Tune in to "Real" Opportunity

04/07/2006 12:00 am EST


Mark Mowrey

Senior Analyst, Al Frank Asset Management

"Although iTunes tops all other online music services in sales, Apple could learn quite a few things from Real Networks," notes Mark Mowrey, editor of The Tech Value Report, a service from the Prudent Speculator family. Here, he tunes into a developing online opportunity.

"Real Networks (RNWK NASDAQ) is long-time player in the Net vibe space. The company has as-strong capabilities as Apple in other areas of online entertainment—namely games and video—that broaden its appeal to both potential customers and partners. That breadth is a key draw to the stock, bested only by Real Network’s ‘Cash is King’ balance sheet.

"As background, I’ve long had a soft spot for Listen.com’s online music service, Rhapsody. It’s year 2000 version offered a vast library of unlimited music selections, including both individual tracks and a long list of DJ-maintained radio stations. Rhapsody was very pretty and easy to use. It was also network friendly. The audio streams were small to start with, and long-term bandwidth usage was moderated by the fact that the software stored a digital copy of songs on the hard drive in files that were later unlocked by a code sent through the application. Pretty wow at the time.

"That technology was just one item that truly set Listen.com apart from its peers. One of those peers was Real.com, then a free Net media player provider seeking other means by which to boost revenue. Real’s own online music service was bogged down by its cumbersome player tech and overloaded design. Perhaps Real understood these deficiencies as well. The company purchased Listen.com and its Rhapsody service in 2003, and since then, Real Networks has matured greatly.

"Though Real’s online apps are still too busy for my online-viewing tastes (blinky-blinky, noisy ads all over), the interface is slick in all the right spots—perhaps even smoother than iTunes. It’s a rough balance—blinky versus slick—but it’s one that Real is closer to getting right. Today, Real sports 2.25 million total subscribers to its radio, music library, gaming, news, and movie services, with 1.425 million music-specific subscribers. In 2005, the company generated $325 million in revenue from monthly subscriber fees, per-song and per-game downloads, and advertising.

"Growth slowed in the latest quarter, and investors noted their disapproval. The slowdown in music subscriber additions, just 100,000 in Q4, suggested to many that iTunes was further solidifying its lead in online music sales. We think their flight a bit premature. iTunes is the undisputed Net music leader, no doubt. But the iTunes/iPod ecosystem is closed to alternative marketers. Have another company’s portable music player? Then you can’t play songs purchased on iTunes on the device. It’s no problem now for most folks, because iPods are so very cool. But they won’t always be the best multimedia players.

"Over the next year, a slew of machines capable of supporting everything but iTunes downloads will hit retail shelves. We bet there’ll be some very enticing designs among them, too. Enticing enough to pull some of the momentum away from the iTunes mothership. Some of that momentum will transfer to Real, we believe, and we want to be on board before it does.

"And we’re not talking only music and only portable audio players here. Real Networks has a new agreement with Cingular (soon to be reborn, again, AT&T) to provide streaming video to mobile phones. Real also has become a major player in the online gaming space—$15.7 million in revenue in the fourth quarter—with a gigantic library of titles targeted at the PC, console (Xbox 360), and mobile phone platforms. In fact, we think gaming can be an enormous driver of growth going forward, especially in the ‘casual game’ segment now so popular.

"Happily, Real Networks has lots of time to prove itself not just a worthy player but also a profitable leader in online and portable media. The company settled a long-running battle with Microsoft for the latter’s having beaten the Real media player into relative obscurity. The Microsoft settlement should boost Real’s cash position past $1 billion, or $6.39 per share. Hard to judge to where earnings are headed, but we bet Real is worth more than 81 percent of trailing revenue. We believe the shares are heavily undervalued and have added them to our TechValue portfolio."

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