Napster Meister

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As for the man who brought Bertelsmann into the Internet age, the lanky Middelhoff was dreaming in digital streams before most of his counterparts knew what they were. He wrote his doctoral economics thesis in the mid-'80s on the failure of one of Germany's first online businesses. And once he arrived at Bertelsmann headquarters, he didn't wait long before pushing the stodgy company to break out of the cow pastures that envelop its local borough of Gutersloh (population 78,414). In 1995, shortly after he was named head of corporate strategy, Middelhoff persuaded the tightfisted Bertelsmann board to gamble $50 million on a 5% stake in a nascent Internet company called America Online. It was a masterstroke. The $50 million AOL investment turned into $1.8 billion and propelled him into the president's suite in 1998.

Before taking office, Middelhoff spent a year in the U.S., improving his English and trying to get to know every media bigwig in the States. He and AOL chief executive officer Steve Case became good friends, and Case began to introduce Middelhoff around. Although he may have that steely look and the precision dress of a Frankfurt banker, his new media friends discovered Middelhoff to be a man of surprising charm and easy humor. That down-homeness may reflect his roots. He lives on a farm outside Gutersloh with his wife, five children, 45 cows and sheep, and a duck pond. "Thomas can defuse the tension in any room," says Aydin Caginalp, Bertelsmann's U.S. attorney for 18 years.

Among Middelhoff's new acquaintances was Samuel ("Si") Newhouse, chairman of Advance Publications, which publishes, among other magazines, Vanity Fair and the New Yorker. A week after attending Si's birthday party, Middelhoff bought Advance's Random House book business for $1.4 billion.

But in January, the Bertelsmann train was sidetracked. Middelhoff's good friend Steve Case announced that AOL was buying Time Warner (TIME's parent company), and other media megamergers left little room for the big deal that might seal a No. 1 content position for Bertelsmann. The private Bertelsmann's board has a deep-rooted aversion to debt. So Middelhoff redoubled his efforts to reorganize the company around digital content and in one stroke sold off its stake in a string of companies before the dotcom meltdown. That netted an estimated $15 billion in cash ($8 billion from AOL Europe alone) to shop with.

Which underscores another point about Middelhoff. "I've learned to be flexible and wait for the right opportunity," he says. "But I have also been very lucky." Lucky enough to have a war chest at a time when Internet assets are dirt cheap.

For Middelhoff, Napster was a natural solution to his long-standing pledge to make Bertelsmann king of the music-content world. "I realized that we had to pursue music from two sides," he said last summer. "There is content, but there is also online file sharing. We could not get ahead without file sharing." Bertelsmann's technology arm had been working on its own file-sharing system for months. "But we realized that all the technology gave us was an illegal way to distribute files," says Middelhoff. "We had to make it legitimate, and Napster already had a base to work from."

So in late August, Middelhoff decided to go after Napster himself. Ironically, he came to that conclusion after a meeting with Seagram chairman Edgar Bronfman Jr., a staunch Napster foe, in which they discussed ways to resolve the Napster question. "We walked out of Edgar's office, and Thomas and I looked at each other, and it just clicked," says Andreas Schmidt, president of the Bertelsmann E Commerce Group, who orchestrated the partnership. That day Schmidt got on the phone to Napster CEO Hank Barry and began eight weeks of intense transcontinental negotiations, from San Francisco to Miami, New York City to Gutersloh.

It is a long way from that base to a real solution, however. Though other music companies last week voiced cautious approval of the Bertelsmann move, there is considerable resentment. Indeed, it took intense negotiations last month and, ultimately, management fiat for Middelhoff to get the support of top executive Strauss Zelnick at his own BMG. So far, nobody has indicated any willingness to drop the legal action against Napster. "We're still not on Napster's side," says Zelnick, laughing. "We're suing Napster. But we are also on the side of creating an array of legitimate distribution alternatives."

The sticking point now is the new business model, which nobody at either Napster or Bertelsmann is certain of. The main reason is technology. So far, it just isn't clear how to track every digital file out there and put a user name and a price on it. And there are huge questions about what a reasonable price would be. Barry has suggested a monthly fee of $4.95. But websites all over cyberspace burned furiously last week as Napster fans threatened to ditch the service if it charged as much as a nickel for music-file access.