Music downloads surge as album sales continue decline

Digital music sales increased 49 percent for the first 6 months of 2007 as sales of conventional albums continued their free fall, dropping 15% year over year. According to the Associated Press, "The trend away from albums and toward digital tracks has been going on for a few years, with industry insiders saying it is fueled by pop music's emphasis on hit singles. Consumers simply buy the songs they want and skip the albums."

There is essentially one pure play on digital music download sales: Napster (NASDAQ: NAPS), the name that started it all. If you want to bet on a recovery in brick-and-mortar music sales, you can choose Handleman (NASDAQ: HDL) or Transworld Entertainment (NASDAQ: TWMC).

Obviously the sales trends favor Napster more than Handleman but remember, markets are a discounting mechanism. Shares of HDL and TWMC are scraping all-time lows, and trading at substantial discounts to their respective book values. Of course that alone does not make these stocks buys, as their fundamentals seem destined to continue to deteriorate. The question investors have to ask is "Is the worst over?" Similarly, Napster shareholders have to wonder "When will the growth slow?"

The latest sales numbers are extreme. Is a 49% increase in digital music sales sustainable? No way. Will sales of CDs continue to decline 15% a year until they reach 0? That is a matter of some debate, and it's entirely possible that companies like Handleman and Transworld won't exist in 10 years, and will continue to bleed red ink until that happens. That's not a stock that I want to own. But I also wouldn't want to own shares of Napster which continues to lose money in spite of rapid growth in the industry.

There's no question that the music industry is in the midst of huge changes, but I can't find a stock that makes me want to get involved.