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StreamCast's undoing

Streamcast_morpheus_logo Like David going 15 rounds with Goliath, StreamCast Networks Inc. battled the biggest companies in the entertainment industry for nearly six and a half years before finally dropping the slingshot and hitting the dirt. The file-sharing company filed a Chapter 7 bankruptcy petition last week, sending it down the road to liquidation.

But the company's demise wasn't triggered by Hollywood studios or the major record labels, as much as they would have liked to have done so. Instead, StreamCast was felled by one of its own rocks: a lawsuit it filed in January 2006 against file-sharing rival Kazaa and a host of related companies. It proved to be a tactical blunder of the first order. Two of the defendants in that case counter-sued, won and locked StreamCast in a financial death-grip. And here's the delicious irony. StreamCast executives had long grumbled that Kazaa had sabotaged their business just as it was taking off in 2002, enabling Kazaa to dominate the second generation of file-sharing networks (i.e., the one that succeeded the original Napster). That may or may not be true, but there's no doubt that StreamCast's attempt to take revenge against the extended Kazaa family proved its undoing.

To understand the latest chapter in this long-running saga, it helps to know the financial stakes and some of the history. StreamCast's staying power was a tribute to the popularity of file sharing, which explains why advertisers  -- and some venture capital firms -- continued to finance it despite the entertainment industry's lawsuits. At the height of its popularity, CEO Michael Weiss claimed in an interview, it had 24 million unique users. It lost many of them in early 2002, when Morpheus was suddenly cut off from the FastTrack network it shared with Kazaa and Grokster. Still, it continued to generate a healthy amount of revenue, thanks to the number of advertisements it showed users and the payments it collected from companies whose software was bundled with Morpheus (by Download.com's count, the Morpheus software has been downloaded more than 173 million times, enough to generate a mountain of cash from bundling alone).

Streamcast_networks_logo StreamCast was founded in Nashville as MusicCity Networks, and it garnered little notice until a federal court ordered the original Napster to stop users from downloading copyrighted songs. The company had initially operated an interconnected group of OpenNap servers, an alternative file-sharing network that relied on the original Napster's software. But as Napster's troubles mounted, StreamCast looked for an alternative approach. That led the company to Niklas Zennstrom and Janus Friis, a pair of file-sharing entrepreneurs in the Netherlands. Their company, Consumer Empowerment (later known as Kazaa BV), had developed (with the help of Estonian coders) a fledgling network called FastTrack, along with the Kazaa software to connect to it. According to StreamCast's lawsuit, StreamCast sought to buy the rights to FastTrack, but settled instead for a licensing deal with Zennstrom and Friis. That deal, the lawsuit claims, included a right of first refusal to buy any Kazaa technology or assets put up for sale.

In April 2001, StreamCast released the Morpheus software, enabling users to connect to the nascent FastTrack network. Morpheus and the FastTrack network quickly became the leaders in the race to succeed the newly crippled Napster. StreamCast tried again in June to buy the FastTrack software outright, the company asserts in its lawsuit, only to be rebuffed once more.

That September, two things happened. Company president Weiss, who worked out of southern California, left the company. And Steve Griffin, the Nashville-based founder and CEO, hired EuroCapital Advisors, a Woodland Hills merchant banking company, to help StreamCast find some additional financial partners. In a letter to Griffin dated Sept. 5, 2001, EuroCapital manager Mark Dyne agreed to assist StreamCast with a "strategic transaction" involving Bertelsmann AG (the European media conglomerate that had stunned the music industry by investing in Napster the previous year), Grupo Telefonica (a multinational phone and Internet company), a handful of venture capital firms and Rock the Vote. The letter also pledges Dyne's assistance in lining up other, unnamed investors. Nothing in the correspondence indicates whether Bertelsmann or the other companies named had expressed any interest in financing StreamCast or entering into other types of strategic transactions, such as sponsorships or advertising deals.

Dyne was more than just a deal maker. He was also founder and chairman of Brilliant Digital Entertainment, a software company in Woodland Hills specializing in simulated 3D animations. By the end of 2001, Brilliant Digital would have deals with both StreamCast and Kazaa to bundle its software with their file-sharing programs. Having broad distribution of that software was critical to Brilliant Digital's plans to create a global platform for online advertising using its 3D technology.

Brilliant Digital was also developing a second technology, called Altnet, which was designed to generate revenue for content owners from file-swapping. The idea was conceived jointly with Zennstrom and Friis in October 2001, Brilliant Digital CEO Kevin Bermeister told the Sydney Morning Herald, but the latter "were really besieged by legal issues ... and just wanted to sell the company." The major movie and music companies had sued Consumer Empowerment, StreamCast and Grokster in the U.S. that month, and in November a Dutch judge gave Consumer Empowerment two weeks to stop infringing music copyrights or face hefty daily fines.

