Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

Will Pandora Ever Make Money?

No company seems to exemplify the central problem facing digital entertainment media better than Pandora Media (NYSE: P). The music service attracts vast numbers of followers (250 million registered users and 81.5 million active listeners in 2014, according to Expanded Ramblings), yet the charts show that it cannot seem to make money.

Pandora reported a net income of -$49.73 million in March 2015, not too different from the -$42.51 million in reported in March 2014. The net income fell even though Pandora reported a quarterly year to year revenue growth rate of 18.76%. Pandora’s revenue keeps growing as its income keeps falling.

This gave the company a quarterly profit margin of -20.91% and a return on equity figure of -9.16%. It also shows us that all those legions of Pandora fans and the vast number of songs they download are a very poor investment from a value perspective. Pandora simply cannot figure out how to make money from its music.

Pandora’s Royalties Expenses Could Increase

One reason for this is the royalties that Pandora has to pay to artists, music companies, songwriters and agents every time a song gets played. That can get real expensive real fast. The New York Times reported that Pandora, which recorded a TTM revenue figure of $957.25 million on March 31, 2015, paid out $446 million in royalties in 2014, meaning more than half of its revenue goes straight into somebody else’s pocket.

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Those royalties are about to get more expensive because a federal judge just ruled BMI, or Broadcast Music Inc., a clearinghouse for songwriters, can raise the royalty rate it charges Pandora to 2.5%, The Times reported. Pandora is currently paying BMI royalties of 1.75%.

That ruling conflicts with a U.S. Court of Appeals for the Second Circuit decision in a case involving Pandora and the American Society of Composers, Authors and Publishers, or ASCAP, a music industry trade group. The court affirmed a judge’s ruling that set Pandora’s royalty rate for ASCAP members’ songs at 1.85%, The Times reported. The ruling lets Pandora pay a flat rate for ASCAP members’ songs rather than having to negotiate directly with publishers for the rights to popular tunes and pay a higher price.

Since both of these cases will presumably be appealed to higher courts, it means Pandora does not know what royalties it will pay for songs. Its whole business model and profit margins are effectively at the courts’ mercy.

Why Is Pandora Buying a Radio Station in South Dakota?

The royalties situation explains two rather interesting moves that Pandora has made.  The digital music service wants to pay $600,000 for KXMZ FM, a small radio station in Rapid City, South Dakota, a deal that was approved by the Federal Communications Commission on May 4.

Owning a radio station could enable Pandora to take advantage of radio industry deals which would allow it to play a lot of music without royalties, The Times noted. That could set the stage for yet another battle with the ASCAP, which is now claiming Pandora is violating federal laws regarding radio station ownership.

It is hard to see how buying a radio station would cut Pandora’s royalties expenses because radio and audio streaming operate by completely different rules. Historically the music industry has let radio play songs without paying to get free advertising but charged royalties for digital music. Under present arrangements, Pandora would still have to pay royalties on songs it places online whether it owns a radio station or not.

Does Pandora want to end up paying Taylor Swift a cut of the gross? It could happen.
Does Pandora want to end up paying Taylor Swift a cut of the gross? It could happen.

Another potential problem is that some radio station operators like Clear Channel do pay royalties for songs to some music companies. Clear Channel has such a deal with Warner Music Group. Clear Channel also gives some performers; such as Taylor Swift, a “cut of the gross” a small portion of the revenue from its operations in exchange for the rights to their songs. That means owning a radio station could actually increase not cut Pandora’s operating expenses in today’s music industry.


Clear Channel owns Pandora competitor iheartradio which streams radio station programming online. It also seems to have a better relationship with the music industry which could give it an edge over Pandora in the music wars.

Pandora’s Next Big Move

The radio station buy seems like a move of desperation on Pandora’s part. The streaming audio service’s other move seems to make a little more sense; it purchased the Next Big Sound, a company that tracks the amount of attention music gets on media like YouTube, Twitter and Wikipedia.

Owning the Next Big Sound could enable Pandora to identify popular music outside the ASCAP and BMI clearinghouses. It might be able to buy songs or negotiate deals with artists or songwriters before ASCAP and BMI get involved. The Next Big Sound’s data could also help Pandora identify more profitable songs for its playlists.

More data could also help Pandora negotiate better deals with the music industry. It could offer artists royalties based on a songs’ popularity rather than the current flat rate, paying more popular numbers and less for obscure tunes.

The problem with that scenario from a value standpoint is that it is purely speculative. The bottom line is that Pandora’s business model simply has no float. It has no source of revenue to cover the royalties it pays out.

Pandora’s situation shows that a subscription-based business model that generates float seems like the best solution for digital entertainment. Pandora proves that having a large number of followers is no substitute for plain old fashioned cash flow.