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Liquid Audio Merger Falls Apart

A significant percentage of Liquid Audio successfully derailed plans for the company to merge with privately-held Alliance Entertainment.

Liquid Audio, a digital media software firm based in Redwood City, Calif., announced the scrapping of the all-stock merger in a brief statement Monday but provided no details about its next move.

"The management of both companies still supports the strategic aspects of the merger. However, a significant percentage of Liquid Audio stockholders have publicly expressed opposition to the proposed merger and the companies believe that the termination is in the best interests of both parties," Liquid Audio said.

The scrapping of the deal, which was already amended in July to give Alliance Entertainment a bigger stake of the combined firm, means Liquid Audio is back on the block with shareholders pushing for an outright sale instead of a stock-for-stock merger.

Terms of the original merger called for Liquid Audio to issue about 46.2 million new shares to Alliance, which would own a 67 percent majority stake in the new entity (the amended deal upped this stake to around 75 percent). Liquid Audio planned to all outstanding stock options and warrants to purchase shares of Alliance Entertainment and take a 33 percent ownership stake.

The deal was meant to give Liquid Audio a physical outlet to hawk its music delivery platform software and entertainment media products. Alliance Entertainment distributes media products and accessories -- like CDs, DVDs, VHS movies and video games.

The saga of Liquid Audio and management's disagreements with shareholders has been well chronicled. Earlier this year, minority owner Josh Schechter of Steel Partners II wrote a scathing letter to Liquid Audio's board, demanding the company be sold to the highest bidder because of its "pathetic performance."

"If the company truly has valuable technology, prove us wrong and sell it immediately to the highest bidder and distribute all of the cash to shareholders," Schechter said, pointing to the disappointing $135,000 of revenue during the first quarter.

Steel Partners had offered to buy the company outright for $2.75 per share but Liquid Audio's board found the offer "inadequate."

Then, Liquid Audio's management opted to merge with Coral Springs, Fla.-based Alliance Entertainment, as a last-ditch push for survival, gambling on the physical distribution channels to prop up faltering sales.

Liquid Audio CEO Gerald Kearby said the company held discussions with "numerous potential partners over the last year" and settled on the merger with Alliance because it offered the most significant return of value stockholders.

Shareholders, by voting against the deal, disagreed and industry watchers expect Liquid's management to be further pressured to sell the company in its entirety or face liquidation.

In September, software giant Microsoft acquired Liquid Audio's patents in a $7 million cash transaction.

Microsoft gobbled up the foreign and domestic patents, including digital rights management (DRM) technology, technology for secure content transfer to portable devices, and technology which will allow it to honor territorial restrictions for digital music content.

In addition to the cash consideration, Microsoft granted Liquid Audio a royalty-free license to continue to use its digital distribution system.