CDnow Scotches Planned Merger

SAN FRANCISCO (03/15/2000) - In a stunning about-face, the planned merger between CDnow Inc. and Columbia House Co., which is owned by Sony Corp. and Time Warner Inc., hit the skids today amid a squirrelly stock price and excessive spending.

The news, which was announced this morning, marks the end of the honeymoon for CDnow, which had attempted to resuscitate its ailing business by merging with old-media companies. Shares of CDnow have tumbled 60 percent since the planned merger was announced in July.

But the writing on the wall became increasingly clear since the announcement in January that Time Warner would merge with America Online Inc. As details of the combined companies' plans emerged, there was no mention of CDnow.

The pullback comes eight months after Sony and Time Warner agreed to merge their co-owned Columbia House with CDnow to create a juggernaut of music sales that would have comprised nearly 20 million members. Sony and Time Warner were each to own 37 percent of the new company, with the remaining 26 percent going to CDnow shareholders. In January, Columbia House announced that it was restructuring to focus on Internet sales. CDnow CEO Jason Olim says his company broke off the deal after discovering 30 days ago that Columbia House's cash flow was too low to fund such expansion. Apparently, Columbia House revised its financials after the restructuring.

"The issue was that we contemplated the merger based on their ability to provide adequate cash flow to CDnow, to enable us to get to profitability," Olim said in an interview. "So basically, what we discovered was cash flow was way too low and debt load was greater than expected."

Because it is a private company, Columbia House's financial records are not public information. Columbia House concedes that its financials have changed since the merger was announced, but it adds that regulatory hurdles also helped erode the deal.

"We were unable to obtain regulatory approval in a time frame that would enable us to move the business forward," says Scott Flanders, CEO of Columbia House.

"Each of us had a number of strategic relationships that we couldn't move forward."

As part of the news, Sony and Time Warner said they will explore "a broader strategic relationship," beginning with an equity investment of $21 million in cash. The companies said they also have agreed to convert $30 million worth of short-term loans into long-term debt. In addition, Columbia House says it will seek to lower quarterly operating expenses by one-third by reducing marketing costs and imposing other belt-tightening measures. In a press release, the company said it will not yet lay off any employees.

Moreover, investment house Allen & Company's managing director, Nancy Peretsman, will help the online music retailer seek new investment opportunities. Once the darling of the new-media community, CDnow was one of the first major players to emerge in the online music industry. When it snapped up rival N2K in October 1998, it was ready to emerge as the leading player in the space -- until Amazon.com flowed in.

Amazon's music sales quickly eclipsed those of CDnow, leaving CDnow to pick up the pieces. Hoping to pump up advertising revenues, CDnow retooled its strategy to focus on creating a destination site with editorial and music downloads. Ad sales accounted for about $3.4 million during the fourth quarter last year. The merger plan found little support on Wall Street, which sent shares of CDnow tumbling. The price has dropped 60 percent since the July announcement, to an all-time low of $7.75 from a high of $23.26. CDnow shares slid $1.44, or 15 percent, to $8 today on Nasdaq.

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