RealNetworks Remains Strong Buyout Candidate

Just a couple of weeks after getting a slight pop in its stock price from a highly publicized online music distribution deal, RealNetworks issued a Q1 report that met lowered expectations, but left investors questioning the company’s future direction.

I believe that future involves an acquisition from a major media player, for the distributor of streaming multimedia software faces serious challenges in its efforts to grow revenue in two key areas — software sales and online advertising.

My top candidate for a buyout of RealNetworks remains AOL Time Warner , one of three major music publishers that early this month announced a partnership with RNWK to launch a subscription service allowing music lovers to download songs from the Internet. EMI Music Group and Bertelsmann also signed on to the distribution deal.

RealNetworks reported after Tuesday’s market close a Q1 net loss of $24.4 million, or 15 cents per share, compared to a net loss of $18.8 million, or 12 cents per share, in the year-ago quarter. On a pro forma basis, RNWK’s profit of $3.5 million, or 2 cents per share, matched Wall Street estimates, but fell short of last year’s Q1 pro forma profit of $8.8 million, or 5 cents per share.

The biggest problem facing RealNetworks is that its core business — selling streaming multimedia software such as RealPlayer — may have maxed out. While overall revenues in the first quarter dropped to $50.4 million from $53.5 million, or 5.8%, software sales plummeted 13.2% to $29.6 million from $34.1 million.

To its credit, RNWK in the past two years has been trying to diversify its revenue streams. Unfortunately, one of those choices was online advertising, and we all know what’s happened to that market. RNWK’s advertising revenues fell to $5.5 million in Q1 from last year’s $8.4 million, a decrease of 34%.

A subscription service introduced last year shows some promise. RealNetworks’ GoldPass service allows users to access exclusive content such as sports highlights and other video for $9.95 a month. That service provided RNWK with $4.3 million in fees during Q1, revenue it didn’t have at this time last year. But it’s far too early to determine the long-term growth rate for RNWK’s GoldPass business.

Then there’s MusicNet, RealNetworks’ subscription music download service. Plans call for MusicNet to begin offering songs from the catalogs of AOL Time Warner’s Warner Music Group, Bertelsmann and EMI sometime this summer.

While the arrangement drew a lot of attention when it was announced on April 2, a number of important questions remain unanswered, particularly how much of the subscription revenue will go to RNWK, which owns 40% of MusicNet and 0% of song copyrights. (Hint: Given the music industry’s record for revenue sharing, RealNetworks’ take will be closer to the latter figure.)

Further, RealNetworks will not have exclusive licensing rights. Other companies will be able to distribute music from these labels, while the two other major music companies, Sony and Universal Music Group, plan to launch their own joint subscription service.

With so many questions regarding its future growth and strategy, it’s hard to see RNWK shares, which closed Tuesday at $8.59, climbing back into the double-digits, despite an after-hours trading rise to $9.25. This makes it an attractive takeover target for the right media company.

That company could be long-time RNWK partner AOL Time Warner, which uses RealNetworks’ streaming software in its servers and distributes RNWK’s client software to its subscribers. It may make sense for this solid working relationship to progress toward a merger.

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