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Pandora's Stock Rally Isn't Solving Its Problems

Brian McAndrews has been on a Wall Street honeymoon. Since he became chief executive officer of Pandora Media (P) in September, the stock price of the music streaming service has jumped about 60 percent, tacking on roughly $3 billion in market value, and the company brought in $400 million from a share sale.

But even as analysts boost their ratings on its stock, Pandora continues to struggle with the same obstacles it’s been dealing with for years. It remains enmeshed in a protracted battle with the music industry over royalty payments, and it’s not yet profitable. On March 6 the company, which makes its money from ad sales and ad-free subscriptions, reported its slowest-ever increase in monthly listener hours. Shares have fallen about 10 percent since then. Analysts estimate that sales growth will slow to 38 percent this year and 30 percent the next, after revenue more than doubled in 2013.

Free for most users, Pandora’s streaming service has 76 million listeners, but its growth may be limited because royalty agreements restrict its use to the U.S., Australia, and New Zealand. The company’s list of rivals keeps expanding and now includes trendy upstarts such as Spotify, as well as Apple (AAPL), Google (GOOG), and, as of March 7, Samsung Electronics (005930:KS), which unveiled a mobile streaming service called Milk Music.

McAndrews, a former advertising executive, says there’s plenty to go around in the $50 billion combined market for broadcast radio, mobile, and online display and video advertising. “Investors understand that we’re in a huge category and we have a huge opportunity to grow,” he says. “Before I worked here, I read about Pandora killers. There have probably been 30 of them, many of them have died, and none of them have hurt us.” He points out that in the month after Apple introduced iTunes Radio in September, the number of Pandora listeners fell 2.6 percent. By December it jumped back above its September level.

Pandora’s biggest problem remains how much it pays for music. The company has struggled to reach deals directly with record labels, and since 2009, it has operated in the U.S. under a federal statutory license that requires it to pay copyright holders 25 percent of revenue or a per-song royalty, whichever is greater. The government has begun to set new rates that will take effect in 2016, but in 2013 music costs equaled 53 percent of Pandora’s revenue as it lost $40.7 million. That cost figure is down from 60 percent of revenue in 2012. Between the two years, Pandora paid almost $600 million to the struggling music industry, which has gotten only hungrier after the number of digital downloads fell for the first time last year. Terrestrial and satellite radio stations pay much less—satellite a royalty of about 7.5 percent, while terrestrial stations pay songwriters, not labels. Apple and Spotify forged direct deals with the record labels and publishers, enabling them to offer their services overseas and bargain for exclusive content.

“Before I worked here, I read about Pandora killers. There have probably been 30 of them, many of them have died, and none of them have hurt us.”—Brian McAndrews

Pandora doesn’t get much sympathy from musicians. David Lowery, the frontman for alt-rock band Cracker, slammed it in a blog post on the website Trichordist last June for shortchanging musicians, claiming the company paid him $16.89 for streaming his song Low 1.16 million times. In a blog post on its website, Pandora said those numbers don’t compare to radio airplay.

McAndrews, 55, a fan of Elton John and Bruno Mars who played guitar as a kid, says he’s interested in providing artists and labels with more data. With Pandora tracking listeners’ tastes, correlated with their ages, genders, and Zip Codes, “there are opportunities to share some data with artists that could be valuable to them, and an opportunity for labels who own either the copyrights or performing rights to make more and more money,” he says. Senior executives at Sony Music Entertainment (SNE), Universal Music Group (VIV:FP), and Warner Music Group confirmed that Pandora’s CEO has contacted them, but they declined to discuss any prospective deals or possible changes to their royalty structures.

In February, McAndrews hired former Microsoft (MSFT) and LinkedIn (LNKD) executive Sara Clemens as chief strategy officer to help with partnerships and potential acquisitions of upstart competitors or technology companies. AOL (AOL) ad network head Bob Lord, who used to work for McAndrews, says he’s interested in some kind of data-sharing agreement down the road. “I’m going to double down on the man, because he made me successful before,” Lord says. “I use Pandora at home all the time. There’s a lot of behavioral stuff they could be using on people like me from an advertising standpoint.”

After running ABC Sports (DIS), in 2000 McAndrews took online ad company AQuantive public and made it one of the first to merge advertising technology with the traditional ad agency business. In 2007 he sold AQuantive to Microsoft for $6 billion. At Pandora, McAndrews replaced nine-year CEO Joe Kennedy. Founder Tim Westergren, who plays piano, bassoon, drums, and clarinet, remains with the company, serving as a liaison with artists and promoting Pandora at events such as the South by Southwest music festival. He’s “better connected to that community than I am, certainly,” McAndrews says.

The bottom line: Despite Pandora’s recent stock run, the company faces obstacles to maintaining its growth.

Levy is a reporter for Bloomberg News in San Francisco.
Fixmer is a reporter for Bloomberg News in Los Angeles.

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