RealNetworks Is Game for Games

BUSINESSWEEK.COM: The online music and video seller's CEO outlines his strategy and talks about the rivalry with Apple

RealNetworks had a tasty valentine for investors, with a lot of help from Microsoft. Real, a digital media company, posted a $295.6 million profit for the fourth quarter of 2005, reflecting a legal settlement from its Redmond (Wash.) neighbor. But as other companies -- namely PC maker Gateway -- can attest, reporting big settlement payouts calls for some complicated accounting. Microsoft is paying RealNetworks as much as $761 million over the course of 18 months (see BW Online, 10/12/05, "Finally, Gates and Real Make Nice"). On Feb. 14 Real said it received $461 million, or nearly 63%, of that payout in the fourth quarter of 2005. Another $281 million is expected over the next five quarters, the company said. Also in the fourth quarter, sales rose 15%, to $83.6 million, with expectations of $82 million to $86 million in the current period. RealNetworks CEO Rob Glaser spoke with BusinessWeek Online's Arik Hesseldahl about the settlement, quarterly results, online gaming, and rivalry with Apple Computers.

BW: This Microsoft settlement really makes the results a little difficult to decode. How are you going to explain this to investors?

RG: From an operating standpoint we were pleased with the core businesses, and that's reflected in the revenue line. We had record revenue on an operating basis, but the bottom line is substantially impacted by the Microsoft settlement. We have, both in our backward- and forward-looking statements, inserted some pretty rigorous explanations about how to take the pieces apart. But basically we got this big settlement. What we're trying to do is give investors as much transparency as we reasonably can about the actual results.

BW: You just made an acquisition in casual gaming. You paid $21 million for Zylom, which is a European gaming concern. You have $781 million in cash, and with the settlement coming in for the next few months, you could make more acquisitions. What can we expect from you in the coming year?

RG: Our balance sheet is extraordinarily strong for a company of our size, and we're trying to be thoughtful about putting that balance sheet to use productively.

BW: Why are so-called casual games showing so much growth for you? It looks like revenue there improved more than 60% year over year. You also just licensed games like Monopoly and Scrabble from Hasbro.

RG: We have a very nice distribution channel here and with the Zylom deal, its an excellent business. It's not a glamour business like the music business. But in terms of the growth prospects of the company, it's growing faster than the music business. We're pretty well known in music. But over time I think we'll be pretty well known in our portion of the games business. Again, it's not the shoot-'em up narrow demographic, but we like the cultural trends associated with our games because platforms like PCs and cell phones emerged as more and more people are playing games on them, the demographic is broader that we're in a position to serve very well.

BW: How do you feel competing against Apple? You've now got 2.25 million paying subscribers to Rhapsody. In a market that Apple seems to own, that's no small feat.

RG: What I would say is that we have an indirect competition with Apple. Apple is principally in the business of selling iPods, and then they sell tracks, and they do an excellent job of selling tracks into that captive iPod base. They don't sell tracks to any portable device other than the iPod. We sell tracks as a secondary part of business. We're mostly in the subscription business. Either radio subscriptions or full on-demand subscriptions. Apple's lock on the iPod creates a smaller addressable market for us in the non-iPod portable music player business. But I think our models are quite different, and so I think it's not zero-sum overall.... On the PC, many of our subscribers are also iPod users. And we think that over time as the ecosystem of devices gets more fertile, with devices other than the iPod, we think we're well positioned there.

BW: Microsoft Chairman Bill Gates has made some statements recently about wanting to compete more vigorously with the combination of the iPod and iTunes. What does that mean for RealNetworks?

RG: I think our relationship with Microsoft will have some competitive elements and some collaborative elements. If you look on MSN Music today, Rhapsody is promoted in there quite substantially. We have plans to do integration with Microsoft on MSN Messenger and MSN Search, but Microsoft is such an octopus, it wouldn't be my expectation that we'll be the only one working with them. So we think they are a nice distribution partner, but I don't think Microsoft is going to be our primary partner going forward, but I hope they are one of our ten partners going forward.