RealNetworks Shifts Its Course Into Media - TheStreet

RealNetworks Shifts Its Course Into Media

The company, which has reported its first-ever profits, is undergoing a makeover to expand beyond the online audio and video software market.
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SEATTLE, Wash. -- Investors who like the sight of

RealNetworks

(RNWK) - Get Report

lurching into profitability will want to take notice of a subtler but more significant change for the company -- its transformation from an Internet infrastructure to a media company.

"We were the enabling software for audio and video on the Net," RealNetworks' Chief Financial Officer Paul Bialek told

TheStreet.com

. "But it's turning into something a lot deeper now."

RealNetworks posted its first-ever profit of 5 cents a share in the third quarter, a cent better than the

First Call

estimate. Inside the earnings announcement lay a number more revealing of where RealNetworks is heading: While overall revenue grew 24% to $34.9 million from the second quarter, revenue from ads on its site more than doubled to $4.1 million, or 12% of revenue. That growth is picking up: In the second quarter, ad revenue rose 60% from the first quarter.

In a conference call, CEO Rob Glaser acknowledged that advertising is "on track to become one of our core businesses." And Bialek pointed to the ad growth as evidence of RealNetworks' "ability to connect Internet users to compelling content." It's also the latest sign that the company is trying to leverage its dominance in the market of streaming-media software to become the Net's leading broadcast network as broadband access becomes more commonplace.

"Most people think of us as an infrastructure company, but we're increasingly becoming a media company," says Dave Richards, RealNetworks' vice president of consumer products.

As RealNetworks slowly morphs into a media company, it's likely to keep generating more of its revenue from advertising as well as e-commerce. The bold strategy holds enormous promise, but is also likely to introduce new challenges as it competes for advertising dollars and audience share with media companies and tries to develop closer ties to Joe and Jane Web surfer.

"They've done a good job at taking advantage of the fact that they're providing infrastructure," says Emeric McDonald, analyst with

Amerindo Investment Advisors

, an investor in RealNetworks. McDonald contrasts RealNetworks to

Netscape

, which squandered a chance to create an advertising-based media business from the huge number of people using its free Web browser.

Already, the RealPlayer streaming-media software boasts 80 million unique users, compared with an estimated 30 million to 35 million for

Microsoft's

(MSFT) - Get Report

streaming media products such as

Media Player

. RealNetworks' market share is all the more remarkable given that it's one of a handful of software companies to take on Microsoft and come out unbruised.

Now RealNetworks is likely to edge into the terrain of

America Online

(AOL)

, which has plans to offer access to data-thick sound and video content. Real's network of Web sites, including its RealGuide multimedia portal, drew 10.6 million visitors in September, making it the ninth most popular Web property in September, according to

Media Metrix

. That's up from 15th place in March.

RealGuide works like a

Yahoo!

(YHOO)

with a multimedia jones, hooking consumers up to everything from the latest

Clint Black

music videos to highlights from the baseball postseason to

Celebrity Death Match

Claymation to an experimental radio station in Amsterdam. And like Yahoo!, the site has forged partnerships with companies like

Film.com

,

Compaq

(CPQ)

and

snap.com

, another site with plans to focus on broadband content.

Amid the growth in traffic and advertising, the company is dipping its toes in e-commerce. The company landed multimillion-dollar e-commerce partnerships to give e-tailers

CheckOut.com

and

800.com

access to the 12 million users of RealJukebox, software that downloads and stores digital music.

Another salient sign of the company's makeover came on Sept. 15, with the promotion to COO of Tom Frank, a former TV programming executive from

Dick Clark Productions

. "His very presence as COO should indicate that Real is progressing rapidly toward monetizing the RealPlayer base," says Rob Martin, an analyst with

Friedman Billings Ramsey

, which maintains a buy rating on the stock and which has done underwriting for RealNetworks.

Frank says that with RealPlayer, RealJukebox and RealGuide, the company can offer advertisers a more effective way to reach consumers. "We're getting much more sophisticated about selling," says Frank.

As RealNetworks prepares for broadband media, the universe of broadband access is expanding. While only 1 million North American homes have high-speed access to the Internet, the continued deployment of cable modems and DSL lines will boost that number to 26 million homes, or 36% of the estimated online population, by 2003, according to

Forrester Research

.

But RealNetworks' transition does not come without its share of risks. Chief among them: alienating the very content providers that helped build RealNetworks' market position. More ads mean more potential conflicts with companies such as

Disney

(DIS) - Get Report

, which has been making its own push into online content.

The stakes are high as RealNetworks moves into media. A wrong turn could send the music industry and other content providers into the hands of Microsoft. But some investors say RealNetworks' massive and seemingly entrenched distribution network has already shifted the balance of power in favor of the company. "They probably don't need those content partnerships as much as they did in the past," says Christopher Lord, general partner with

Pivotal Asset Management

, a long-time RealNetworks investor.

To pull off the transition, RealNetworks will have to focus its marketing more on consumers, an effort that execs say is already under way. And it will need to hire more people who, like Tom Frank, have experience with consumers. To address that need, RealNetworks is currently trying to hire a new VP to work in e-commerce. "The origins of the company were very Microsoft-focused," notes Jim Breyer, an investor and board member of RealNetworks. "Microsoft does not have a very successful record in the consumer-oriented businesses."

Meanwhile, the company will have to keep building innovative applications that push the broadband market forward. "RealNetworks needs to be in a position to provide a rich content experience for the increased bandwidth environment," Breyer says. RealNetwork executives wouldn't disclose details of new products, but are holding to their strategy of staying out of the content development business.

Whatever the challenge, some investors remain confident in where Glaser and his team are taking the company. "Rob Glaser walks on water," says Lord. "They're adjusting the model as they need to. I bet you that

RealNetworks will be vastly more valuable in the future than it is today."