RealNetworks just announced that it's going to restructure Rhapsody and spin the subscription music service off into a standalone company.

Real is the majority owner of Rhapsody, which is also partly owned by MTV. The venture was formed after Real bought Rhapsody -- formerly known as Listen.com -- in 2003 for about $36 million.

Rhapsody sells monthly subscriptions starting at $13 providing unlimited access to a vast library of digital music.

The subscription approach didn't catch on while Apple dominated the music business with a model selling individual tracks, but some have speculated Apple could enter the subscription business itself and invigorate the approach. Meanwhile, subscription ventures are in fierce competition with ad-supported services offering free music online and competitors such as Best Buy's Napster service that undercut Rhapsody's price.

Subscriptions to Rhapsody have settled to about 700,000 after peaking at more than 800,000 in the first quarter of 2009.

The spinoff is the first major change since a Jan. 13 executive shakeup in which founder Rob Glaser passed chief executive duties to chief counsel Robert Kimball. That was presented as the beginning of an effort to restructure Real to focus on core businesses.

Real's remaining operations include its music business selling digital content, ads and other subscriptions; PC and mobile games; media software including RealPlayer and technology services and products sold to corporations.

"Separating Rhapsody into its own independent company is a significant first step in making RealNetworks a more focused and profitable company," Kimball said in a release. "Rhapsody will be the largest pure play digital music service in the market. We have provided Rhapsody with the right team and financial and intellectual property assets to succeed in the competitive market for digital music."

Rhapsody will be based in Seattle and have about 150 employees, including current Rhapsody staff and some members of Real's music group, which will move to the new company. The total includes a San Francisco office that has fewer than 50 employees.

Employees were notified during a music group meeting about two hours ago and by an e-mail from Kimball.

It's a complicated deal -- Kimball told employees today, "It was brain surgery trying to disentangle a decade-old music business from the rest of Real" -- but basically Real and MTV's parent company Viacom are unwinding a partnership that split their ownership of Rhapsody 51 to 49 percent.

When it's done, sometime in the first quarter, both companies will own an equal number of shares in Rhapsody. Real is contributing $18 million and the Rhapsody brand, and MTV is contributing $33 million worth of advertising support (and canceling a $111 million advertising commitment to Rhapsody).

How the deal will affect Real's earnings will be discussed further in a conference call with investors on Thursday, spokesman Ryan Luckin said.

Asked if Rhapsody is being positioned to go public or be acquired, Luckin said the plan is to set the venture up to operate as a standalone business.

"It's got the IP [intellectual property] and the cash to go forward and try to be successful in the digital music space," he said.

At the end of 2008, the Rhapsody America venture with MTV had lost $17.8 million and had remaining equity of $384.3 million, according to Real's November's earnings report.

Being removed from the RealNetworks umbrella will give Rhapsody more flexibility to partner with other companies, Luckin noted.

Subscribers to Rhapsody won't see a change, he said.

Here's the e-mail Kimball sent to employees:

Dear Team,

Last month I spoke to all of you about our plan to make RealNetworks a more focused and simplified company. Today we are announcing the first major milestone along that path: we have signed an agreement with Viacom to separate Rhapsody into a completely independent company. Although the deal is signed, it will not be "closed" until the end of the quarter while we do the final work to set up Rhapsody's HR, legal, finance and other systems. This is typical for a complex deal like this (much like buying a house) where you sign the contract and then close the deal later when everything is in place.

This means that our Rhapsody colleagues will soon take up headquarters in a new location. As part of the deal, both Real and Viacom have ensured that Rhapsody will have the right team, assets, flexibility and independence to build a fantastic music business. I'm very excited about the deal for both Rhapsody and Real. It enables both of us to focus more intensely on our businesses without distraction and unnecessary complication.

This is a big step for both Real and for Rhapsody, and I don't want to let the moment pass without pausing to recognize what we have accomplished. We have taken Rhapsody from internet startup to the largest pure play digital music company in the country. Rhapsody has provided many hundreds of millions of song plays for our customers and generated hundreds of millions of dollars in revenue over the years. Rhapsody is actually well ahead of the curve in providing compelling cloud-based music services - which are just now becoming the rage. I think the trends are moving in Rhapsody's favor. I want to personally thank each and every RealNetworks and Rhapsody America employee who has worked tirelessly to make Rhapsody the industry's premier digital music service.

I also want to specially thank the cross-functional team that made this deal a reality: it was brain surgery trying to disentangle a decade-old music business from the rest of Real. It was great to see people pulling together from virtually every part of our company. We need more of this kind of team effort. Nice work, all.

Best,

Bob

P.S. Oh, and about those subscriptions to Rhapsody . . . . we've made sure that everyone's account will remain active and paid at least through the end of the year. Thanks Rhapsody team!