Can RealNetworks Survive the Competition?

RealNetworks (RNWK) is a digital media services and software company. They have such products as Rhapsody, RealArcade, and RealPlayer. Their recent downward guidance for the 1st quarter of 2007 has sent the stock down from a $10.50 a share to a more recent trading price of $8 a share. The company predicts that earnings are going to be between 16 and 18 cents for the 1st quarter 2007 and full year 2007 earnings to be between 18 and 23 cents a share.

Issues with the company

The only reason they turned to profitability in 2005 and have been profitable since is because of their windfall in the lawsuit against Microsoft (MSFT). They have received Payments of $478 million in 2005, $221.9 million in 2006, and 61.1 million in January 2007. Over the same time period, their net income in 2005 was $312.3 million and $145.2 million in 2006. The January payment is their last and as you can see, this has been a huge part of their earnings in the past couple of years.

Their main competitors in music are Microsoft, Apple (AAPL), and illegal music downloading. Microsoft has been known to be very aggressive with their competitors and has taken aggressive steps against Real Networks. Apple's iPod's dominate the music hardware market and iTunes dominates the legal music downloading market. The iPod line holds a market share of over 70% in U.S according to GfK and NPD. The iTunes music downloads hold a market share of over 85% according to Nielsen Soundscan data. Apple dominates with the quality of their products and Microsft dominates with their size, intimidation, and operating system package advantage. Illegal music downloading has been going on for a long time and still takes a lot of money away from legal competitors. The RIAA has been at it for a while now with no success.

Their SuperPass subscription which deals with media services and software competes with YouTube (GOOG), which is a free service. It is the number 2 video site on the Internet behind MySpace (NWS).

One of their major strategies is acquiring companies for growth, depending on your perspective, this isn't the best way to grow a company because of the different difficulties that occur in mergers and acquisitions.

They have a number of provisions in place to discourage acquisitions and mergers. This will discourage potential acquirers that like their valuation and their wide range of products.

Positives about the Company

They have a superb valuation with cash and short term investments less long term debt of $3.22 per diluted share. This should give them money for acquisitions and a very nice margin of safety for an investment.

Their revenue growth has been superb. As you can see the revenue more than doubled in 5 years.

Some of their revenue has not been through organic growth though, for example, in the fourth quarter of 2006, $26.7 million out of $125.6 million were from the acquisition of WiderThan.

33% of the stock is owned by insiders so that means their interests are aligned with investors. Insiders have also recently stopped selling their shares in RNWK since the stock dropped to $8 a share. As of December 31, 2006, $78.1 million remained authorized to repurchase shares.

They have been spending a consistent 20% of Revenue on Research and Development expenses. This number has to be looked at closely to because an investor wouldn't want the company to forgo R & D expenses to boost short-term earnings.

Technicals

The 20 DMA is below the 50 DMA, and the 50 DMA is below the 200 DMA, so the downtrend is firmly in place. The stock price is basically back to the support of $7.50 it was at before the lawsuit win against Microsoft in 2005. It seems like it has found some support in the $7.50 area and both MACD and the RSI show that it is slightly oversold.

Conclusion

I see a lot of positives in that their Revenue growth has been superb, their insiders own 33% of the shares, they have a wide range of video products, and their valuation is attractive. They also face intense competition from Google, Apple, Microsoft, and illegal music downloads that might stunt their growth. A lot of their products that they charge a fee for face competition that doesn't charge like Google's YouTube and unless there are more laws that restrict the use of illegal music downloading or companies take Google to court over copyright like Viacom (VIA) recently did, I'm not sure how RealNetworks can succeed in this environment.

Disclosure: none

Comments

[Malkiel:]

The Realplayer media player is an outstanding software that's constantly being upgraded with new codecs and capabilities. Despite that, I've never been tempted to pay for its premium addition, and I think one reason is that the Realnetworks home page that comes up on startup never gives me any reason to believe that deep down there is a treasure trove of downloadable music or video clips. Instead of presenting a slow, boring collection of free pop music video clips (like an annoying version of MTV where you have to do too much exercise to watch the program) they need pizazz--like a Youtube window showing the latest clip or an Amazon.com scroll and search bar for music or movies. Every application should have a live window working, drawing you in.

Realplayer has been so much more attractive and functional than Windows Media Player, I hope it survives, even if I hate its spyware cookies...

2007 Apr 27 04:19 PM

[YenKenZen:]

what about its game business? the management is claiming strong success in casual games.

all in all - I think Real consistently comes up with some good quality, solid products much ahead of competition but they just arent able to hold hte ground against more marketing savy competition.

2007 May 04 06:57 PM