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The disposal forms the latest phase of AOL’s debt reduction strategy, which aims to cut its net debt from a peak of $29bn at the beginning to this year to $20bn by the end of 2004.

In the past few months, the company has sold its 50 per cent stake in the Comedy Central cable channel to Viacom for $1.23bn, and settled a lawsuit against Microsoft in return for a $750m payment. AOL is also nearing a deal to sell its Atlanta Hawks basketball and Thrasher ice hockey teams.

Cinram's offer was favoured over a management buyout bid by Jim Caparro, head of Warner's WEA division, which includes the manufacturing operations.

Cinram, which had cash and cash equivalents of C$164.2m (US$118.2m) at the end of last year, is expected to fund the acquisition with a mixture of debt, cash and new equity. As a result of the acquisition, Cinram will take over seven factories producing CD, DVDs and printed materials for Warner Music as well as AOL's Warner Home Video and New Line Cinema businesses.

The company has seen its share price rise from C$8.40 to C$17 since March.

The sale of the CD and DVD manufacturing division could also pave the way for a break-up of AOL's music division, including the sale of Warner Chappell, its music publishing arm and a joint venture in recorded music with BMG - the music division of the German media group Bertelsmann.

Talks are progressing with BMG on the potential music joint venture, but AOL Time Warner has not made a final decision on the sale of music publishing. It may invite offers only once the music joint venture is agreed, partly to satisfy regulatory concerns. Citigroup and Morgan Stanley are advising AOL on those transactions.

"By selling manufacturing and then publishing for cash and joint venturing music, they could raise up to $2.6bn of cash and have 50 per cent of one of the world's largest record music operations," according to one person familiar with the plans.

Progress on debt reduction will give AOL flexibility regarding an initial public offering of its Time Warner Cable division. Dick Parsons, AOL's chairman and chief executive, said last week the company no longer needed the IPO to raise cash for its balance sheet, but that the decision would be driven by strategic considerations.