Picture in your mind a panel of administrative judges staring at their scuffed shoes in the Library of Congress. That gaggle of legal minds holds the fate of Pandora in their hands.
Dec. 15 is a crucial deadline for a tribunal within the Library of Congress to rule on music royalty rates for Pandora. The company’s investors have been anxious for months about the judges' decision, which seems likely to push Pandora’s already prohibitive music costs even higher. Yet into the maw of uncertainty, Pandora on Wednesday evening announced it was seeking to raise $300 million in a sale of convertible bonds. Shares fell 10 percent in a dour market day.
The timing was odd. No doubt Pandora could have struck better terms if it had waited for the fog to lift from the royalty decision. Plowing ahead makes it clear there is a risk the tribunal won’t go Pandora's way. If investors needed another reminder of Pandora's frailty, this is a company whose success or failure rides largely on the decisions of government judges. This is not the makings of a healthy business.
Content costs have been an understandable obsession for Pandora and its investors for years -- and it’s reaching a fevered pitch now. To understand why, let’s take a brief trip into music industry arcana.
Pandora, which operates more like a radio station, is governed by rules different from those for the on-demand digital music services like Spotify, YouTube and Apple Music. They have to strike upfront deals with record labels for each musical act they stream. Pandora can play songs online without going deal by deal with the record labels -- which is why it is able to play tracks from Adele’s latest album even though she refused to release her songs for play on streaming services like Spotify.
Pandora does, however, have to pay a royalty determined by those judges at the Copyright Royalty Board, the tribunal established within the Library of Congress. Pandora pays a fee set by the board. This year that amounts to 14 cents for every 100 songs played. The pennies add up. Pandora last year paid more than $400 million, or 44 percent of its revenue, just for the rights to stream songs. The music royalties are a big reason Pandora consistently loses money.
And it may be about to get worse. Those judges are considering Pandora’s payment rates for the next five years. A group that includes some record companies and musical acts thinks Pandora is paying them far too little for their songs and asked the board to increase the royalty fee to 25 to 29 cents for each 100 songs played. Pandora wants to cut the rate to 11 to 12 cents. Therein lies the difference between profit and pain.
No doubt there will be legal squabbling back and forth no matter which way the judges rule, but once the decision comes it won’t be easy to overturn, said Bloomberg Intelligence analyst Matthew Schettenhelm. Both he and Barton Crockett, an analyst with FBR & Co., said it’s tough to predict where the rate-setting body will land, but they think Pandora’s rates will most likely go up.
The music rates aren't Pandora’s only headache. It’s also getting more competitive for music lovers. Apple Music entered the picture recently. Spotify is making a bigger marketing push. YouTube is working on a subscription option without ads to expand what is already the biggest music-listening service in the world. The rivals are having an effect on Pandora. In the three months ended Sept. 30, the amount of time Pandora users spent on the service grew 3 percent from a year earlier. In the final quarter of 2014, the growth rate of listener-hours was 15 percent. The pace of new sign-ups to Pandora has slowed to a crawl.
Pandora has sought to diversify its business and wriggle out of dependency on those Library of Congress judges. It bought a company that provides ticketing services and software for concert venues. Using the pieces Pandora purchased from failed music service Rdio, the company has said it plans to start a music subscription service that would be more like Apple Music (which makes the record companies happy) than like the current Pandora (which makes the record companies angry). If it catches on, a new type of subscription music offering should help Pandora.
Still, Pandora has known for years about its problems with music royalty fees, and hasn’t done enough yet to shift its business model. And now those judges are about to get cued to play more sour notes for Pandora. That can’t be music to investors’ ears.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
(Clarifies makeup of group seeking higher royalty fees in seventh paragraph.)
To contact the author of this story:
Shira Ovide in New York at firstname.lastname@example.org
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