RealNetworks: A Value Trap With Significant Downside Risk Over The Next 2 Years

| About: RealNetworks, Inc. (RNWK)


Trades at about 70% of market cap in cash, but every core business segment is experiencing declining growth and significant recurring losses.

RealNetworks owns 45% of music service Rhapsody, which is growing rapidly but is seriously troubled and it is not certain if it will ever be profitable.

Company future is heavily dependent on new RealPlayer Cloud offering which has yet to be monetized and may not have a viable market as a paid platform.

I've received a number of inquiries from value investors looking at RealNetworks (NASDAQ:RNWK). The stock spiked as high as 15% at the open on July 17. Rumors on Twitter suggest that the cause of the move is a Stansberry Research newsletter release. The only actual news that I have found is some obscure Chinese CODEC deal with Xiaomi. So I find this move puzzling and it also makes the stock even less attractive in terms of value as it traded up.

To start, RealNetworks has a very strong cash position after selling its patent portfolio to Intel (NASDAQ:INTC) for $120M in early 2012. Currently the shares sit as of July 17 at about $8 which equals a market capitalization of about $288M. As of March 31, the company reported cash and short term investments of $210M. In 2013, RealNetworks lost over $65M. In Q1, all four business segments were losers. That is, RealPlayer, Mobile Entertainment, Gaming and Rhapsody (of which the company owns a 45% interest).

CEO Robert Glasser, who returned to the company just over 2 years ago, says that he expects losses to continue into Q2 in all segments except a small gain in mobile. Q2 earnings will be reported on July 30 after the market close. Given the mounting losses and no signs of a turnaround, it is reasonable to assume that the cash balance will show further degradation.

The main source of revenues for the company is RealPlayer. This is a software released in 1995 that has outlived its usefulness. In fact even in 1999 it was shunned by many experts for its adware and spyware inclusions. So while RealPlayer use is in a rapid state of decline, the company has pinned its future hopes on the new RealPlayer Cloud.

On the Q1 call, Glasser boasted of 2M free users of RealPlayer Cloud and likens it to the "Dropbox of video." Cute tagline, but the fact is that marketing spend to attract these users has well exceeded expectations and there is no evidence of successful monetization of the service. As a technology buff myself, I can't figure out why anybody would use this software, let alone pay for it.

If you want to upload, store, stream and share videos in any format you can use YouTube for free to do just that. For this reason, I don't think that it will be successful as a paid platform and the seemingly impressive 2M free users are simply a testament to the heavy promotional spending needed to attract them.

Certainly, the Mobile Entertainment division is the most promising. With revenues of $19.9M in Q1 it reported the smallest EBITDA loss of $300,000. The newly launched LISTEN product may be a catalyst for future growth. However, this is the only business segment that I believe has any value and frankly it is peanuts and overshadowed by continued massive losses in all other segments.

RealNetworks' bulls seem fixated on the fact that the company owns 45% of struggling music subscription service Rhapsody. They believe that this is a major unlocked value proposition. The fact is, you only need to read the RealNetworks 10-K to realize that Rhapsody's loss widened to over $14.6M in 2013 from $12.23M in 2012. Rhapsody cut its workforce by 15% in September 2013 and its President Jon Irwin resigned.

Although shortly after this announcement, Telefonica took an equity stake in Rhapsody. The goal is to expand internationally. However, at this time, there is no evidence that would suggest that Rhapsody will be successful in the midst of massive competition from Pandora (NYSE:P), Spotify and other far more entrenched and innovative players. Certainly the losses are compounding YOY, so we cannot just assume that it will suddenly become profitable. If this is to be the case it is still years (and many millions more in losses) away.

Given the mounting losses, Rhapsody ownership can be considered more of a liability rather than an asset. Just like RealPlayer Cloud, there is no evidence to believe that Rhapsody will ever be a viable platform. While the paid subscriber count showed 62% Q1 YOY growth, much of this can be attributed to a one-time benefit of Telefonica's Sonora customers being transferred over to Rhapsody's Napster. Ultimately, the continued losses are what is most deeply troubling.

My thesis here could be challenged by a surprise acquisition of Rhapsody, which would undoubtedly cause the RealNetworks share price to surge. When RealNetworks sold its patent portfolio to Intel in 2012 for $120M, the stock rallied 25% that day on the news. Furthermore, while not very likely in my opinion, a sale of any of the other business segments or the company as a whole would have an exponentially accretive effect on the share price.

However, I believe that in a real world scenario investors should expect this potential turnaround to take a minimum 2 years before bearing fruit. That is, if the turnaround is ultimately successful. This remains to be seen. So at the current rate of cash burn and given no other catalysts, the stock can easily trade down to the $4 range in this 2 year time frame. This represents a decline of 50% from the current share price. I will be avoiding RealNetworks as it is a classic value trap.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a short position in RNWK over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.