Washington Post

Judge Blocks Napster's Sale to Bertelsmann

by Frank Ahrens (Sep. 4, 2002)

The Napster era -- a fast few years in which an underground Internet service arced from a cultural phenomenon into a perceived threat to the future of the record industry and finally into a bleeding pariah -- appears to have finally ended yesterday with a court ruling in Delaware.

But the demise of the illegal Internet song-swapping service was preordained with the July ouster of a German media lord.

Yesterday, U.S. Bankruptcy Judge Peter Walsh blocked the sale of ailing Napster to Germany's Bertelsmann AG, one of the world's largest media companies, which owns BMG music and Random House publishers, along with several other assets. Bertelsmann's previous regime wanted to turn the vestiges of Napster into a retooled service that would not face legal challenge.

Walsh ruled that the deal had been "tainted" by the potential conflicts of interest of Konrad Hilbers, who worked at Bertelsmann before joining Napster as its chief executive.

Hilbers was unavailable for comment, a company spokeswoman said. The ruling is likely to mean liquidation for Napster, which filed for bankruptcy protection in June, listing assets of $8 million and liabilities of $101 million as of April 30.

"As a result of the record companies' and music publishers' opposition, Napster's creditors will be denied substantial repayment and the company will likely be forced into Chapter 7 liquidation," Napster said in a statement. "As with most start-up technology businesses, Napster's technology is of little value without the talented team that created it, so it is an occasion of loss on many levels."

All 42 employees at Napster's Redwood City, Calif., headquarters were laid off yesterday afternoon, the company said. The company's Web site is now a single page, featuring the logo and the phrase "Napster was here."

Napster offered a peer-to-peer file-swapping service that allowed users to trade and download copyrighted songs. At its height early last year, Napster was the fastest-growing software application ever monitored by online tracking services.

Napster peaked with 13.6 million U.S. users in February 2001. Record companies blamed it for declining CD sales and the labels sued, obtaining an injunction in March 2001 that barred the service from offering copyrighted materials. Napster countered with statistics showing that CD sales actually rose during its heyday.

The sole record label to embrace Napster was Bertelsmann, which agreed to drop out of the industry lawsuit if Napster implemented a membership-based service. Former Bertelsmann chief executive Thomas Middelhoff bid about $14 million to acquire Napster -- part of Bertelsmann's total investment of about $93 million to aid Napster's transition to a pay service.

Middelhoff -- a new-millennium media mogul often compared to former Vivendi Universal SA chief Jean-Marie Messier, who was ousted by his board in July after running up billions in debt -- saw a new Napster as a natural and profitable fit in Bertelsmann's empire.

But Bertelsmann's family-controlled board of directors stood at odds with Middelhoff's vision and ousted him. Yesterday, the company said it would not challenge the judge's ruling and would not pursue the purchase.

One analyst pointed out that, although Napster was once a powerful brand, it would have limited appeal as a pay service.

One of Bertelsmann's problems in acquiring Napster was "How do we get a vast majority of the population to pay for . . . a brand that meant free -- not just online -- music?" said Mike McGuire, an analyst for San Jose's GartnerG2. "This is Bertelsmann saying, 'We're going to take a break before we move in this direction' " of online distribution of digital music.

In reality, Napster died last week when the judge asked Bertelsmann to extend the deadline for its offer to buy Napster because he needed more time to make a ruling. Bertelsmann declined, signaling that the company was no longer interested in buying Napster and pursuing Middelhoff's vision.

"That's not to say the Internet isn't a viable channel for [Bertelsmann] businesses, but those businesses are either integrated in existing off-line businesses or [the company] . . . is divesting itself of that property," said an industry source familiar with the Bertelsmann-Napster proposal. "It's clear there isn't a whole lot of capital around for Internet music start-ups" such as a new Napster, as Middelhoff had envisioned.

Internet song swapping remains hugely popular. Kazaa Media Desktop is the most popular Web site, with 8.3 million U.S. users in June, according to ComScore Media Metrix, which tracks Internet use. That is an increase of nearly 1,500 percent over the same time last year. Kazaa is followed by Audiogalaxy Satellite, with 3.2 million users in June, and Morpheus, with 3 million users in June, according to ComScore. Both are up more than 200 percent over last year.

This week, Kazaa is No. 2 at buzz.yahoo.com, which tracks the most popular Internet sites accessed through the Yahoo portal, behind only the site for "American Idol," the hit TV series. Kazaa has been on Yahoo's Top 20 chart for more than a year.

The record labels would have a more difficult time shutting down Kazaa, because, unlike Napster, Kazaa does not rely on a central server to list songs available on users' machines. Instead, Kazaa helps users trade directly with one another. Recently, however, the Recording Industry Association of America -- which lobbies for record labels -- asked a federal court to force Verizon Communications to hand over the name of an individual user of Kazaa, whom the RIAA called "a hub for significant music piracy."

The labels have also tried to get a piece of the online music pie, starting their own pay services, such as Pressplay (created by Sony Music Entertainment Inc. and Universal Music Group) and MusicNet (AOL Time Warner Inc., Bertelsmann and EMI Group PLC). Consumer reviews have been tepid; most of the pay services don't have the extensive musical libraries of a Kazaa, and, of course, they are not free.

The legal pay services have had slow going because, unlike their illegal counterparts, the must acquire the licenses to distribute and sell copyrighted material. They must negotiate with smaller labels and often with intransigent artists, some of whom oppose the pay services.

"Napster was part of something huge, but its fate was sealed" when it was shut down by a court injunction, said George Nichols, media analyst with Chicago's Morningstar Inc. "That was a death sentence. Since then, it's been dying by degrees. Napster has always been saddled with too much legal baggage for Bertelsmann -- or anyone else, for that matter -- to ever make it a commercially successful enterprise."