Napster has revealed that it is in talks over a sale or possible strategic partnership.

The announcement comes as a steady stream of new competitors enter the internet music sales market, including SanDisk partnering with RealNetworks, and Microsoft with its Zune Marketplace strategy. It also comes amid a sharp downturn in user figures for Napster, which saw its user base erode to 512,000 users at the end of June, from 606,000 at the end of March.

Napster said it has hired UBS Investment Bank to assist management in the "evaluation of strategic alternatives", in response to interest from a third party in potentially acquiring or establishing a venture with the company. Napster also said it remains in a strong position to continue building its own business, with or without such a deal, highlighting its cash position of $97m (about £50m).

The announcement sent Napster's Nasdaq-listed stock up 12.4 percent in after-market trading, to $3.99 (£2.10). The company set no timetable for finalising the evaluation, and said the talks may not result in any deals.

Formed in 1999, Napster popularised P2P (peer-to-peer) music sharing on the internet, gaining notoriety when a recording industry lawsuit ultimately shut it down and set the precedent for further legal victories over similar online services. A few years after the legal defeat, Roxio bought the rights to its name, and in late 2003 relaunched it as a legal music download store.

Napster faced stiff competition from the moment of its rebirth, mainly from Apple and the iTunes Music Store. The company reported a net loss of $9.8m (£5.2m) in the three months ending 30 June, on revenue of $28.1m (£15m).