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Liquid Audio unloads its download technology

The online music company agrees to sell its digital encoding patents to Microsoft for $7 million in cash, moving the company closer to its proposed merger with Alliance Entertainment.

Online music company Liquid Audio said Monday that it agreed to sell its digital encoding patents to Microsoft for $7 million in cash, opening the door for its proposed merger with Alliance Entertainment.

The agreement will allow Microsoft to own Liquid Audio's patented digital rights management and secure file-transferring technologies. Along with the $7 million in cash, Liquid Audio will receive a royalty-free license to continue using the patents.

Once the patents are sold, Liquid Audio will focus on selling digital distribution technology to online retailers, said the company. The move will complement Alliance's existing business of distributing media in the offline world.

The sale came after a shareholders meeting last week during which Alliance's buyout offer was considered. The meeting had its fair share of controversy because a group of dissident shareholders has been seeking to oust Liquid Audio's board of directors, shutter the company, and return its cash reserves to investors.

Liquid Audio is expected to announce the results of the Alliance merger vote on Friday.

The sale to Microsoft concludes Liquid Audio's quixotic journey to create a business selling digital music downloads. The problem was that despite playing ball with copyright holders and record labels, Net users gravitated to file-swapping services such as Napster and Kazaa to download virtually any song for free. On top of that, record companies only opened a limited amount of songs for Liquid Audio to sell, often at an expensive price per song.

As a result, Liquid Audio has been struggling financially for years. For the second quarter this year, the company reported a loss of $5.6 million on revenue of $151,000. Still, it has a sizable nest egg of cash, totaling $81 million as of June 30.

For Microsoft, the acquisition further boosts its bid to develop the encoding technology standard for digitally distributing content. Microsoft has been aggressively courting entertainment companies to use its Windows Media technology to digitize their movies and music. Liquid's patents could help Microsoft forge deeper relations in the entertainment industry.

"It wouldn't be a surprise that in the back of Microsoft's head they want to be the platform that all people think of when they develop music," said Lee Black, an analyst with research company Jupiter Media Metrix.