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A new tune for RealNetworks
The digital media firm's stock plunged when Yahoo! entered the online music biz. Is it time to buy?
May 24, 2005: 4:58 PM EDT
By Paul R. La Monica, CNN/Money senior writer

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Sad songs: RealNetworks took a hit after Yahoo! introduced a music service that's cheaper than Real's Rhapsody.
Sad songs: RealNetworks took a hit after Yahoo! introduced a music service that's cheaper than Real's Rhapsody.

NEW YORK (CNN/Money) Investors in RealNetworks haven't been whistling a happy tune lately...it's been more like a funeral dirge.

Shares of the digital media software firm have plunged nearly 30 percent during the past two weeks due to a perfect storm of bad news.

The biggest reason for the decline was news on May 10 that Yahoo! (Research) was introducing an online music subscription service at a much lower price than Real's Rhapsody service. That raised fears of subscriber losses for Real (Research) and an online music price war.

In addition, a big quarterly loss by fellow online music firm Napster (Research) heightened concerns about how tough it will be to make money selling music over the Web.

And CNN, which is a co-owner of this Web site, announced earlier this month that it was going to begin featuring a free video service in June on CNN.com that uses Microsoft's latest Windows Media Player. CNN had previously been using a premium subscription video service that featured Real's technology.

But has Wall Street overreacted?

Bohemian Rhapsody

Sure, the online music business is brutal for just about every company not named Apple (Research), which has thrived thanks to its ubiquitous iPod and iTunes music store.

"There is too much competition in online music. It's not clear who has the upper hand," said Sunil Reddy, manager of the Fifth Third Technology fund. Reddy said he sold his stake in RealNetworks earlier this year.

But for a longer-term investor that's willing to take on some risk, RealNetworks actually might be a good bet.

For one thing, several analysts question whether Yahoo!'s low-price is sustainable.

Yahoo! is charging just $4.99 a month for an annual subscription or $6.99 a month on a month-by-month basis for its Yahoo! Music Unlimited service. Real's Rhapsody, by way of comparison, costs $9.99 a month for unlimited streaming. And if you want a version of Rhapsody that allows you to transfer songs to a portable device, it costs $15 a month.

"Yahoo! is definitely a pretty formidable competitor and Real may lose business in the short-term but there's no way Yahoo! can sustain this pricing. They couldn't have negotiated exclusive deals with labels to make this profitable for them," said Pete Spear, an analyst with Delafield Hambrecht, a Seattle-based brokerage firm.

Street ignores possible good news on the horizon

There's also more to Real than the music business. The company has expanded aggressively in the lucrative area of online video games.

Subscription and advertising revenue from games now account for nearly 16 percent of the company's total sales and has increased 80 percent from a year ago.

There are a couple of other factors that investors may have overlooked in their haste to dump Real's stock.

First, the company still has outstanding antitrust litigation against Microsoft (Research). And considering that Microsoft has been busy settling various legal cases with rivals such as Sun Microsystems (Research), Gateway (Research) and Novell (Research) during the past few years, analysts think an eventual payout to Real is likely.

"An end to litigation with Microsoft is not priced into the stock. If Real gets a big payout, which Microsoft has been doing, that could be a boon for them to help fund growth," said Spear.

Second, Real already has $370 million in cash, a decent sum for a company with a market value of about $880 million. And Real has only $100 million in debt. With that in mind, the company could wind up being an attractive takeover target in the near future if the online music business continues to get increasingly competitive. That doesn't appear to be factored in the stock price either.

"Real might need to look for a merger partner and I think the assets are valuable," said Kit Spring, an analyst with Stifel Nicolaus, an investment bank based in St. Louis.

Spring doubts the company is shopping itself just yet but that it is likely looking for strategic partnerships with larger companies seeking a piece of the online music action. He said Internet firms like Google (Research) and the ever-acquisitive IAC/InterActive (Research) or media titans such as News Corp. (Research) or Viacom (Research) could be possible partners or eventual acquirers.

And unlike Napster, RealNetworks is expected to post a profit this year and next. Analysts are forecasting earnings of 3 cents a share in 2005 and 10 cents per share in 2006. In fact, the company raised its sales and earnings guidance for 2005 just a week before Yahoo!'s online music announcement.

So sure, it may not be a harmonious time to be a RealNetworks investor right now. But there could be sweet music ahead for patient investors that want to take advantage of the big sell-off.

For more about Yahoo!'s new music service, click here.

For more about personal tech, click here.

Analysts quoted in this story do not own shares of RealNetworks and their firms have no investment banking ties to the companies.


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