Can Bertelsmann Take Wing?

It's off to a slow start in becoming an e-commerce giant

Bertelsmann CEO Thomas Middelhoff spends so much time yakking about the Internet that you might mistake him for Al Gore. But then, it takes a lot of talking to convince people you can turn a former publisher of religious pamphlets into the biggest e-commerce media company in the world. Middelhoff's ambition: to leverage Bertelsmann's vast store of books, magazines, music, and TV programming into big Net dollars through ventures such as, an online bookstore. The plan is working, insists the 46-year-old CEO. Already, Bertelsmann claims more online turnover than Yahoo! Inc.

But there's one element of this New Economy scenario that Bertelsmann is missing: publicly traded shares. While it's the world's fourth-largest media company in terms of sales--$14.9 billion last fiscal year ended June 30--privately held Bertelsmann's stock market value is a big fat zero. America Online Inc., a Bertelsmann partner, was able to use its soaring stock to buy Time Warner Inc., a Bertelsmann archrival. Company executives say they prize stability and independence over a volatile, if valuable, stock listing. That's why Bertelsmann rebuffed merger overtures from AOL, which could have paid in stock. AOL also would have certainly assigned the German company a subservient role.

HANDICAP. Since it doesn't trade publicly, Bertelsmann would have to pay real money to join the merger binge. That may explain why Middelhoff hasn't tried to outbid Time Warner for British recording giant EMI Group PLC, which creates a threatening rival to Bertelsmann's own BMG Entertainment. "Fundamentally, Bertelsmann's strategy is very good, but the absence of shares is a huge problem," says Robert Mutschler, a director of forit, a German Internet market-research firm.

Europe's e-commerce future hinges on whether Middelhoff can overcome that handicap and keep Bertelsmann from becoming a minor player as rivals forge megadeals. If Bertelsmann can make the transition, there's hope for Europe's other Old Economy giants. But the going could be tough. AOL-Time Warner served notice that a new kind of media company, one combining content and technology, could swiftly overwhelm the old. If Bertelsmann can't move fast enough, companies such as Yahoo! and Inc. will dominate e-commerce, while hybrids such as AOL-Time Warner could threaten Bertelsmann's traditional publishing and entertainment markets.

Bertelsmann already has lots of catching up to do. For all the chatter about the Internet, multimedia still accounts for a mere 1.8% of sales. Old-fashioned books contributed 31%. Bertelsmann earned $467 million in profits last fiscal year. At 3% of sales, that was slightly below its rivals: Time Warner's profits were 3.6% of sales, while Walt Disney Co.'s were 5.3%.

Recent weeks have brought a few setbacks for Bertelsmann. AOL Europe, Bertelsmann's joint venture with AOL, now looks unworkable since Time Warner is a major Bertelsmann competitor. Middelhoff quit the AOL board on Jan. 25 because of conflicts of interest created by the AOL-Time Warner merger. Most likely, Bertelsmann will sell its stake in AOL Europe in an initial public offering. That could raise as much as $7 billion but will take away Bertelsmann's stake in a system that boasts 2.8 million Internet surfers. At the same time, Time Warner's planned merger with EMI thwarts Bertelsmann's plan to vault to first place in the music business. Bertelsmann has ruled out a counterbid.

TRAILING. Middelhoff is not beaten yet. Bertelsmann's corporate treasure chest holds lots of the things Internet pundits like: brands, content, customer relationships. Its Gruner & Jahr publishing unit, for example, boasts 170 million magazine and newspaper readers. Through Random House Inc. and other publishing subsidiaries, Bertelsmann sells 1 million books a day. BMG Entertainment is the world's fifth-largest record company. Bertelsmann is also partners in Europe's giant TV group, CLT-UFA, which has 22 stations in nine European countries.

The trick is to transform all those viewers and readers into e-commerce customers, by offering a wide range of products tailored to their interests. So far at least, Bertelsmann is sticking to selling media products--and trailing behind. Take its online book-and-music venture. After starting almost a year ago, now claims to sell 10,000 books and CDs a day in six European countries. But it's behind's European ventures in countries where they compete. Customer service is also weak. In a test by Forrester Research Inc., Bertelsmann took more than 24 hours to answer a customer's e-mail. That's no way to build loyalty. Bertelsmann doesn't stand a chance on the Internet until it uses its traditional businesses to offer services its competitors can't.

Middelhoff, to his credit, has stayed on message. He rarely makes a public appearance without mentioning the Internet. He was the one who linked Bertelsmann to AOL in the first place, which helped propel him to the CEO's post. With his spectacles and goofy grin, Middelhoff even looks the part of a Silicon Valley nerd visionary. People who know him say he's persuasive. "He really motivates you," says Heinz Wermelinger, chief of

Not everyone seems so charmed. It's clear that Middelhoff still faces major internal resistance as he tries to reorient Bertelsmann. That's one silver lining of the AOL-Time Warner deal. It sends a message to doubters that the Internet is revolutionizing the media business. "Those people who've looked strangely at Thomas Middelhoff and me now have to recognize that these [Internet ventures] are real, substantial companies," says Klaus Eierhoff, a member of Bertelsmann's management board who is responsible for multimedia.

CABLE DEAL? Eierhoff, one of Middelhoff's closest advisers, insists that Bertelsmann won't be held back by its lack of share currency. Even a blockbuster merger is possible, Eierhoff says. "It depends on whether it's the right partner, the right timing." Analysts speculate that Bertelsmann could break new ground by joining with a major European bank to offer online banking, which could be used to draw customers to Bertelsmann's Web sites. Or Bertelsmann could invest in cable: Deutsche Telekom's cable network is for sale.

At least Bertelsmann doesn't have to worry about a hostile takeover. Ownership is firmly in the hands of the Bertelsmann Stiftung, a foundation. And Bertelsmann is creating some share capital by launching IPOs for selected business units. One example is Pixelpark, a Berlin Internet consulting company nurtured by Bertelsmann. The October IPO raised $59 million, and Bertelsmann's remaining 60% stake is worth $1.3 billion after the shares rose more than sixfold. Still, it's not enough to play in the major leagues.

An IPO of the parent company is technically possible, but unlikely. Traditionally, Bertelsmann has made employee and community welfare as important as profit, in line with the philosophy of company patriarch Reinhard Mohn. Shares could be used for takeovers, but they could also make Bertelsmann takeover bait. For now, Bertelsmann, with its headquarters in the pastoral North German town of Gutersloh, just doesn't look quite ready to plunge very far into the Internet economy.