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Whatever else investors may make of RealNetworks (RNWK), it's first and foremost a bet that high-speed access will transform the way people use the Internet -- from a way of gathering written information to a medium for tapping into music, news broadcasts, movies, and other kinds of entertainment. As the industry pioneer with a commanding lead in delivering these so-called rich media, RealNetworks stands to be a big winner in a broadband, entertainment-oriented Internet of the future, many analysts believe.
That future could be sooner than you think. On June 6, RealNetworks announced results of a test it commissioned, where 70% of people using its newly released video player on broadband systems said the quality was as good or better than a VHS videotape. Analysts figure the Internet would be transformed into an entertainment medium once its broadcasts could compete with television quality. With RealNetworks' latest upgrades, "we're getting there," says Rob Martin, an analyst with Friedman, Billings Ramsey & Co.
The news had RealNetworks investors smiling. The stock climbed 1 1/16 points, to 45 1/16, on June 6 and is now up about 12 points, or 36%, from its late May doldrums. That's when RealNetworks' slate of product upgrades were announced, followed in quick succession by its meeting for analysts, a user conference, and its shareholder meeting.
DUELING P.R.
But the RealNetworks investment scenario has another side. Buying the stock is also a bet that a nimble startup can stay ahead of the Microsoft juggernaut. That's where the big argument over the stock has always resided. And lately, it's heating up again. Both RealNetworks and Microsoft released new versions of their media player software in May and launched dueling public relations campaigns designed to show that each has a superior product and is gaining market share.
While RealNetworks still boasts that 85% of all rich-media content on the Web is in a format that requires use of its RealPlayer software, few companies have survived once Microsoft set out to take over their market. And Microsoft's media player is clearly making inroads. An increasing number of sites broadcast in both Microsoft's and RealNetworks' formats, which has allowed Microsoft to increase its share without eating into RealNetworks' share.
Martin estimates that Microsoft now has 40% to 50% of the market. Plus, it has a powerful advantage because its player is included with the Windows operating system -- making it nearly ubiquitous. RealNetworks' player must be downloaded -- which hasn't been too tough a hurdle considering that it has 125 million registered users.
FLAWED ANALOGY?
Still, many investors avoid RealNetworks because of concerns it will become the "next Netscape," the software company that, despite its pioneering role and early market dominance, lost the browser wars to Microsoft Internet Explorer and was eventually acquired by America Online.
Credit Suisse First Boston analyst Heath Terry thinks the Netscape analogy is flawed, for several reasons. First, he thinks RealNetworks' software is measurably better than Microsoft's, a claim Netscape's browser couldn't make. How much better? RealNetworks' upgraded software is 50% better than Microsoft's, Terry says, and it can save broadcasters money because it uses much less bandwidth (these are hotly debated issues).
Most important to holding onto its lead, RealNetworks is a beneficiary of the Internet's much vaunted "network effect," Terry believes. Since so many people already use RealNetworks' products, any Web site that wants to broadcast audio or video will have to offer the Real format -- and license the software from RealNetworks. "Real is one of the very few companies that has been able to create that kind of a network effect, and that is worth something," he says. "That is why I'm excited about this company."
WILD CARD.
Michael Davey, a technology analyst at Investec Ernst, isn't so sure. He doesn't think subtle differences in software prowess win out over marketing. In its quest to gain market share, Microsoft is in a position to offer better value to customers than RealNetworks. He thinks Microsoft may have held back in challenging RealNetworks because of the Justice Dept.'s antitrust case -- which remains the real wild card in evaluating RealNetworks' chances. If Microsoft is broken into separate companies where its media player division is divided from the operating system division, RealNetworks would be in a far better competitive position, he says.
Ultimately, RealNetworks will have to remain flexible to adapt to the changing Internet as well as the Microsoft threat. It will need to go beyond collecting licensing fees for its software, collecting more service fees for handling the broadcasts, or incorporating more advertising on its Real.com portal or into the broadcasts themselves, suggests Terry. "It will take smart management," says a more skeptical Davey. But most analysts think RealNetworks founder Rob Glaser has the kind of vision the job requires.
If investors can get past the Microsoft issue -- and past broader market concerns about tech stocks -- they'll see that RealNetworks has dominance in an exploding market, plus operating profits and growing revenue streams that Wall Street loves. "As investors become more comfortable with the market and start to place their bets in technology names again, they're going to focus on the names that are leading the space," says Terry.
He thinks RealNetworks deserves a spot in the upper echelon with the likes of Yahoo! and America Online. But for RealNetworks to prove it belongs in that company, it'll first have to fend off the challenge from Microsoft.
Amey Stone covers investing for Business Week Online
Got a question or comment? Go to our Ask Amey Stone Forum now! EDITED BY DOUGLAS HARBRECHT
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