SAN FRANCISCO (Business 2.0) -- When a European court last week voted to annul the 2004 marriage that created Sony BMG out of the music divisions of Sony and Germany's Bertelsmann, investors quickly concluded that the ongoing courtship between Warner Music Group and Britain's EMI would never happen. Warner's stock sold off 16 percent on the news.

So does this mean Warner Music (Charts) is on the rocks? Hardly. In fact, Warner has been doing just fine without EMI, with digital sales that far outpace its rival. And it very well could make more progress without a merger in the coming years, since it could continue its digital push unburdened by the need to meld different corporate cultures and wring cost cuts from a combined company.

Warner Music Group CEO Edgar Bronfman, Jr.

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"Warner is the leader in the digital [music] transformation," said Bishop Cheen, a debt analyst with Wachovia Securities. "It has accomplished more on all digital fronts than any other company."

After the news of the court ruling came out, Warner CEO and chairman Edgar Bronfman Jr. sent an email to his employees stressing that while management is examining the impact of the Sony (Charts) BMG case, Warner by no means needs a deal to thrive.

"We have strong underlying momentum in our business," Bronfman wrote to his 4,000 employees. "As we have said all along, we can achieve our growth strategy on our own."

That may sound like corporate spin. But since Bronfman cobbled together a group of private equity investors and beat out EMI to buy Warner Music from Time Warner (Charts) (the parent of CNNMoney.com) for $2.6 billion in 2004, he has transformed the company into a digital powerhouse that's ahead of the rest of the industry. Bronfman has cut costs and restructured the company so that digital has become a key component in every part of the business -- from signing new artists to selling recorded music through retailers. He likes to refer to Warner as a "music content company," not a collection of record labels.

Warner has aggressively been striking deals with all kinds of new outlets for music - from Apple's (Charts) iTunes to cell phone carriers.

On iTunes, Warner's online marketing skills give lie to the conventional wisdom that Internet music buyers have abandoned albums in favor of buying songs one at a time. Warner is a leader in selling so-called bundled albums on Apple's digital music store, having discovered early on that consumers will gladly pay for the entire digital album if it comes with digital extras - a music video, for example, or interviews with the artists.

And Warner recognized early on that music on cell phones would be a more lucrative business than on computer-based online music stores. Ringtones sell for $2 - twice the price of an iTunes song download - and overseas, cell phones are a vastly more popular way to get digital music than PCs. Warner has inked deals many wireless carriers, from Cingular to China Unicom and SK Telecom. As a result, Warner can now reach 1.4 billion cell-phone subscribers, up from 540 million when Warner went public in May 2005, according to one company executive.

And where others cry piracy, Warner seeks ways to make money. Record label executives have expressed concern about amateur Web videos in which people lip-sync to copyrighted music - technically a use for which the labels are owed licensing fees. But Warner is negotiating with YouTube to figure out how to license its catalog to the popular user-generated video website. The idea is that, for instance, if someone puts up a video of herself lip-syncing to a Madonna song - something that's going to happen regardless of what the copyright laws say - Warner will profit from it.

Of course, digital sales still make up a small part of the overall music pie, and it's been slow going to convince Wall Street that in the end the industry really will be stronger and profitable than in the age when CD was king.

But the numbers are starting to improve, especially at Warner. For the 6 months ended March 31 - the most recent period for which comparable numbers are available - Warner's digital sales made up 9 percent of its total revenue compared with 6 percent for EMI. (EMI only reports financial results every six months).

And in Warner's latest quarter, digital revenue from recorded music (not including publishing) reached $86 million, making it 13 percent of the company's total recorded music sales. That was a 177 percent increase from the year-earlier period, and is believed to be the highest digital-to-physical mix in the industry.

EMI has also stressed the importance of embracing digital, but its efforts are far behind Warner's. It's also recently seen a number of high-level defections from its digital staff, including Ted Cohen, a senior vice president well-known in the industry.

Most of the arguments made by analysts for an EMI-Warner deal have focused on cost-cutting and economies of scale. But Warner's digital prowess arguably provides an equally powerful rationale for EMI to seek it out.

Even after the court ruling, EMI execs in London said they're still confident EMI can make the acquisition. For its part, Warner, which itself has been trying to buy EMI, said its management is reviewing the court decision before it decides how to proceed.

However the merger drama plays out, Bronfman's ongoing digital makeover has strengthened Warner's hand - and shored up his once-shaky reputation as a business leader.

Related:

• Pressing pause on an EMI-Warner deal
• Warner-EMI: A sad song
• Warner Music: The remix