Thursday, February 15, 2007

Color On Quarter: RealNetworks (NASDAQ:RNWK)

Couple of firm commenting RealNetworks (NASDAQ:RNWK) following 4Q06 report and 2007 guidance issued yesterday.

- Goldman Sachs notes that 4Q06 results beat their forecasts; however they are lowering 2007 revenue estimates by 4% and 12%, and maintaining their Sell rating. Areas of concern include: a slowdown with 100k net music sub adds (ex-WiderThan) vs. 125k in 4Q2005 and their 160k estimate; music ARPU fell for the 8th consecutive quarter; and other net subs (includes game subs) declined 25k vs. their forecast for a 25k gain.

Firm believes the lowered outlook is likely to be negative for the shares given that Street estimates must be reset lower. They also believe that slowing growth in music revenue and lower net other sub adds (including gaming) despite the still early stage of growth may increase concern regarding the growth potential as it may prove to be another initiative that matures at a faster rate than anticipated. Music growth has slowed from ~50% yoy in 2005 to 21% in 2006, and 11% in 2007E despite the lift from ad revenue, and a similar trend occurred with RealPlayer. In addition, visibility could be reduced across music, games, etc. as the company may not separate WiderThan metrics, which may mask the underlying ARPU and sub trends.

- Stifel notes that RNWK beat revenue and EPS 4Q guidance: Revenues of $125.6MM beat guidance of $117-123MM, while EPS of $0.22 beat guidance of $0.18-0.21. The upside to their estimates came mainly from WiderThan, which contributed $26.7MM in revs. vs. guidance of $22-24MM.

Firm says guidance was weak and implies significant sequential declines in 1Q07: 2007 revenue guidance was $540-560MM, below the Street at $577MM. They are lowering our 2007 EBITDA estimate from $60MM to $48MM.

Seasonality or deterioration? Management noted its business is more seasonal this year due to higher advertising revenues and WiderThan. While this seems reasonable, firm estimates the y/y growth rate for 1Q revenues excluding WTHN is just 5% and 2007 growth excluding WTHN is just 9%.

Firm believes changing EBITDA definitions/lack of EBITDA guidance could be a red flag: RNWK has changed its definition of EBITDA since 2005. The original definition included one-time equity gains which inflated 2005 EBITDA, which in turn helped show EBITDA growth in 2005. This quarter RNWK reported EBITDA for the first time in several quarters, which shows 2005 without those gains, which in turn aided 2006 EBITDA growth. To be fair, RNWK has a new CFO and they believe the newest definition makes sense. RNWK would not offer 2007 EBITDA/operating margin guidance on the call - why so secretive?

Reiterates Sell and $9 price tgt.

- Piper Jaffray says that while the quarter was in line, RNWK guided well below the Street for 2007 with revenue and GAAP EPS guidance of $540-560M and $0.18-0.23 vs. consensus of $573M and $0.40 (firm notes part of the EPS shortfall is due to higher non-cash charges). That said, they believe the financial accretion from WiderThan may have been overstated and it appears as if 2007 may be another year of investment for RNWK. As such, firm is lowering their EBITDA estimate for 2007 from $72.5M to $50.8M. Despite firm's more cautious view on fundamentals and estimates, they are maintaining Market Perform rating. Firm would expect shares to be down off the lowered outlook and note the company has a significant cash position (approximately $4/share which limits downside). Price tgt goes to $9.30 from $10.

Notablecalls: $10 seems to be line in the sand for the stock. Expecting the stock to trade below it today as the outlook seems to disappoint the Street.

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