Best Buy to buy Napster for $121 million

The Napster ''Cat'' logo is shown on the floor at a launch event for the Napster online music service in New York in this October 9, 2003 file photo.

NEW YORK (Reuters) - Best Buy Co Inc plans to buy digital music service Napster Inc for $121 million in cash in an effort to compete with Apple's dominant iTunes service and its iPod music players.

Best Buy, one of the largest retailers of CDs, and Napster, once the best known name in digital music, both offer digital subscription services, but neither have mounted much of a challenge to Apple, which holds more than 70 percent of the U.S. digital music market.

Napster and Best Buy are betting they have a better chance by combining rather than competing with each other.

Best Buy said on Monday it would pay $2.65 per Napster share, nearly double its closing price on Friday. Napster shares jumped 87 percent in early trading to $2.54.

In 2006, Best Buy teamed up in with RealNetworks Inc and SanDisk Corp to create a digital music subscription service and compatible media player.

The original Napster helped set the digital music market in motion in the late 1990s with a free music sharing service, which was shut down following a lawsuit filed by the music industry. The brand name was bought and resurrected as a legal digital subscription service, although it never really threatened iTunes.

Best Buy plans to use Napster to reach new customers over an array of devices. The proposed acquisition includes Napster's approximately 700,000 subscribers, its Web-based customer service and mobile capabilities.

"This is a very natural and appropriate time for Napster to lever up our position in the industry with a strategic bear hug from such a powerful partner," Napster Chief Executive Chris Gorog told Reuters in an interview.

Best Buy is moving into categories that are outside traditional consumer electronics as it looks to double annual sales to $80 billion over the next five years. It is also boosting its wireless offerings since completing the introduction of Best Buy Mobile shops at its U.S. stores.

Napster has been facing the threat of a proxy battle by three dissident investors, who criticized management's strategy in competing with iTunes, the country's largest overall music retailer.

Its share price has plummeted about 60 percent from a high of $5.80 in October 2007.

Last month, Napster said it was willing to consider a sale and hired UBS Investment Bank to consider options.

Included in the deal is approximately $67 million in cash and short term investments held by Napster, meaning the net price of the deal would be $54 million, the companies said.

Gorog and key members of senior management have entered into employment agreements with Best Buy, effective at deal closing, to continue as the Napster leadership.

He said Best Buy has indicated it would retain the Napster name after deal closing, expected in the fourth quarter.

Best Buy expects Napster and its 140 employees to remain at its current Los Angeles headquarters

Napster also said on Monday it would postpone its September 18 annual meeting in connection with the Best Buy agreement.

Best Buy shares rose 0.47 percent, or 21 cents, to $44.70 on the New York Stock Exchange.

(Additional reporting by Karen Jacobs in Atlanta; Editing by Derek Caney)