Kazaa_logo Bermeister introduced Zennstrom and Friis to Nicola Hemming, with whom he'd worked on an interactive amusement park in Sydney, Australia, called SegaWorld. (The park flopped and was closed in 2000.) That introduction, he has said, was the extent of his and Brilliant Digital's involvement in the maneuvering that led to the establishment of Sharman Networks, which bought the Kazaa software and a permanent license to use the FastTrack network from Zennstrom and Friis in mid-January 2002. Sharman was incorporated in the Pacific island tax haven of Vanuatu, which enabled it to keep secret the identities of its investors and directors. Within days Sharman had announced itself, relaunched Kazaa's website and began distributing the Kazaa software.

Not long thereafter, Griffin and Dyne called off the arrangement between StreamCast and EuroCapital Advisors. On February 11, 2002, the two companies entered a confidential agreement that released them from the previous deal. A little more than two weeks later (around Feb. 26) Morpheus users were cut off from the FastTrack network. The shut-down seemed mysterious at the time, but Zennstrom offered a simple explanation to CNet's John Borland: StreamCast wasn't paying the royalties it owed for using the FastTrack software, so it didn't get an update that was incompatible with Morpheus. StreamCast hurried out a new version of its software days later, enabling users to connect to the Gnutella file-sharing network. But the setback was decisive. Kazaa went on to dominate the file-sharing universe for about three years, until users drifted off to p2p protocols such as eDonkey and BitTorrent that were more resistant to spoofing and less cluttered with ads. Morpheus remained a perpetual also-ran.

StreamCast lashed back in March 2006. With Weiss having returned serving as CEO, it filed a racketeering lawsuit against nearly two dozen people and companies, including Sharman, Zennstrom, Friis, Bermeister, Dyne and EuroCapital Advisers, accusing them of conducting an elaborate corporate-finance shell game to keep the FastTrack technology out of StreamCast's hands and drive Morpheus' users to Kazaa. The lawsuit alleges that the FastTrack technology was transferred to Skype, the voice-over-Internet-Protocol communications firm that Zennstrom and Friis sold to eBay in 2005 for more than $2.5 billion. (StreamCast amended its lawsuit in May to add eBay as a defendant.)

It's certainly true that many of the lawsuit's targets were intertwined to some degree, and that Dyne's involvement in Brilliant Digital linked him closely to Sharman, Zennstrom and Friis. According to Brilliant Digital's SEC filings and website, Altnet is a joint venture between Brilliant Digital and Joltid, a company established by Zennstrom and Friis. And executives from Sharman and Brilliant Digital have described Altnet -- a technology overlaid on top of a p2p network to promote the authorized distribution of files -- as a fundamental part of Sharman's vision for Kazaa from Day One. Nevertheless, U.S. District Judge Florence-Marie Cooper summarily rejected several of StreamCast's claims, including those against Dyne and EuroCapital, in September 2006, and tossed the rest of the case the following January. The fundamental problem, Cooper ruled, was that FastTrack wasn't the only file-sharing network, so excluding StreamCast from it couldn't constitute an antitrust violation.

Dyne and EuroCapital quickly responded, filing a counter-suit in November 2006. The suit alleges that the confidential agreement signed by Griffin, as well as the initial deal between his company and Dyne's, included provisions barring StreamCast from suing EuroCapital and requiring StreamCast to cover EuroCapital's legal fees if it were sued. It demanded more than $260,000, plus interest, to cover the cost of defending Dyne and EuroCapital against the racketeering claims.

StreamCast evidently agreed to pay almost as soon as the lawsuit arrived on its doorstep, because court records show that the case was dismissed six days after the complaint was filed. In an interview, Dyne declined to go into much detail, citing a confidential settlement agreement. But he reported that StreamCast gave him an IOU, then defaulted on it. He went back to court and obtained a temporary restraining order, and after that he won a second order effectively freezing their assets. He then called the Sheriff's Department to start foreclosing on those assets, but StreamCast short-circuited the process by filing for bankruptcy protection.

In a matter of weeks, Dyne accomplished something the biggest entertainment companies in the world hadn't been able to do in more than six years. But then, he had an insider's advantage.

In a memo dismissing StreamCast's employees, Weiss blamed the shutdown on an unnamed creditor who'd taken control of all the company's bank accounts and other California assets. He ended the memo on a hopeful note, writing, "If the situation changes, or if the creditor agrees to retain employees, I will contact you." But Dyne doesn't seem interested. Although the Morpheus name has some value, he said, "we would never have operated the Morpheus program."


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Times editorial writer Jon Healey pens opinion pieces about a variety of business issues, and blogs about technologies that are changing the entertainment industry's business model.

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