A Real deal for digital shares?

Rhapsody parent 'undervalued' vs. Apple, Napster

Shares of digital media companies were spotlighted Wednesday by a Wall Street analyst who sees more potential in the next 12 months for RealNetworks than for Apple or Napster.

Morgan Keegan analyst Tavis McCourt initiated coverage of the three stocks Wednesday, assigning an "outperform" rating for RealNetworks while giving Apple and Napster "market perform" ratings.

The analyst said that Real enjoys gross margins in the 65%-70% range and that strong revenue and earnings growth is reasonably likely if the company "can execute on its strategy to bring digital media to wireless devices."

Wireless is a theme on which the analyst is bullish concerning Napster and Apple as well. McCourt, however, argues that Apple's shares already are fully valued and that Napster needs to prove itself before he can aggressively recommend shares.

Napster has digital music partnerships with mobile phone operators AT&T, NTT DoCoMo and others. "Assuming it can capture just 1% of this customer base, Napster could create significant value for its shareholders," McCourt said.

Shares of the three companies were little changed Wednesday. For the year, Apple has been a stellar performer, while its smaller competitors have lagged significantly. Apple shares are up 61% and Real and Napster are down 43% and 15%, respectively.

McCourt noted that Apple has produced $4.6 billion in free cash flow during the past three years, has no debt and that its iPhone should boost cash flow for the next two to three years, but those positives already are baked into the stock price.

The analyst saved most of his praise for Real, saying its shares "are significantly undervalued" and a more fair price for them is $10, which would represent a 61% premium to Wednesday's close of $6.22.

McCourt added that Real boasts $541.8 million in cash, or $3.21 per share, on its balance sheet.

He figures that the company's Rhapsody America music business, co-owned by MTV, is worth $250 million to Real, while its gaming business is worth $577.7 million. Add up all its assets and Real is worth more than $1.7 billion, the analyst said, but its market capitalization was just $933 million Wednesday.