Microsoft split sinks Real stock

Microsoft has admitted it made a Real mistake.

Shares of RealNetworks plunged nearly 10 percent in early trading today after Microsoft yesterday announced that it is divesting its holdings in market-leading streaming media firm. The stock was down 7.87 percent or 3.38 points, to 39.5. Real Networks' shares have traded as high as 49.75 and as low as 13.5 during the past 52 weeks.

The alliance between Microsoft and RealNetworks has become increasingly untenable as the two companies have sparred over their relationship and fought tooth-and-nail for market share in streaming media.

Microsoft made a $30 million minority investment in RealNetworks in July 1997. Microsoft paid RealNetworks an additional licensing fee of $30 million, and the two companies entered into a nonbinding marketing agreement to collaborate on interoperability of their respective streaming media systems.

As part of that deal, the companies agreed to use Microsoft's Advanced Streaming Format (ASF) as the default file format for streaming media, according to Microsoft.

In October, however, RealNetworks released a beta version of its Version 5.0 RealSystem that did not include support for ASF.

"We took that as a sign that we might not be headed in the right direction," said Gary Schare, lead product manager for Windows media technologies at Microsoft.

Relations between the two companies then progressed from bad to worse as they continued to trade barbs over compatibility of their products. Hostility eventually emerged, when RealNetworks alleged in a Senate hearing that Microsoft's Windows Media Player "broke" RealNetworks' G2 player. Microsoft retorted that the problem was caused by a bug in RealNetworks' software.

That war of words with Microsoft caused RealNetworks' stock to fall precipitously.

But while the relationship between Microsoft and RealNetworks soured, Redmond's $30 million investment in the company appreciated nicely. Microsoft paid 9 per share for 3.3 million RealNetworks shares, which closed yesterday at 42.875.

Microsoft planned to begin divesting during the past six months, and first informed RealNetworks of the its intentions in June, Schare said. The companies discussed handling the divestment jointly, as an underwritten secondary offering, but could not agree on terms.

The divestment will begin as early as tomorrow and will take place over the course of several months.

"Our goal is to divest responsibly," Schare said. "In order to maximize our return, we're not going to dump [our holdings] all at once."

"RealNetworks has expected for some time that Microsoft would sell its shares in RealNetworks," the company said in a prepared statement. "Beginning last spring, it became clear that the two companies' business strategies were not aligned."

While hardly a surprise, the divestment is a significant setback for RealNetworks.

"For the streaming industry, this doesn't mean a lot, because the companies have not been working together for a full year now," said Forrester Research analyst Seema Williams.

"It's the final nail in the coffin of a relationship that's been on the skids for a while. But it subverts confidence in RealNetworks because the investment in some sense legitimized the company, which grew because of it."

While Microsoft and RealNetworks have long recognized one another as competitors, the final severance of their tie puts RealNetworks even more squarely in Microsoft's firing range.

"The relationship with the company that owns your desktop gave partners and other investors the sense that Microsoft was on your side," Williams noted. "And betting against Microsoft is a scary thing." But RealNetworks disputed the notion that the divestment would harm the company in the industry or on Wall Street.

Noting that his company maintains an 85 percent market share, RealNetworks spokesperson Jay Wampold said, "Microsoft's decision to go down their own path means we're not moving in lock-step together. It shows they didn't want to go along with the leader in this space."

Wampold also pointed to distribution deals RealNetworks has struck recently with Intel, America Online, Lotus, and Netscape as a sign of the company's viability post-Microsoft.

"We are poised to continue to maintain a leadership position and become even more entrenched in this space," Wampole said.

Regarding Microsoft's profit in selling its RealNetworks share, Wampold said, "They've made about $100 million on that investment. We're proud to be one of Microsoft's most profitable Internet ventures."