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Pandora Media Inc (P), Google Inc (GOOG): Who’s Doomed?

The number of companies which offer a music subscription or internet radio service seems to be growing larger every day. There’s Pandora Media Inc (NYSE:P), which has proven to be exceptionally popular with its free ad-supported model and an ad-free subscription service. Then there’s Spotify, which has a much larger library than Pandora and also offers a free ad-supported version. Pandora has about three times as many active users as Spotify does, but the company has also been around a lot longer. There’s also iHeartRadio, which allows you to stream live radio, and the smaller Slacker Radio.

Here comes Google

This already crowded space got a new competitor recently as Google Inc (NASDAQ:GOOG) launched the Google Play Music All Access service. This new service is similar to Spotify, where users pay $10 per month to be able to stream an unlimited number of songs. But Google introduces some unique features, like the ability to merge your personal music library with the streaming catalog. This allows you to listen to songs which you already own in addition to Google’s catalog all in the same place. The service also has a radio feature similar to Pandora Media Inc (NYSE:P)’s, where playlists are automatically generated.

The benefit that Google Inc (NASDAQ:GOOG) has is its already large and ubiquitous ecosystem of products and services. With Android being the dominant OS in the mobile space integrating the new music service into Google Play gives the service a big advantage over the competition.

The problem with online music

Pandora Media IncAny business model which involves paying royalties to content owners in order to serve that content is not a very attractive one. A huge portion of the revenue which these companies generate is spent on royalties, and that fact is unlikely to change anytime soon. This means that profits, if they exist at all, will necessarily be small.

Pandora Media Inc (NYSE:P) and Spotify pay royalties in different ways. While Spotify negotiates directly with the content owners Pandora pays a royalty rate which is determined by the federal government. So every time Pandora plays a song it must pay a fraction of a cent in royalties, and this is the reason that the company limits its free service to 40 hours per month.

Pandora’s struggles

Most of Pandora Media Inc (NYSE:P)’s revenue comes from selling advertisements, but thus far costs have grown just as fast as revenue. In the most recent quarter revenue jumped by an impressive 54% year-over-year but operating income fell from $-8 million to $-14 million as costs rose. This is a fundamental problem with the business model which will not go away unless federal laws are reformed.

Buying Pandora Media Inc (NYSE:P) stock essentially boils down to a gamble on the actions of the federal government regarding royalty rates. You’re paying $2.8 billion for a company that is not profitable and will likely never be profitable unless laws are changed. And even if royalty rates come down Pandora faces an onslaught of competition. Pandora only has about 900,000 songs in its librarycompared to Spotify’s 20 million, putting it at a major disadvantage.

What about Apple?

Apple Inc. (NASDAQ:AAPL) has been long rumored to be working on a music streaming service. Apple’s iTunes remains popular, with the service passing the 25 billion songs mark in February. But with Google Inc (NASDAQ:GOOG) launching a service it’s likely only a matter of time before Apple joins the fray. Recently rumors have emerged suggesting that Apple is close to an agreement with Universal Music Group, the largest of the major record companies, on a streaming deal.

Apple Inc. (NASDAQ:AAPL)’s goal with the service will be similar to Google’s – locking people into the companies’ respective ecosystems. Apple’s service will likely have some sort of iTunes integration, meaning that users of iTunes with considerable libraries will have a reason to choose Apple over the competition. Competing with both Google Inc (NASDAQ:GOOG) and Apple in an industry like this is not exactly a recipe for success.

The bottom line

Pandora Media Inc (NYSE:P) is in a world of trouble. Not only is its current business model unable to turn a profit, competition from Google Inc (NASDAQ:GOOG)and likely Apple Inc. (NASDAQ:AAPL) along with the current competition from companies like Spotify puts Pandora’s future in jeopardy. Investing in Pandora is almost certainly a huge mistake.

Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google.

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