December 26, 2000, 9:55 AM

Money blues at CDnow

First Beyond.com, then Cybershop, and now Internet powerhouse CDnow faces a grim financial test. For the past month, analysts and market watchers have been playing the online music retailer’s song, and it sounds a lot like “The Party’s Over.” The company has hired New York investment banker Allen & Co. to identify options, including a merger or sale.

The apparent problem is that CDnow is burning its cash faster than its customers can burn a CD. The site has lost $175 million over the past three years, including $119 million last year. The company has vowed to slash its spending, starting with its marketing costs. In the final quarter of 1999 alone, CDnow spent a whopping $26 million on banner ads with portals and other promotions.

Though recognized as one of the earliest Internet success stories, CDnow began to show outward signs of distress in mid-March, when a proposed merger with Columbia House collapsed. Columbia House parents Time Warner and Sony Corp. agreed to invest $51 million in CDnow, but more bad news arrived days later, when the company’s independent auditor expressed doubts about its viability. The result on Wall Street, predictably, was a freefall of CDnow stock.

CDnow has fought back, reiterating a belt-tightening plan to reduce its cash burn. The company also met the words of commentators with a few of its own, clarifying statements made by its auditor, Arthur Andersen, and blasting predictions of its imminent demise. CEO Jason Olim, who founded the business in 1994 with his brother, told InternetNews Radio, “The perception in the marketplace is profoundly wrong. My company will be able to get to profitability, and I’ve got more to leverage and build on than anyone you can think of.”

The company says it has enough cash to continue operating for the next six months, during which time it expects to find new partners or investors. Ken Cassar, senior analyst at Jupiter Com-munications, New York, thinks an acquisition of CDnow is likelier. “I would be amazed if they could get the financing,” he says.

Despite its troubles, Cassar doesn’t think CDnow will follow Cybershop to the e-retail graveyard. “The site is too good, the customer list is too deep. But it doesn’t make any sense for them to stand alone.”

Ironically, the news hit just as CDnow reported record traffic. For February, Media Metrix says the retailer ranked fifth overall in Internet traffic and was the Web’s most visited music site. The music retailer also placed first on PCData Online’s e-retail traffic ranking, ahead of even Amazon.com for the first time. But the site needs more than traffic to right its balance sheet. “They’ve got to find a partner,” says McMillan/Doolittle analyst Will Ander, “or they’re gone.”

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