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News that Yahoo! (YHOO - Get Report) is rolling out its own monthly online music service at a significantly lower price than the competition sent shares of RealNetworks (RNWK - Get Report) and Napster (NAPS) plunging this morning to $5.80 and $4.27, respectively.
We believe investors who want a short-term trade should consider taking a long position in these two stocks. (We aren't taking any action because we are fully invested.)
We view the respective 20% and 30% selloffs Wednesday morning in RealNetworks and Napster as overdone and believe Napster's earnings report after the close will drive shares of both companies 10% higher by the end of the week. Analysts expect the company to lose 62 cents a share on sales of $17 million.We expect Napster to surpass these analyst expectations in its earnings report, similar to the performance that competitor RealNetworks delivered last week. For the first quarter, RealNetworks had sales of $76.6 million, up 27% year over year, and above consensus revenue estimates of $75 million. Break-even earnings came in ahead of analyst expectations for a penny-a-share loss. RealNetworks also raised revenue guidance by $10 million to a range of $320 million to $330 million, and raised EBITDA guidance by $3 million to a range of $25 million to $28 million. Today's announcement of RealNetworks' acquisition of mobile games designer Mr.Goodliving.com adds another $3 million in sales for 2005 that is not in its previously issued guidance. Also, Yahoo!'s music page reveals that its format for digital music is not compatible with Apple's (AAPL - Get Report) iPod. While this will likely change in the near term, it has not been widely reported in the press and will likely cause investors to reconsider their near-term opinions of RealNetworks and Napster. Both companies are sitting on healthy cash balances that limit near-term downside potential. RealNetworks has $2.16 a share in cash and some long-term investments on the balance sheet, while Napster has about $3 a share in net cash. Also, 17% of Napster shares and 6.5% of RealNetworks' shares are sold short, so any good news in Napster's earnings tonight could lead to a nice move higher tomorrow.