RealNetworks: Good, But Not Great

Sep. 6.07 | About: RealNetworks, Inc. (RNWK)

First, let me say that I like RealNetworks, Inc. (NASDAQ: RNWK). I think it is a safe investment – and I think at its recent closing price of $6.23, it has some upside. I feel $9-$11 is a realistic price target for this one, though it may not happen. I must admit, that I am a buyer of RNWK at these levels and have been slowly nibbling away at this one. It just looks to be a very safe play with some things coming together that can result in upside.

As for the merits of RNWK, those are no secret:

  • Slew of upgrades, including the most recent buy rating by Pacific Growth Equities on August 31, 2007 and a $11 price target from Think Equity on August 27, 2007;
  • A parade of new deals and announcements with Verizon/MTV in an effort to rival iTunes;
  • Lots of cash ($4/share), nominal debt, and trading right around 1x book value.
  • Significant stock buyback program in place.

The stuff sounds exciting, yes. RNWK is an online music play that appears to have been oversold and is right in the midst of some deals and markets that can potentially get very hot. So, recognizing that the market typically does a good job of pricing in available information into the mix and the trendiness of online music and mobile media, why is RNWK trading at the valuation of an insurance company?

The biggest factor, I believe, that will hinder RNWK from becoming a 10-bagger is the CEO and Founder, Rob Glaser. I am not suggesting Glaser is incompetent by any means – in fact, I think he has done, at the very least, a satisfactory job of diversifying the company and expanding from a technology service to an entertainment/media company. Recall that RNWK's primary business used to be technology licensing of their streaming media technology. RNWK still has that line of business but also has a slew of other offerings and new deals in place that can drive their more exciting business lines: music, gaming, entertainment, mobile.

Glaser, by virtue of being the founder, owns about 30% of RNWK and in 2006, from June to December, parted with over $12M of stock at around $10.50-$11.00 per share. Certainly, that is his prerogative and I do not blame him for it, but that $12M was about 12% of the $100M RNWK stock buyback program. The matter of a buyback program is nothing new. RNWK completed their 2005 and 2006 buyback programs and it appears that they will with their most recently announced repurchase program. If Glaser is not enough, note that between March 31, 2007 and June 30, 2007, institutions registered net selling of 28,427,000 shares – that dollar volume far exceeding the RNWK buyback efforts. Simple supply and demand – if there are more sellers than buyers, price goes down. To get to the point, the RNWK buyback is a good gesture but is not accomplishing the real purpose of what a buyback should accomplish. Simplistically, it is simply allowing some of the larger institutions and Glaser to part with some of his shares (albeit a small % of his shares). If there were no sellers, than the buyback would be a very bullish indicator for the stock and seem to be a prelude to higher levels.

From an acquisition standpoint, the size of Glaser's holdings and his well publicized liquidation of shares at the $10.50-$11.00 level, even if premeditated by a company approved 10b5-1 plan, shows that he is willing to let some go at that price. If he is willing to let go of some at that price, basic logic suggests that he would be willing to take less to get rid of them all in one shot. I believe that many possible buyers of RNWK exist. Google, for sure is one of them, but it seems they are working with gBox for their digital music future. However, the RNWK gaming platform might make sense as Google (NASDAQ:GOOG) has yet to offer a Google Games, a piece of the puzzle they currently do not have and their top competitors (Microsoft (NASDAQ:MSFT), AOL (NYSE:TWX), Yahoo! (NASDAQ:YHOO)) do. Any of the ILECs, such as Verizon (NYSE:VZ) or AT&T (NYSE:T) are possible suitors. The cable companies, perhaps Comcast or Time Warner, may make a good fit. Universal Group may also be a candidate to take out RNWK. Wal-Mart (NYSE:WMT), Yahoo!, or Microsoft? Well, maybe, but all three already have their own digital music solutions available to their traffic base.

Unfortunately for RNWK and those looking for pie in the sky, the takeover price would likely be in the $8-$9 range – which, mind you, is still a strong premium over Friday's closing price. However, my best guess suggests that such an offer would not be acceptable to the RNWK board and shareholders (e.g., Glaser) at this stage. I believe the opportunity is there, but really is more of a Plan B if the newly announced initiatives do not work out – consider it like a bail-out or a cushion. This will leave RNWK to fend for its own and try to drive shareholder value through its own internal efforts, which may or may not work out.

Why is the buyout price seemingly so low? Funny – who thinks a 30% premium is low? It does not seem that way, but a 30% from the company's recent price is also 30% less than the company's 52-week high and fractionally lower than the triple-digit price RNWK traded at during the peak of the Internet bubble.

Well, the Glaser selling spree is part of the equation as is RNWK is participating in an increasingly commodity-driven business. This element is the second aspect as to why RNWK is trading at these apparent low prices. The online music business simply is not exciting and as everyone in the world seems to get into it and the major labels become more receptive to it, it eliminates some of the premium given to the industry. Players like eMusic, which used to be public, gave way to a private equity-buyer. Napster, which is a popular name in the space, has yet to turn a profit. iTunes is the dominant leader, but only because they have the captive audience of the iPhone and iPod to basically force people to use their digital music platform. Furthermore, Apple (NASDAQ:AAPL)is in the hardware business – not the digital subscription business. Even with the royalty-free usage being endorsed by some of the record labels, you are seeing Wal-Mart get into the game and will obviously do whatever it takes to be the lowest cost provider of digital music downloads around. The end-result, once Wal-Mart is in the game, the sexiness is out – hence no major market premium.

To summarize, RNWK is a solid company and it appears there is some upside in this one based on the condition of the balance sheet and an array of new opportunities on the horizon. However, the digital music business is just not that exciting any more, now that it seems anyone can get into it. Plus, Glaser has already played his hand of the price he is willing to let go of this one. RNWK may be worth more than $6, and I agree with that sentiment, but given the status quo, it's certainly not worth more than $10 to any potential suitor.

So, is RNWK a winner? Well, yes, I believe it is and has some upside and limited downside. Perhaps shareholders may get a boost from the plethora of new developments and agreements RNWK is moving into, especially in the gaming, music, and mobile spaces.

Just your classic case of if it's too good to be true, it probably is. RNWK is worth $9-$11 per share – but no more – and if their new relationships do not pan out, it could be at $6-$7 for a long-time. I still like RNWK, especially at under $6.00. Be smart with this one – and be realistic – and all should fall nicely into place – particularly if your mindset is to stack nickels in your portfolio over the long-haul rather than try to shoot the moon. If you belong to the latter group of investors, well, then RNWK is not going to make you happy. The only person getting rich off RNWK will be Glaser, but the upside leaves a little bit of crumbs for the rest of us bottom-feeders. For me, for 30%-50% upside, well, I'll bottom-feed all day.

Happy buying, but do not expect a double or a triple and I would advise not waiting for it. We all say we are ok with 30%-50% gains in a 12-24 month period, but considering AAPL's double in the past year, it may be easy for your eyes to get bigger than your stomach with this one. Let's keep it Real.

Disclosure: Author is long RNWK