Friday, July 28, 2006

Color on quarter: RealNetworks (RNWK)

RealNetworks (NASDAQ:RNWK) will be on the casualty list today as the co failed to meet analyst estimates:

* Goldman is lowering their 6-month price target to $7.50 ($8.00) due to their 35% and 20% reductions in 2006E and 2007E EBITDA given a 42% miss in 2Q2006 and outlook for weaker than expected profitability for the full year due to greater operating expenses as RNWK invests to compete in a highly competitive market. Valuation is extended as shares trade well above firm's price target and at 27x 2007E EBITDA, a 52% premium even to Google at 18x despite Google's 20% -25% long-term growth vs. 15% for RNWK. Lower 2006 revenue guidance to $370mn from $372.5mn implies a $3.5mn reduction in 2H2006 top line expectations. The results and the outlook result in lower EBITDA, creating increased uncertainty around profitability in 2007.

Goldman reiterates their Sell rating as they expect 2Q2006 results and an ~35% reduction in 2006E EBITDA to put downward pressure on RNWK shares given results were below expectations and a lowered outlook only makes an expensive stock, on an absolute and relative basis, look more expensive. Shares are trading almost 200% above the sector on 2007E multiples, which the firm believes is unwarranted given declining EBITDA vs. the sector's 25%-plus EBITDA growth. Strong growth in games could fuel investor optimism in the potential of this segment; however, they continue to believe that competition is only likely to heighten in this area and growth could diminish without acquisitions.

* Stifel notes the stock will likely pull back, particularly if market refocuses on valuation metrics outside of EV/revenues: RNWK has risen from $8 to ~$10 this year on very little news, perhaps a result of the company's buyback or investor optimism that RNWK will use its balance sheet to become the next JAMDAT, Akamai, or a company with hidden patent value. Given an extremely high valuation on traditional metrics (104x 2007 cash adjusted EPS excl. MSFT proceeds and 38x 2007E EBITDA) in combination with potentially aggressive guidance, they believe the shares are subject to a pullback. RNWK trades at 2.3x EV/revenues, the firm believes somewhat reasonable based on a sum-of-the-parts. Maintains Hold.

* Oppenheimer notes the company added roughly 50,000 music subscribers in 2Q vs. an average of 150,000 new subscribers for the past four quarters (total paid subscriber count was flat QoQ at 2.4mm). Music subscribers increased 41% YoY, while music revenues grew only 21%, indicating lower music segment ARPU. Firm believes the slowdown may indicate a lasting market preference for end-to-end systems such as Apple's iPod. Microsoft recently announced it is launching a similar end-to-end service in late 2H.

Games segment revenues were up 55% YoY, though likely 23% YoY organically. Firm believes the company is likely to see continued success in monetizing its games franchise through mobile and retail channels, as well as through the inclusion of in-game advertising.

The company bought back 2.1mm shares at an average price of $9.43. Believes the company has roughly $80mm outstanding in its share buyback authorization. Reits Neutral rating.

Notablecalls: I expect RNWK to go sub-$9 today. The valuation is sky high and without any sub growth it can only mean lower price for the stock. I must note that I did like the growth number the co put out for their Games segment. I suspect this one has better margins than the Music one. But that won't have any real impact in the s-t.

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