RealNetworks announced Q4 2008 and full-year earnings last week (read SEC filing). Taking into account digital trends, RealNetworks’ music gains are fairly disappointing. The company’s music revenue increased 8% for the entire year and 8.2% in Q4. Those gains are well behind the increase in U.S. digital download revenue (about 30% in 2008) and the high adoption rates of free, ad-supported services for both PC and iPhone.

In 2008, RealNetworks launched an MP3 download store with a multi-million advertising campaign (from this press release, $50 million over a year and $15 million in Q3 alone). In addition, it has a partnership with Verizon Wireless that effectively gives it a nationwide sales force — Verizon customers are now able to sign up for Rhapsody at Verizon retail locations and the Verizon Wireless web site.

Yet with all the new developments, RealNetworks is missing out on much of the the digital music boom. iTunes’ growth most likely mirrors the 30% growth in digital downloads. has grabbed MP3 market share — although it is taking a loss on many of those bargain album sales. New services are capturing the attention and affection of the media and marketplace. In comparison, Rhapsody is stuck in the mud.

The earnings release says music revenue increased 8% in 2008. Where is RealNetworks’ revenue growth coming from? Based on the numbers provided in the earnings release, almost half of the growth has come from the Rhapsody subscription service and the rest is from digital downloads.

The company said it added 175,000 Rhapsody subscribers from Q4 2007 to Q4 2008. In Q3, 150,000 new subscribers were added. In Q4, another 25,000 subscribers were gained. If we assume those subscribers were obtained at an even rate over those six months (a mid-point method of estimation) and each paid $15 per month, that’s an increase in Rhapsody revenue of $5.34 million for all of 2008.

RealNetworks’ music revenue increased about $12.9 million in 2008. If you take out a $5.34 million increase in Rhapsody revenue, you’re left with $7.5 million that is accounted for by MP3 store sales and Verizon over-the-air downloads. It’s not a terrible number, but it shows what little success Rhapsody has had in selling more digital downloads. And that’s a problem. Part of the company’s music strategy is to lure MP3 buyers to its higher-margin subscription service. Few new MP3 buyers means few potential subscription customers.

The company just started disclosing the number of subscribers it has had going back to Q1 2007. The problem here is that its declared number of subscribers looks fishy. If we trust their numbers, we are to believe Rhapsody stayed flat at 600,000 subscribers from Q1 2007 through Q2 2008 and then jumped by 25% after its deals with Verizon and MTV Networks started. Those partnerships started in May 2008, which is in Q2 2008, but subscribers didn’t jump to 750,000 until Q3 2008. Not only is the timing of the subscriber increase odd, six straight quarters level at 600,000 subscribers is really odd. Since RealNetworks’ music revenue has steadily increased over time, I think it’s safe to assume the number of Rhapsody subscribers has increased over time as well. A jump in Q3 is understandable given the Verizon partnership, but six straight quarters stuck at 600,000 subscribers is not believable.

Given all of the above, it’s difficult to properly assess RealNetworks’ performance in digital music over the last two years. We know revenue growth is lower than the overall growth in digital music spending. We could safely guess that Rhapsody’s MP3 store isn’t gaining much traction. Beyond those items, there’s a lot of guessing going on.

Posted by: Amy Sikkes