CDNow, Columbia House Cancel Merger

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CDNow Inc. yesterday said it terminated its merger agreement with membership club business Columbia House Inc. that was to have created a music-retailing powerhouse with strong ties in the online and offline worlds. A source close to CDNow who asked not to be identified told DM News that CDNow became aware "in the last couple of weeks" that Columbia House was not generating enough cash to fund both its own growth and that of CDNow.

"Part of that had to do with the fact that Columbia House has [some new executives] and they were able to give a different picture of the company's projected financial situation," the source said, adding that the Columbia House business model was not as profitable as CDNow originally believed.

A spokesman for Columbia House, New York, could not be reached for comment.

Meanwhile CDNow said it retained Allen & Co. to explore strategic options and said it would implement strategies to reduce its expenses, including lowering its marketing costs. The company will focus on affiliate marketing, co-marketing with other advertisers and other strategies. Some reports indicated that CDNow is reacting to being out-muscled in the online music space by diversified e-commerce giant

In a prepared statement, CDNow said its own customer base, brand awareness and advertising revenues had increased significantly since it first agreed to the merger. The original plans called for CDNow to leverage the offline marketing muscle of Columbia House, which has about 16 million members.

Instead, Columbia House and CDNow reached a revised agreement in which Columbia House's joint-venture parent companies, Sony Corp. and Time Warner Inc., will acquire about 2.4 million shares of CDNow's common stock, or about 8 percent of the Fort Washington, PA, company's outstanding shares, for $21 million. They also will convert a $30 million short-term loan into long-term debt that will be convertible to an ownership stake.

The original plan, unveiled in July 1999, called for Sony and Time Warner to each own 37 percent of a new company formed by the merger, with CDNow shareholders retaining the remaining 26 percent of the new company. In November the Federal Trade Commission began scrutinizing the deal for possible antitrust violations, but it was not clear whether that investigation, on which the FTC had not yet issued a decision, played any role in the cancellation of the merger agreement.

An FTC spokesman said any joint agreement between the companies would still be subject to FTC approval.

Columbia House last month announced plans to reorganize its operations into three divisions to prepare for the CDNow merger and shift more of its offline business to an Internet-based environment. The reorganization was to involve the layoffs of 87 people. At the same time, the company named a new team of executives and announced the departure of chairman/CEO Richard Wolter.

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