Napster Meister

Thomas Middelhoff liked the Post House because the clubby Manhattan restaurant seemed just the place in which to persuade Shawn Fanning that the two men had a lot more in common than a lawsuit. It was early September. Middelhoff, 47, chairman of Bertelsmann, the world's third largest media conglomerate, had never met Fanning, 20, whose ingenious file-sharing program, Napster, had created the world's biggest online free-music community--one that was costing Middelhoff and the rest of the music industry many millions of dollars in lost sales. But by the time they tucked into their steaks, the code-writing whiz was digesting the media mogul's sermon on the Internet being the world's first viable commercial democracy.

"I had to explain the Bertelsmann culture and the Internet, the speed at which everything is changing and the importance of our similar thinking about the value of membership communities," recalls Middelhoff, stopping just short of delivering the sermon again. By the time they finished the $219 Phelps Insignia Cabernet, Fanning was entranced by the precision and the passion, and he walked back to his hotel convinced that the gregarious German with the rimless glasses and earnest gaze was a man he could trust.

It was that discussion that led to last week's audacious partnership between Napster, the 18-month-old music swap shop that has spawned a following of 38 million file-sharing enthusiasts, and Bertelsmann, the German behemoth that began 150 years ago as a religious-hymnal publisher. No matter how it benefits (or maybe damages) both sides, the deal vaults the global entertainment industry into a new arena, where the game will be played by the freewheeling rules of the Internet, not the dictates of a handful of media barons. "Peer-to-peer file sharing is the future of media distribution," says Eric Scheirer, media and entertainment analyst for Forrester Research. "This is an incredibly significant development."

Under the agreement, Napster will develop a business model that should allow record companies and performers to be paid for their music. To help the tiny, 53-employee company overcome the enormous technological hurdles involved, Bertelsmann has opened a $50 million line of credit that could easily double. (Now hiring: any geek who thinks he or she can come up with a way to keep music files simultaneously accessible and copyright protected.) The Germans agreed that once the new model is in place, Bertelsmann's subsidiary BMG Entertainment will make its music catalog available and drop out of the copyright-infringement lawsuit that Napster has been fighting for nine months. Even before the deal was announced, Middelhoff began working the phones to persuade his counterparts at Time Warner, Sony, Universal and EMI to do the same.

And if all that happens, Bertelsmann becomes a majority stakeholder in the world's largest community of online music enthusiasts, with 38 million potential new customers not just for its music offerings but ultimately for books and movies and videos as well--the stuff that Internet types call content. "This could be really amazing," gushes Middelhoff, who is rarely able to contain his enthusiasm over a good opportunity. "This is like AOL in the beginning, a new community that we can build around the world. AOL is the example."

Everything about the Napster partnership is classic Middelhoff. It is counterintuitive, iconoclastic and so bold as to be regarded with derision, if not anger, by some of his competitors. Bertelsmann may lack the cartoon rabbits or mice that make its competitors household brands, but under Middelhoff, it has become more global and more diverse than most of them. Last year the privately held company had sales of $13.7 billion and profits of $480 million. Its empire stretches from John Grisham's novels (Random House) to Whitney Houston's hit tunes (BMG), and from Family Circle magazine to Germany's most prominent publications, like the provocative newsweekly Stern (both owned by Gruner + Jahr). Through a joint venture with British media giant Pearson PLC in the RTL Group, the company owns syndication rights to a vast universe of television programs, including Baywatch and The Price Is Right. And Bertelsmann also does a multibillion-dollar global business in printing and publishing services; the magazine in your hand may have come off a press at one of its 18 global plants.

Even before Napster, Bertelsmann's e-empire spanned global Web brands, including partnerships with giant search engine TerraLycos, music sites CDNow and GetMusic and a 40% interest in Barnes&Noble.com; . Middelhoff claims that as of July, Bertelsmann was ahead of every competitor except the Walt Disney Co. in visitors to its online sites. "Speed, speed, speed" is the Middelhoff mantra. "The world is changing fast," he said over dinner in Germany last June. "Companies must continually reinvent themselves and not be tied to one structure."