Back in October I warned investors from loading up on digital media darling RealNetworks (Nasdaq: RNWK).



Well, it looks like the market agreed.

Over the past five months, the shares have plunged by almost a third and more than $560 million has been knocked from RealNetworks' market cap.

Sure, the stock looks cheap at these levels -- but not cheap enough.

Bottom fishers will be dismayed to learn that the stock is bound to stay down. RealNetworks is still risky, and it's hard to fathom how the company can deliver the kind of growth that investors demand.

The shares could stay stuck in a holding pattern for some time. Even worse, the shares could slip further.

For starters, the company is having a hard time delivering music and video subscriber growth. In the third quarter, RealNetworks added only 25,000 music subscribers. That's down from 50,000 in Q2 and 150,000 in Q1. As for video, RealNetworks meanwhile is struggling to grow in the face of ad-supported free video content on the Web.

What's more, the wolves are at the door. Web giants -- Yahoo! (Nasdaq: YHOO), Google (Nasdaq: GOOG), Microsoft (Nasdaq: MSFT), News Corp's (NYSE: NWS) MySpace.com, Amazon (Nasdaq: AMZN), Apple (Nasdaq: AAPL) and Viacom (NYSE: VIA.B) -- either have existing products or have announced new ones that go head-to-head with RealNetworks.

To make matters worse, making profits from music and video will keep getting tougher for the company. It's important to remember that retailers, for the most part, are willing to sell music as a loss-leader.Yahoo!, for instance, continues to offer its subscription for $8.99 versus the $9.99 that RealNetworks charges for its Rhapsody music service.




Valuation should concern investors. The stock is priced at 40 times 2007 earnings. That's an awfully rich multiple, even compared to PEs of other fast-growth new media and technology stocks such as Google or Red Hat (NYSE: RHT). If you agree that stock options are an expense, then that earnings multiple shoots even higher – to more than 70 times earning, by my calculations.

Time Warner (NYSE: TWX) AOL's recent sale of its digital music business to Napster (Nasdaq: NAPS) speak volumes about RealNetworks' excessive valuation. Napster bought AOL's 350,000 music subscribers for $15.5 million or $45 per subscriber. Investors take note: that price implies a value of just $80 million for RealNetworks' music business, or just 6% of its market capitalization!

At today's share price, investing in RealNetworks remains, at best, a long-shot gamble.

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Tickers in this Article: RNWK, GOOG, MSFT, AAPL, NWS, RHT, AMZN, NAPS, VIA.B, YHOO

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