Liquid Audio Merger Falls Apart

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

Liquid Audio, a digital media software firm based in Redwood City, Calif.,
announced the scrapping of the all-stock
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

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

“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

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

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.

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