Online Music Sounds Death Knell of AOL-Microsoft Talks

A growing media rivalry prevents a deal that could have helped both sides.
By George Mannes ,

Back in 1994, when Microsoft (MSFT) - Get Report was readying its Microsoft Network, America Online executive Ted Leonsis was quoted as saying that interactive services would become "Microsoft's Vietnam."

Now it looks as if AOL is trying to make online music Microsoft's Balkan War.

Over the weekend,

AOL Time Warner

(AOL)

and Microsoft broke off talks related to a wide range of issues. Most accounts say the sides' differences were most visibly focused on the America Online service's presence in the next generation of Windows software, known as Windows XP.

That said, analysts say the future of online music played a major role in the talks. And though AOL isn't exactly famous for standing up for the little guy, it appears that the online service threw its support behind online music company

RealNetworks

(RNWK) - Get Report

, which competes with Microsoft in the online music business, and which benefits from AOL's the-enemy-of-my-enemy-is-my-friend attitude.

On Monday, AOL's shares fell $1.10 to $49.80, Microsoft fell $1.14 to $66.88, and RealNetworks fell 18 cents to $10.21.

Disagreement

For its part, AOL says the Microsoft talks broke down after the discussion turned to music. The deal-breaker issue, says AOL spokeswoman Kathy McKiernan, was "Microsoft's determination to control music on the Internet."

"I don't understand what that means," responds Microsoft spokesman Jim Cullinan. "Clearly that was not an issue in these discussions." Talks broke down over "a wide variety of issues that could not be agreed upon," says Cullinan. "There's no role of Windows Media Player in these discusssions."

Though McKiernan wouldn't comment further, reports indicated that the sticking point in negotiations was Microsoft's desire to have its Windows Media Player establish a presence on AOL's service in addition to, or perhaps in place of, RealNetworks' RealPlayer.

Microsoft, which has integrated its Windows Media Player into Microsoft Windows software, is fighting with RealNetworks for dominance of the streaming-media player market, just as it previously fought

Netscape

to establish the dominant browser for the World Wide Web.

Microsoft doesn't make much money directly from Windows Media Player, says Matt Rosoff, an analyst at the consulting firm

Directions on Microsoft

. But Web sites that want to offer Windows Media streams have to use Microsoft Windows servers, he says. That's why Microsoft wants to make Windows Media the dominant format for streaming audio and video on the Internet, Rosoff says. "When that happens, companies will be forced to buy Windows servers in order to make the Windows Media files available," he says. Rosoff's firm doesn't consult for any of the parties involved.

Turf Wars

Sasha Zorovic, media infrastructure analyst at

Robertson Stephens,

sees a two-fold strategy for AOL's support of RealNetworks. One is an anti-Microsoft motivation. "They see Microsoft as a competitor on a number of fronts," says Zorovic. "Clearly one is media." While Microsoft wants to establish itself in online media the way it has in the computer operating system, he says, "That's clearly something that AOL sees as their turf."

The second motivation, says Zorovic, is less personal. As the parent of the

Warner Music Group

record label, AOL Time Warner doesn't want any single company to control its distribution, the way that Microsoft would control online music in the absence of RealNetworks (or RealNetworks in the absence of Microsoft). "You don't want to be captive to anyone in the distribution chain," he says. Zorovic has a market perform rating on RealNetworks, for which his firm has done underwriting.

John Corcoran, Internet analyst for

CIBC World Markets

, sees the breakdown in talks as a part of the ongoing cooperation and competition between AOL and Microsoft. "From AOL's perspective, RealNetworks is a very valuable thorn in the side of Microsoft," says Corcoran. Though Microsoft would love to steamroll RealNetworks, he says, "RealNetworks is far less of a threat, and more of a helpful, smaller ally, than Microsoft will ever be to AOL." Corcoran has a strong buy on AOL and a hold on RealNetworks; his firm hasn't done underwriting for either.

Loading ...