Given that "music" is a keyword for excitement for many companies, it makes sense that a lot of investors were interested to see what RealNetworks' (NASDAQ:RNWK) earnings report would hold on Tuesday night. RealNetworks did indeed post a profit, but real life proved disappointing, considering the stock surged 15% on an analyst's positive comments before the earnings report was even released. Investors have good reason to be a little less excited today.
RealNetworks' fourth-quarter profit came in at $295.6 million, or $1.61 per share, but its results are still buoyed by its legal settlement with Microsoft (NASDAQ:MSFT). It's important to note that RealNetworks recorded a $434.4 million gain from the settlement. Sales increased 15% to $83.6 million. In a red flag for investors, RealNetworks gave guidance lower than Wall Street's estimates.
In RealNetworks' conference call, Chairman and CEO Rob Glaser celebrated the return to profitability but admitted that profit was "substantially enlarged" by the Microsoft settlement. There are only $283 million in payouts left, and that's payable over the next five quarters. Again, the cash from the settlement will dry out soon, and RealNetworks will have to prove the mettle of its core business.
True, RealNetworks' musical services doubled to 1.4 million subscribers on a year-over-year basis, but that represents only 100,000 more subscribers than last quarter. Compare that with Nielsen NetRatings' recent data that between December 2004 and December 2005, Apple's (NASDAQ:AAPL) iTunes users increased 241% to 20.7 million, meaning that 14% of active Internet users use iTunes. It stands to reason that iPod frenzy over the holidays certainly didn't benefit RealNetworks and other rivals.
After all, the big smackdown everybody's watching is whether budding music services -- coming not only from RealNetworks but also Napster (NASDAQ:NAPS), Yahoo! (NASDAQ:YHOO), and Microsoft, for example -- can take the wind out of Apple's sails.
I've long had doubts as to just how well the subscription-focused musical services will fare. The a la carte option that Apple's iTunes offers lures the cream of the crop when it comes to music lovers -- I'd argue that they're audiophiles who love their music and want to own and collect it, not just access it. The subscription services may attract more casual listeners, but how loyal might they be when there are so many choices that are not yet differentiated like Apple is? Plus, the iPod segues with iTunes, and that's a great example of complementary products locking in loyalty. (RealNetworks will be the preferred provider of services to people who buy SanDisk's (NASDAQ:SNDK) E200 music player, most certainly a bid to emulate Apple's success.)
RealNetworks' shares decreased by as much as 9% in today's trading, and it's no wonder that investors' sentiment has soured today after yesterday's pre-earnings euphoria. Although Microsoft's settlement has provided RealNetworks with a cash infusion to help prop up its balance sheet, which will allow it to pursue acquisitions and otherwise grow its business, I think investors don't yet have enough proof that RealNetworks can deliver the sustainable growth they're looking for in such a competitive environment.
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Alyce Lomax does not own shares of any of the companies mentioned.
