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CDNow stumbles after merger with Columbia House

Shares of online music retailer CDNow Inc. (Nasdaq: CDNW) fell 10 percent Tuesday after the company said it will merge with Columbia House, which is jointly owned by Sony Corp. (NYSE: SNE) and Time Warner (NYSE: TWX).

In early trading, CDNow was down 2 1/4 to 20.

What's the problem? A sketchy valuation. Analysts were wrestling with what premium, if any, was paid for CDNow. One analyst, who didn't want to be named, said he couldn't imagine Sony or Time Warner paying a lot for CDNow given the competition. Other analysts contacted by ZDII were still sorting out the details.

The new, yet-to-be-named public company resulting from the merger will be owned 37 percent each by Sony and Time Warner. CDNow's existing stockholders will own the remaining 26 percent. Like Monday's Disney-Infoseek deal, the valuation became an issue. The companies didn't put a price tag on the merger.

CDNow-Columbia House: Good deal?

CDNow, which just recently merged with rival N2K Inc., is in a fierce battle with Inc. (Nasdaq: AMZN) to be the leading retailer of online music.

Synergy fest

The companies said the merger will create a major entertainment, e-commerce and direct marketing company that will combine the CDNow site with the largest music and video club in the U.S. and Canada. CDNow will be able to tap into the Columbia House database of 16 million profiles. CDNow will continue to operate as an e-tailer and Columbia House, which projects online revenue of $100 million this year, will remain a music club.

Sony and Time Warner will make the new company the centerpiece of their e-commerce moves. ``Through this alliance, we are creating an exciting new enterprise that will be the centerpiece of our strong and growing presence in music and video e-commerce," said Gerald M. Levin, chairman and CEO of Time Warner, in a statement. Time Warner has repeatedly struggled with online efforts and now plans to get it right by focusing on e-commerce.

Sony and Time Warner will provide links to the CDNow/Columbia House site and provide ample promotion in both companies vast media properties. Sony and Time Warner have also agreed to provide "certain financing guarantees to afford the merged company financial flexibility."

"This merger will dramatically accelerate our growth and fulfill our vision of leading the digital revolution in the music industry," the company said.

Bad news for Musicmaker?

One of the big issues to watch in the near future is the effect the CDNow-Columbia House combination has on the newly public (Nasdaq: HITS).

Musicmaker's has two main partnerships -- Virgin Holdings' EMI music division and Columbia House. According to regulatory filings, Columbia House can end the Musicmaker relationship if it doesn't make financial sense to them.

If Columbia House bails on Musicmaker, it triggers EMI's exclusive agreement to become non-exclusive.

Given the Columbia House-CDnow merger and the fact that CDNow purchased SuperSonic Boom, which is in the same business as Musicmaker, the Musicmaker-Columbia House deal could be on shaky ground.

Despite Musicmaker's paltry sales, the company had a larger market capitalization than CDNow after a successful opening day.

Another exec cashes out

The new company will be headed by a new CEO. CDNow CEO Jason Olim will serve as CEO of the new company's Online/Retail division and Richard C. Wolter, chairman and CEO of Columbia House, will continue to head the club operations of the new company. After a transition period, CDNow chairman Jonathan Diamond will leave the new company "to pursue other opportunities in the Internet world."

On Monday, Infoseek chief Harry Motro said he would leave following the Disney merger.

The deal should be completed by the end of the year. of the transaction by year end.

CDNow's 2Q

In a separate statement, CDNow said it would post a smaller-than-expected loss in the second quarter. First Call was expecting a loss of 83 cents a share.

The earnings estimate excludes amortization of goodwill and other intangibles and one-time charges.

However, CDNow noted problems integrating N2K. The company, which called the second quarter "transitional," said it didn't go after new customers in the quarter, but did combine the N2K and CDNow sites on time.

Revenue for the quarter was hurt by delays in transitioning marketing partner links and delays in fulfilling customer orders because of a supplier's warehouse relocation.

CDNow sees sales of $34.5 million to $35 million. In June, the first month of the combined CDNow-N2K store, sales were $14 million. CDNow added about 350,000 new customers in the quarter.