Updated from 12:33 p.m. EST

Wall Street frowned Monday on the news that a merger agreement between music e-tailer

CDNow

(CDNW)

and

Columbia House

, the music club jointly owned by

Time Warner

(TWX)

and

Sony

(SNE) - Get Report

, collapsed, as investors sent CDNow into a sharp decline.

CDNow said it has hired media investment bank

Allen & Co.

to explore its strategic options in the wake of the aborted merger, which was announced in July.

Sony and Time Warner said Monday they will invest $51 million in CDNow, including $21 million in cash to acquire 2.41 million shares, or 8%, of CDNow stock and converting an existing $30 million short-term loan into long-term convertible debt.

Jason Olim, president and chief executive of CDNow, said in an interview the merger was derailed because the cash flow and debt positions of Columbia House had changed significantly since the merger was first announced last July. "This was not an entity we all wanted to be shareholders in," Olim said of CDNow, Time Warner and Sony.

Regulatory hurdles as well as Time Warner's pending merger with

America Online

TST Recommends

(AOL)

, announced in January, also became roadblocks to the deal, according to sources familiar with the situation.

CDNow shares fell 1 7/16, or 15%, to close at 8 on Monday. Time Warner rose 1 1/2, or 1.8%, to 86 1/2. Meanwhile Sony dropped 18 1/4, or 7.5%, to 225 1/2; the company announced a two-for-one stock split in its ADRs Monday afternoon.

"We are obviously disappointed that the merger originally envisioned last July will not be completed," Olim said in a statement. "However, we feel the termination of the merger is the best move for CDNow and its shareholders."

Olim added that the investment by Sony and Time Warner will allow the company to continue building its brand.

CDNow, founded in 1994, said it will cut costs by nearly one-third, mainly by reducing marketing expenses. "The company will focus on its successful affiliate marketing programs, co-marketing programs with other advertisers, and other marketing initiatives that provide the company with an immediate return on investment," CDNow said.

CDNow is still looking to add a strategic partner to deepen its pockets and accelerate its drive to profitability, said Olim, who said he expects a deal within in the next three to six months. The deal with Columbia House offered the company access to the music club's 16 million members as well as to content and financing. Olim said CDNow will continue to look for ways to gain that access but a step short of a merger. "The vehicle has changed but the destination remains the same," he said.

At CDNow's current stock price, languishing in the single digits, Olim called the company "a bargain."

"Certainly, it is my belief that this company is one of the best-known brands on the Internet," he said. "We are a very attractive company right now and we'll generate a lot of interest."

Potential acquirers include digital download companies such as

Emusic.com

(EMUS)

,

MP3.com

(MPPP)

and

Launch Media

(LAUN)

-- "anybody who is looking to acquire 3.2 million customers in a hurry," said Rob Martin, analyst with

Friedman, Billings, Ramsey & Co.

. Martin rates the stock an accumulate; his firm has not done any underwriting for CDNow.