RealNetworks: Merger Arbitrage With Potential For An Increased Offer

RealNetworks (NASDAQ:RNWK) digital streaming/software company has been approached by the company founder (38% stake) and CEO (Rob Glaser) with a non-binding take-private offer of $0.67/share. RNWK formed a special committee of independent directors to evaluate the offer. The company trades at $0.60/share with the current spread standing at 12%. If the merger breaks, the downside to pre-announcement is 22%, though, it can be somewhat lower due to the recent buys from the second-largest shareholder above the current market price. The RNWK’s EV is at $4.5m (including the restricted cash portion from the recent sale of marketable securities) versus a $28m market cap.

Post announcement spread stood at about 13% which later narrowed after the second-largest shareholder, Thomas Satterfield, started to add significantly to his position. Up until Monday, the company was trading almost at the offer price only to widen again due to the recent market sell-off making the setup relatively more attractive. Currently, Satterfield’s stake is 12.5% after the buyout announcement he added about 4% to his holdings. Satterfield’s first investment in the company was made back in 2020 at about $1.2/share for a 5% stake in RNWK.

Information on Satterfield is limited, but from what I see, he is a founder and a managing partner in a small investment fund. Satterfield’s recent activity might mean two things. In the first scenario, he wants to exit his losing position and now is recouping some of the losses by decreasing the cost basis on the trade. In which case, he votes in favor of the transaction and the spread closes. In another scenario, he believes that the stock is worth more than the current offer (historical low), so he is accumulating a larger position to force a higher bid.

The main risk of the whole setup is the inability to pinpoint the value of the RNWK to strongly support the argument for the higher bid. However, if we look deeper there is some potential to make an argument for a higher bid such as hidden profitability in the consumer media segment and the recently started reorganization of the gaming segment. On top of that for Rob, this is mainly a bet on new products introduced a little over 2.5 years ago. He did seem to believe in the growth story of these products investing $10m of his funds back in 2020 for about $1.2/share at a slight discount to the prevailing price of $1.3/share. Public investors also seem to have caught on to the story of SAFR and KONTXT, just in April 2021 company raised $22m cash through a stock offering at $2.7/share.

The revenues for these two products are already quite substantial at about $7.4m in FY21 vs $58m of total RNWK revenues and higher than RNWK’s current EV. Both SAFR and KONTXT showed promising growth over the last 2 years unexpectedly starting to show signs of stagnation over the last couple of quarters with lower-than-expected growth projections for FY22. This in combination with a significant shift in the business model limits the optimism for a higher offer. Unless Rob expects that taking the company private at its historically low price gives him a chance to turn around the company in private markets, utilizing the benefits of being private such as lower corporate expenses, and lower regulatory and shareholder scrutiny. The company seems cheap enough for Rob to bet on a chance of a turnaround in the private markets.

In the nutshell, the current developments due seem to warrant a small exposure to this idea with the spread standing at 12% and a potential bump in the offer price.

Business Description

A few words on RNWK’s current operations: The business operates in three segments: Consumer Media, Mobile Services, and Games.

• The Consumer Media segment includes their Codec software, mainly sold in the Chinese market where the product remains popular, albeit quickly declining. Codecs are encoding and decoding software designed to reduce the number of bits required to stream or store media content. Revenues are made through licensing agreements. This segment also includes the legendary RealPlayer which has started to wane in popularity since it was overtaken by Microsoft’s media player in the 2000s.
• The mobile service segment includes both new initiatives: SAFR a face recognition software and KONTXT AI-based text message management software (anti-spam and classification product) plus ringback tone service (the songs you listen to while on hold).
• The Games segment has been with the company for a while now. The primary focus is free-to-play mobile games, most notably Delicious Bed and Breakfast and Delicious World games. Revenues are based on in-game advertisements and in-game purchases. Plus for the PC players GameHouse and Zylom websites.

More on SAFR Technology

Early on company’s facial recognition technology got some traction with several clients integrating software into their hardware products. For example, one of their clients was a Japanese company using RNWK software in their biometric access control system for construction workers in Japan. The technology is also licensed by another company working with the Japanese healthcare system. Also, the company has been involved with the US air force through several grants received for the development of SAFR technology back in 2020 of about $1.9m in total. However, the last few quarters have seen a decline in growth and future performance expectations in both SAFR and KONTXT technologies.

On the latest earnings call in May, management restated their expectations of growth in sales of SAFR. They anticipate that growth would be lower than anticipated for FY22. Plus, the company decided to change its strategy with SAFR by shifting away from safety and security end markets to authentication and access control space. Moreover, they decided to enter the new space with a shift into hardware by introducing SAFR scan, a low-cost access control camera. This step does seem to be an indication that their licensing model was not working out and their soft was not gaining as much interest as anticipated. Moreover, the transition into the hardware business does not seem to be a solution for the company that has been involved with only software for 27 years. Overall, this change does not seem to be a positive development for the company and its flagship software SAFR.

Historical Business and CEO Overview

RealNetworks is one of the relics of the dot-com bubble that has managed to survive as a living enterprise. In 1994, he founded Progressive Networks, later known as RealNetworks. The primary product introduced during the early days was RealPlayer an audio and video streaming service that was at its peak towards the end of the 90s and the beginning of the 2000s.

The company was one of the pioneers in the streaming media business until big tech players like Apple and Microsoft started implementing solutions in-house. Microsoft created a media player which significantly hurt RealPlayer’s position in the market. Apple created iTunes for its iPods, hurting RNWK’s position in the subscription-based music streaming space.

Since about 2004 it has all been pretty much downhill for the RNWK. Bottom line is that during the tech boom of the 90s Glaser created an attractive product that even made him a billionaire at one point. Though, since reaching the peak, all of the products introduced by him, and the company were largely subscale or unsuccessful outright.

In 2010, he stepped down from the CEO role only to come back in 2012 to lead the company’s turnaround. Since then, the company did not perform much better either. The new product initiatives failed, and the legacy businesses were eating away all the rest of the cash. The company has not been profitable for more than a decade now. The turnaround that started 10 years ago put the company in a worse position than it was before.

Conclusion

Overall, the setup is fluid and quite speculative because of the preliminary nature of the offer as well as the difficulty in pinpointing the current value of RNWK. However, the recent purchases by the second-largest shareholder and the CEO’s belief in the RNWK turnaround do warrant a small exposure to the RNWK merger with a potential for a bump in the offer given some potential but limited value hidden in RNWK.