Will the Real RealNetworks Please Stand Up?

If we're living in a digitally-delivered age, why is RealNetworks (Nasdaq: RNWK  ) such a market laggard? After all, the company has its feet in all of the right doors. Online music, Web-delivered games, media software, and technology products are all the rage. So why is RealNetworks trading for nearly half of its December peak?

If we're going to reverse-engineer this puppy, we may as well start with last night's report. On the surface, it's a winner. Revenues soared 55% to a record $145.1 million. Earnings clocked in at just $0.03 a share, although adjusted profitability did come in slightly higher than last year's showing.

There was strength where one expects it -- games (up 28%), music (up 24%), and technology products (up a whopping 377%) -- although weakness in media software and services (down 14%) was a downer.

So what's the problem? Well, all of the growth wasn't organic. The company spent $350 million in acquiring South Korean ringtone specialist WiderThan, a purchase that led to the initially impressive 377% spurt in technology products. There's nothing wrong with peppering organic growth with a few buys.

The bigger problem here is the income statement. The profit is a bit of a mirage. The company actually posted an operating loss of $15.4 million during the quarter. Interest income and gains as a result of the formation of Rhapsody America with Viacom's (NYSE: VIA  ) MTV are what turned red into black on the bottom line.

Yes, interest income is a big part of the RealNetworks story. The company was flush with cash, even before a favorable settlement with Microsoft (Nasdaq: MSFT  ) led to a deluge of even more greenbacks. Share buybacks and the purchase of WiderThan have eaten into the vault, though the company still has $590.4 million -- or $3.62 a share -- in cash and short-term investments.

Unfortunately, it takes more than money to get a company out of a funk. It's been more than six years since shares of RealNetworks poked their heads into the teens. Music rival Napster (Nasdaq: NAPS  ) is also cash-rich but share-price-poor. Besides, if greenbacks ever dictate success in digital music, Napster and RealNetworks won't be able to compete against the billions in the bank at companies like Apple (Nasdaq: AAPL  ) and Microsoft.

So when will RealNetworks turn itself around? Not in the current quarter. The company expects to post a profit between $0.00 and $0.01 a share, on $152 million to $157 million in revenues. Yes, it will be another record quarter on the top line, but do I need to spell out the bottom line for you? Even worse, the company is good for another $7 million in interest income in that bottom-line figure, masking another operating loss at RealNetworks.

Poor company. You're in the right place at the right time, but still turning out to be the wrong investment.

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