Peeking Inside Pandora Media Inc (P)’s Music Box: Sirius XM Radio Inc (SIRI), Apple Inc. (AAPL)

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Pandora Media Inc (NYSE:P) has had a nasty ride since its IPO in July 2011. The online radio company’s stock has gone nowhere over the past two years, as it continues grow revenue but fails to post a profit – a sign that costs may be spiraling out of control. Is Pandora about to doom investors, just as its namesake destroyed the world with her mystical box, or should investors save some hope – just as Pandora did, despite her grievous error?

Yet another unprofitable fourth quarter

For the fourth quarter of 2013, Pandora Media Inc (NYSE:P) posted a loss of 9 cents per share, or $14.6 million, down from a loss of 5 cents per share, or $8.18 million, it reported in the prior year quarter. Accounting for one-time charges and benefits, the company lost an adjusted 4 cents per share, beating the Thomson Reuters’ consensus estimate by a cent.

Pandora Media Inc (NYSE:P)Revenue at the company climbed 54% to $125.1 million, beating the consensus estimate of $122.8 million.

Royalties are a royal pain

Pandora’s obvious problem is its continued lack of profitability. Although ad sales – its main source of revenue – rose 51% to $109 million, royalty payments made to record companies and artists rose 59% to $77 million.

The fact that these costs are outpacing revenue growth is troubling, since co-founder Tim Westergren reported that Pandora’s per-track royalty costs have risen 25% over the past three years, with a 9% jump in 2013 alone. These costs are expected to rise an additional 16% over the next two years.

In addition to rising royalty costs, Pandora’s SG&A (sales, general & administrative) expenses have been rising, due to a rapid expansion of its sales team workforce, which it needs to promote and maintain its ad revenue.

A steadily growing user base in a fragmented market

Pandora Media Inc (NYSE:P) finished last month with 67.7 million users – claiming approximately 8.5% of the domestic Internet radio market.That seemingly small market share makes Pandora the largest Internet radio company in the U.S. – a testament to the fragmented state of the market, which includes rivals Spotify, Soundcloud and Vevo.

However, Google (NASDAQ:GOOG)recently announced plans to launch streaming music on its YouTube platform. With over 800 billion unique monthly users, YouTube’s music platform could flatten the entire landscape of Internet radio. With $48 billion in cash at its disposal, Google isn’t worrying about royalties – rather, the company’s enormous size could give it leverage against record companies to gain pricing power and better rates.

To make matters worse, Apple Inc. (NASDAQ:AAPL) is also rolling out its own streaming music platform. However, Apple demanded lower royalty rates than Pandora, which has resulted in a temporary stalemate with record labels.

Therefore, Pandora’s dominance of the market may be short lived.

Listener growth is a double edged sword…

Pandora’s total user base is still growing, but at a slower rate than before, with 47% growth in the previous quarter and 38% growth at the end of January.

Yet a slowdown in listener growth may actually be a blessing for Pandora Media Inc (NYSE:P).

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