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Merrill Lynch: RealNetworks could be Netscaped by Microsoft

RealNetworks shares trimmed 56 cents to $11.50 Wednesday after Merrill Lynch analyst Henry Blodget downgraded the stock on valuation concerns as well as recent data suggesting the company was losing market share to Microsoft.

Blodget cut RealNetworks (Nasdaq: RNWK) from an “accumulate” recommendation to a “hold,” citing the growing popularity of Microsoft’s (Nasdaq: MSFT) Windows Media Player and its pricey valuation, currently around 86 times its projected earnings for 2001.

"We continue to believe there is a significant risk that Microsoft will do to RealNetworks what it did to Netscape -- take over the market by bundling functionality in larger products and giving it away for free,” Blodget wrote in a research note.

According to Media Metrix data, RealNetworks’ share of media streaming software fell 10 percent in the second half of 2000 while Microsoft’s Windows Media Player share increased 30 percent.

“RealNetworks client software has lost share to Microsoft over the last six months," Blodget said. "This is a major concern -- RealPlayer usage drives about 80 percent of revenue, indirectly and directly."

RealNetworks shares have come under pressure in the past four months, falling from around $30 a share in October to a 52-week low of $5.19 in December. The stock traded as high as $96 a share in February.

The company’s lukewarm third-quarter earnings and reduced outlook for the fourth quarter, especially a projected 20 percent decline in advertising sales, help explain the lack of confidence on Wall Street.

But CS First Boston analyst Heath Terry isn’t buying Blodget’s Netscape analogy.

“Microsoft’s been doing this for three years and it still hasn’t had any real effect,” Terry said. “I’m surprised it still gets brought up. Sure, Microsoft is a competitor but the dynamics of streaming media are significantly different than those of a browser. I think that’s a weak argument.”

Terry, who maintains a “hold” rating on the stock, has another slant on the valuation argument.

“Valuation depends upon how you want to look at it,” he said. “With any technology stock these days, it’s a moving target. “In the near-term, it’s trading at a high multiple but if you look far enough out, you can make the argument that the stock is undervalued relative to the future potential of the technology and the company.”

Justin Post, an analyst at Deutsche Banc Alex. Brown said that while Microsoft is making inroads, it’s far too early to draw any definitive conclusions about the stock at this point.

“RealNetworks is going through an adjustment period right now from dot-com customers to more traditional clients,” he said. “We aren’t seeing a lot of traction in this area at this point. But RealNetworks still has double the number of users using its player each month than Microsoft.”

In December, RealNetworks warned that it would miss analysts’ profit estimates by 2 cents a share, mainly because of slumping advertising sales.

First Call Corp. consensus now expects it to earn 2 cents a share in its fourth quarter on sales of $61 million, down from a profit of $7.6 million, or 4 cents a share, on sales of $67.1 million in the third quarter.

RealNetworks will report its fourth-quarter results Jan. 30.

Fifteen of the 26 analysts tracking the stock rate it either a “buy” or “strong buy.”