SNS in the News - December 9, 2001

Seattle-Based Realnetworks Launches On-Line Music Rental Service

Monica Soto
09 December 2001
The Seattle Times

A large sign above the main atrium inside RealNetworks' offices reads "Days to Go." The numbers below it: 00.

For months, the Seattle-based streaming media company has toiled over a set of digital products it said would change the industry. Now that the countdown is over, the real wait has begun.

Six years after it first brought voice to the Internet, RealNetworks is staring down the barrel of the Internet media revolution.

The company last week launched the first online music-rental service involving major record labels and a heftier version of its year-old, cable-style Internet video-subscription service.

All this comes as its core business -- selling software tools to broadcast Internet audio and video -- is declining, and its main competitor, Microsoft, is no longer nipping at its heels, but chomping on its collar.

Analysts say they'll wait to see whether RealNetworks' new subscription services generate significant sales or become niche businesses.

"What's the real challenge?" said John Corcoran, CIBC World Markets analyst. "It's going from 400,000 to 4 million (subscribers). That's the challenge."

If RealNetworks built its reputation -- and wealth -- selling streaming-media tools and building a massive consumer audience, the strength of that business has been called into question this past year.

The companies that once bought these tools have dramatically cut back spending or gone out of business. The ones left have struggled to find ways, apart from Internet ad sales, to make money posting content online.

That has weakened RealNetworks' financial performance, though it remains one of the leading Internet companies.

Third-quarter revenue fell 32.6 percent to $45.2 million. After slicing 15 percent of its staff in July, the company managed to remain profitable, on a pro-forma basis, at a penny a share.

Net loss was $19.4 million, or 12 cents per share. The company has $438.2 million in cash and short-term investments, enough to sustain it for several years, if financial performance never improved.

Much of the financial hit came from the company's core business, where revenue dipped 33 percent to $26.8 million.

The one bright spot -- and, some argue, the company's future promise -- was its service revenue, which included sales from its consumer subscription service, GoldPass. That business grew 15.5 percent to $16.04 million.

Jack Ripsteen, JP Morgan research analyst, said the subscription services are more than just another way to make money. "It's an absolutely critical new initiative for them," he said. "This is the direction the company is taking."

With RealNetworks' fate tied so closely to those who put content on the Web, the company had sought to demonstrate one could indeed build a viable media business online.

Last August, it stopped selling an enhanced version of its digital media player, software that plays Internet audio and video, for $30 a pop. GoldPass took its place, a subscription service that offered exclusive content for $9.95 per month.

The idea was that, if GoldPass proved viable, more content producers would jump online. The more content produced, the more tools Web sites would need to broadcast. This would reinvigorate the company's core business and produce growth.

GoldPass became the only place a fan could listen to a Major League Baseball or a National Basketball Association game online. Besides a deal with CBS' "Big Brother 2," however, the exclusive content was male-oriented and spotty at best.

Even with a limited offering, GoldPass amassed 400,000 subscribers in the first year -- a number that surprised analysts. Multiply that by $9.95 per subscriber and 12 payments per year, and it becomes a $47 million-a-year business.

Last week, when RealNetworks unveiled RealOne, the newest version of its digital media software and services, it included the heir to GoldPass, dubbed RealOne Programming.

It marked the company's first true attempt to offer consumers a package to which perhaps not thousands, but millions, might subscribe. Aside from every NBA and MLB game, the package included exclusive celebrity interviews, some prime-time TV shows and content not available before on the Web.

ABC News, for instance, provides the full version of "World News Tonight" and "Nightline" on demand for the first time. Other media partners include All-Food Network, BBC, C-SPAN, New Line Cinema and Discovery.

"This is one of the few business models on the Internet that does make sense," said Bernard Gershon, senior vice president and general manager of

In addition to the cable-TV-style service, the company launched RealOne Music, the first of several legal music-subscription services to be released in coming months.

RealNetworks in April formed a partnership with three of the world's largest record labels to create MusicNet, a subscription service that would allow consumers to purchase music from its libraries via the Internet.

AOL Time Warner, Bertelsmann and EMI provided the music, while RealNetworks provided the underlying technology. Each of the four own a minority stake in the stand-alone company, which plans to sell private-label copies of its platform to portals and other sites. RealNetworks and America Online were its first customers.

In a separate deal, the two other major record companies, Sony and Vivendi Universal, formed Pressplay, a venture that includes Microsoft and is expected to launch its own music service soon.

Such services were the music industry's defensive play against illegal file-sharing offerings made popular by Napster. Much speculation, however, surrounded what exactly a legal Internet music service might look like.

In the end, RealOne Music announced it would allow consumers to rent music from the three major record labels and others, such as Virgin, for $9.95 per month.

The fee gives users the right to download 100 files (which they can listen to again) and play 100 streams (which they cannot) from a library of 75,000 songs. They can keep, or switch out, songs every 30 days.

Perhaps the biggest criticism so far is that users cannot burn (or create) their own CD or download music to a portable MP3 player -- two inherent advantages digital music has over CDs.

Analysts expect both services -- RealOne Music and RealOne Programming -- to add users quickly.

Market-research company International Data predicts online music subscriptions, including RealOne Music, will grow to 2 million in 2002 and 10 million in 2005. Some analysts expect RealOne Programming to surpass the 1 million mark in its first year.

Even so, analysts say RealNetworks' new services will not add as much to the bottom line as its core business. In the third quarter, software-licensing fees carried a 94 percent gross margin.

RealNetworks President Larry Jacobson said the investment is designed to increase the length of each subscription, reduce canceled subscriptions, and aggressively add new users.

"The opportunity," he said, "surpasses the investment."

Other hurdles exist. Subscription services are relatively new to the Internet. The company must overcome public belief that a monthly Internet-connection charge gives one access to everything on the Web.

In addition, the number of consumers who use a high-speed Internet connection in their homes is much lower than expected. (Without a cable modem or DSL, a user can view video only the size of postage stamp.)

More important, the company is fending off aggressive competition from Microsoft, which bundled the latest version of its Windows Media Player with its new Windows XP operating system. Although Microsoft's inclusion of the player in XP has been an issue in its antitrust case, every copy of XP sold means one more competitor to the 215 million copies of RealNetworks' media player in the market.

Observers say RealNetworks' strength lies in RealOne Programming, a service others have yet to mimic.

Each time the company, through exclusive partnerships, offers content an Internet user can't view anywhere else, it means less content and fewer potential customers for Microsoft.

"It is the one kind of advantage which plays against Microsoft's weakness," said Mark Anderson, publisher of the Strategic News Service newsletter. "A lot of content providers are worried with linking up with Microsoft, and (RealNetworks) is playing that card as heavily as they can."

With the countdown over, it's time to wait and see.

Sasa Zorovic, Roberston Stephens analyst, said not to expect a financial impact overnight; investors will wait to see how many consumers subscribe.

After RealOne's launch Tuesday in New York, RealNetworks' stock closed down 4 cents to $6.31. The company's shares are down 56 percent for the year.

Jacobson said he believes RealOne services are indeed its advantage. It's the bet the company has placed on its future.

"We don't think we're going backward; we think we're going forward," he said. "No one has anything close to what RealOne is."