RealNetworks Offers
Online Services

By MARCELO PRINCE
DOW JONES NEWSWIRES

So the software gig didn't pan out. How about online music and movies instead?

RealNetworks Inc., a pioneer in software that streams audio and video over the Internet, survived the dot-com collapse and an assault from Microsoft Corp. Now, it is trying to remake itself into a cable-like provider of paid Internet content -- everything from online Scrabble to audio broadcasts of Nascar races. For $9.95 a month, for example, customers can rent songs to play on their computer.

This shift has offset declines in the Seattle company's software business but there aren't any profits to show for it yet. In fact, revenue from consumer services increased 50% in the first half of 2004 and accounted for four-fifths of the company's sales. Yet RealNetworks has racked up five straight quarters of losses and, last week, widened its loss estimate for the third quarter after slashing prices on its music downloads.

Competition in this digital-media arena looks stiff. There is Apple Computer Inc. for starters. (The music download price cuts were aimed squarely at Apple.) There's also Napster Inc., Sony Corp. and others selling music online. Yahoo Inc. harbors such plans and Microsoft's MSN unit plans to join the fray later this year.

Still, some investors are betting the RealNetworks foray into digital music, games and video will blossom into profitable businesses. Also, the company had $363 million cash in its coffers in June -- a safety net for its battered shares, say its bulls.

"The market is myopic and focused on what Real used to be. It's really not a software company any more," said Chris Bonavico, a portfolio manager at Transamerica Investment Management. The San Francisco firm holds 10.4 million RealNetworks shares, or a 6% stake. Mr. Bonavico said Wall Street has "underappreciated" the potential of its new initiatives.

RealNetworks shares -- which debuted at a split-adjusted price of $3.13 in late 1997 and soared to more than $90 in early 2000 -- have languished below $8 for much of the past three years.

RealNetworks was started 10 years ago by former Microsoft executive Robert Glaser, who is its chairman and chief executive. It made a name for itself with its RealPlayer software, first released in 1995 and now installed on millions of personal computers.

But Microsoft undercut RealPlayer in the late 1990s by giving away a digital media player with Windows. RealNetworks sued on antitrust grounds. Microsoft has paid billions of dollars to settle similar suits with rivals such as Netscape Communications Corp. and Sun Microsystems Inc. Some investors think a similar settlement with RealNetworks could boost its stock price.

But Mr. Glaser, who still owns about a third of RealNetworks shares, isn't banking on a legal windfall. He has used acquisitions and partnerships to expand into the business of selling digital music, video and games to consumers.

"We are well along the way in that transformation," Mr. Glaser said, noting that 80% of the company's revenue in the June quarter came from its consumer services. Wall Street wants profits. Mr. Glaser dubs some investors "a little short-term oriented," saying they underestimate the "great long-term economics" of its online services.

RealNetworks has more than 1.4 million subscribers for its various services, including about 550,000 for its Rhapsody music jukebox. Revenue from its consumer services rose 50% to $99 million in the first half of 2004, while its business-software sales fell 14% to $26 million.

The changeover dates back to 2000 with the roll out of SuperPass, a service that lets users watch sports and news clips for a monthly fee. More recently, RealNetworks has acquired GameHouse, a maker of downloadable games; inked pacts to send music and video to mobile phones; and launched a service for downloading movies with Starz Encore Group LLC, which is owned by Liberty Media Corp.

RealNetwork's online-music services have captured the most attention. It operates the Rhapsody service and runs an online store that sells music downloads.

Rhapsody, which has thrived since the recording industry clamped down on illegal music-swapping sites, charges users $9.95 a month for unlimited playing of songs on a personal computer. The songs are rented, not purchased, and can't be transferred to portable players like Apple's popular iPod.

Looking to bridge that gap, RealNetworks recently introduced Harmony, a technology that lets consumers purchase songs on its RealPlayer Music Store site and transfer them to iPods or dozens of other players. Apple has threatened to sue RealNetworks and alter its technology to block such transfers.

Fueling this fire, RealNetworks last week cut the price of its song downloads to 49 cents from 99 cents for a limited time. Apple, which has sold more than 100 million songs on its iTunes site, charges 99 cents for each tune.

The price cut is great publicity for RealNetworks, but it will lose money on each song it sells for 49 cents. Hence, last week, the company's third-quarter loss forecast was widened by one cent a share to a range between three cents and five cents a share.

Anthony Noto, a Goldman Sachs analyst, said in a report that the music campaign reinforces his concerns that "either pricing or content costs will continue to limit RealNetworks's margin expansion and profitability," especially as it goes up against larger rivals. Mr. Noto rates RealNetworks at "underperform."

Mr. Glaser said the company still plans to turn a profit, excluding Microsoft litigation costs, by year end. However, it decided to invest in the promotion to introduce consumers its music offerings and Harmony technology. "Our goal is not to lose money on every sale. ... We wanted to shake things up, get attention," he said, "make sure consumers know they have freedom of choice."

Some investors think RealNetworks needs a sharper focus. "We think it's going to be very hard for any company to be both a technology enabler and a media company serving content up," said Michael McGuire, research director at Gartner G2, a market-research firm.

Mr. Glaser argues that it is the software-consumer mix which helps it create new products. "Yahoo or Google are clearly evidence that a company can grow up out of the Internet competing with Microsoft," he said. Consumer services is "not a zero-sum game like PC operating systems."