RealNetworks: Time to Sell Rhapsody?

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Rhapsody, which is minority owned by Viacom's (VIAB) MTV Networks, has some advantages, including a relationship launched in mid-2008 with Verizon Wireless, itself owned by Verizon Communications (VZ) and Vodafone (VOD). Verizon customers accounted for much of the company's recent revenue growth, although RealNetworks recently got a green light to make its service available to users of the iPhone. Rhapsody applications already run on other wireless devices, including Research In Motion's (RIMM) BlackBerry.

Still, Rhapsody is at best a cash-flow-neutral business, says Tavis McCourt, an analyst at Morgan Keegan. The service's appeal, especially at $15 a month, is limited, analysts say. RealNetworks declined to comment on the prospect of exiting Rhapsody.

Wireless Data Acquisitions?

So without music, what is RealNetworks? For starters, it's a decent software company focused on casual gaming. In 2008 the games unit showed so much potential—in the first half of the year it reported only a $4 million loss on revenues of $67 million—that Real sought to spin it off. Volume has since grown by 12%. And while it's true that revenue has dropped and losses have widened, some analysts see greater potential in casual gaming than streaming music.

The greatest potential may lie in the technology products and solutions group, which counts Korea's SK Telecom among its larger customers. Revenue has suffered in that division, too, but RealNetworks could shore it up through acquisitions of small, private wireless-data companies. One potential target is Motricity, which is backed by Intel (INTC), among other investors. "This is a fast-consolidating industry with lots of small, private players," McCourt says.

Selling off music wouldn't solve all the woes RealNetworks faces. The company is in the midst of a legal battle with Hollywood movie studios that object to its RealDVD software, which would let consumers copy DVD movies to their hard drives. RealNetworks lost the first round of the case in July but is still fighting the case. Even in the unlikely event that it wins, other companies might easily replicate the technology in question.

A second legal threat is more serious. In July, RealNetworks lost an arbitration with VeriSign (VRSN) over a partnership dating to 2001. VeriSign alleged that Real had prevented it from selling off some business units. RealNetworks said in a July regulatory filing that VeriSign is seeking "material damages."

Should VeriSign prevail, RealNetworks may end up in a better position to pay those damages—and meet its manifold other challenges—if it leaves Rhapsody behind.

Hesseldahl is a reporter for BusinessWeek.com.

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