Does CDnow, N2K merger add up?

The deal will almost double CDnow's customer base from 980,000 to more than 1.7 million, but its stock is wallowing around 16, far off its 52-week high of 39.25, which it reached last November at the peak of Wall Street's excitement about shoppers using the Web to buy holiday gifts. Since the merger was announced, Amazon.com, which trades around 133, has released its own music sales numbers: $50 million for the second half of 1998, close to CDnow's total 1998 revenue of $56 million. Separately or together, N2K and CDnow face an uphill battle.

The new company, which will be called CDnow/N2K, has plenty of traffic, "but traffic is very fickle on the Web," said Mark Hardie, an analyst with Forrester Research. "When a big brand gets in, the traffic goes that way." It took Amazon less than six months to take a large market share for itself, he added.

Throwing more uncertainty into CDnow's future is the emerging state of the market. Internet sales represented just 0.5 percent of the $38.8 billion total music sales in 1998, according to Market Tracking International. Many of the major offline music retailers have yet to enter online music sales, but when they do, CDnow's shallow pockets could inhibit its growth. That has fueled speculation that a major media player like Time Warner could pick up CDnow as an easy way to start selling on the Web.

Hardie isn't optimistic about a buyout, but Steve Frankel, who follows CDnow for Adams Harkness Hill, describes the combined company as "very attractive to a large media company looking to get their feet wet in cyberspace." Viacom, the parent company of MTV, which has a marketing partnership with CDnow, plans to launch a "music destination site" in June with editorial content and shopping.

The CDnow-N2K merger, which faced initial opposition from some N2K shareholders, is a done deal, say analysts. Each N2K share brings the holder .83 of a share of the new company's stock, or about 14, below the IPO price of 19. But N2K stockholders have no choice but to agree to the merger, according Frankel, who has an accumulate rating on CDnow stock.

"The reality is that an N2K without CDnow probably ends up with a stock price that's lower, not higher," said Frankel. N2K's problems stemmed from its inability to rein in ballooning costs, Frankel added. With the merger, "You've blown up the whole N2K organization and that is exactly what you needed to do."

When the merger was announced, CDnow said it would result in some layoffs, which Frankel expects will be mostly on the N2K side, starting from the very top: John Tulk, the company's chief technology officer, has already announced he is joining HealthAxis, which sells health insurance on the Internet.