the industry, the strategy is unusual. The labels that do go public tend to do so by first achieving a certain level of success and recognition, then by being bought by a public corporation. The company’s viability in the eyes of investors hinges entirely on the marketability of signed artists. Record companies without very prominent artists can have a hard time standing up to the scrutiny of a public offering. Companies can only bank on the perceived value of the parties involved.

But some say it’s getting harder than ever to raise the dollars necessary to lift a private label out of obscurity. Wade Jesson, Nashville-based country editor and director of charts for Billboard and Radio and Records magazines, said Nashville Records sounded “a bit unusual.” But that doesn’t mean he would rule out the possibility of success for the company.

“The business practices are changing,” Jesson said. “The money comes from a variety of sources. I don’t think there are many funding options that would really surprise anyone.”

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