AAPL and Pandora

Is Apple going to move into radio as content,


Nicholas Ward says yes.



Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…)

Last Friday I ran across a market current quoting a source from The Verge proclaiming that an Apple (AAPL) iRadio was imminent (scheduled for a summer 2013 launch). I found this interesting; this was a direction that I did not expect Apple to go to. The company’s stock is still down, trading 5.65% off its 52 week low. Apple needs a catalyst to give life back to its stock. The initial negative news surrounding Samsung’s Galaxy S4 gave Apple shares a spark; but, during the latter half of last week the stock fell 6%.

I recently expressed my opinion that a new piece of hardware would be key to the stock’s redemption. I like the idea of any new product for Apple, especially since lately it seems as if no news is bad news for this company’s stock price. However, I can’t help but wonder if moving into the low margin space of internet radio will truly benefit Apple in the long term. Apple thrives off of its high margins and even if the company is able make unprecedented agreements with record companies in regards to low royalties paid, its iRadio can only achieve so much success with the vast majority of revenues coming from advertisement dollars.

But then, on Tuesday I stumbled upon another market current citing a Wall Street Journal report that the new iPhone 5s would be available this summer as well. The more and more I thought about it, the more and more this sequence of events made sense; especially when I consider previous iRadio rumors concerning its possible iOS exclusivity. While iRadio serves as a stand alone division, this service, if done well and accepted by consumers as a must have app, might be the added weight that would tip the summer smartphone battle into Apple’s favor. To see just how productive this new product could be for Apple I looked into Pandora (P), who is the dominant player in the industry right now.

Pandora has over 125 million registered users in the United States. The company’s total radio market share is growing rapidly; at fiscal year 2012’s end P controlled 5.55% of the total radio market. At the end of Q1 2013 this figure had risen again to a record 5.74%. P has a strangle hold on the United States internet radio market with a 69.8% market share. Pandora has developed itself into a major brand name in the American markets; however, the company has yet to attempt to move into international markets.

For iRadio to make a noticeable difference as far as shareholder performance goes I believe that it would have to essentially swallow the market. Pandora is growing fast but even with such massive growth, profits have yet to be seen. The company has suffered $101.4 million in operating losses since its inception in 2000. The company expects that it will continue to suffer operating losses “on an annual basis through at least fiscal 2013.”

Pandora did however set records for revenue and advertisement revenue in their 2012 fiscal year: $274.3 million and $240 million respectively. These figures represented 99% total growth and 101% ad revenue growth over the period. Audio advertising revenue more than doubled for Pandora during fiscal 2012, exceeding $100 million for the first time. I can see Apple doing even better as far as Ad. revenue goes because I believe companies will pay a premium that Pandora cannot demand to align themselves with a popular Apple product.

Total mobile revenue was Pandora’s shining star during the year, more than quadrupling from roughly $25 million in fiscal 2011 to over $100 million in 2012. Total mobile listener growth for the company has grown steadily over the past 4 years. In 2009 only 5% of Pandora’s total listener hours were coming from mobile devices. In 2010 this percentage increased to 24%. In 2011 P saw another large jump to 51% and in 2012 the total listener hours coming from mobile devices totaled 65%.

Pandora’s listener numbers are sky-rocketing as well. Pandora’s active users increased 62% during 2012, totaling 47 million as opposed to the 29 million users the company tallied in 2011. The total listener hours for fiscal 2012 set a record of 8.2 billion. This figure was up 109% from the total 2011 figure: 3.8 billion listener hours.

Pandora’s digital music library consists of over 900,000 songs produced by over 90,000 artists spanning across 350 genres. These songs are sorted and played in specific sets and orders organized by Pandora’s Music Genome Project. This genome consists of human opinions covering over 450 distinct musical characteristics which are then compiled and considered by the company’s music data algorithms creating radio stations unique to each user’s input data. Pandora has accumulated over 15 billion “thumbs up” from its users who have created more than 2.4 billion unique stations. P’s mission statement, “to enrich people’s lives by enabling them to enjoy music they know and discover new music that they’ll love” is achieved by this Music Genome Project. Because of this, Pandora believes it is clearly offering the best personalized radio experience in the world, making their situation in the marketplace firm and defensible.

Now, these numbers all seem great until you look at Apple’s parallel figures. Apple’s iTunes music library consists of over 26 million songs. This figure dwarfs Pandora’s 900,000 song library. Although the two business segments generate cash in entirely different ways, I think it is worth mentioning the success of Apple’s iTunes division; in Q1 2013 iTunes revenues were 3.68 billion, accounting for 22% growth YoY. This 22% growth number for the quarter is the same percentage growth that the iPad experienced. I think that sometimes Apple investors forget about the iTunes division. This is understandable with it only accounting for 6.7% of quarterly revenue, but more than 3.5 billion is nothing to sneeze at and it makes sense that this iRadio project will enable Apple to use its massive music library to create more revenue through increased iTunes exposure and sales, and advertisement dollars.

Apple also already has a program in place with iTunes that is similar to Pandora’s Music Genome Project. Apple’s iTunes Genius tracks purchases made by iTunes users and provides customers with other song options that fit into their established tastes. This system can also be put to use in the creation of play list from a personal iTunes library. The fact that Apple already has a successful music sorting algorithm in place makes its transition into user friendly personalized internet radio very reasonable.

The success in user growth and activity that Pandora has shown makes it clear that there is public demand for this niche radio. If Apple is able to use its weight in the music marketplace to convince record companies to charge a lower than average royalty rate for songs streamed on the iRadio which could lead towards more artist exposure and song sales via iTunes, then Apple may have found the golden ticket for internet radio profitability.

This sentiment is exactly what Pandora’s management has feared since Apple’s original announcement of an iRadio last summer. In the risk assessment section of P’s 2012 10-k filing the company is quoted as saying,

“We believe that companies with a combination of financial resources, technical expertise and digital media experience also pose a significant threat of developing competing internet radio and digital audio entertainment technologies in the future. In particular, if known incumbents in the digital media space such as Amazon, Apple, Facebook or Google choose to offer competing services, they may devote greater resources than we have available, have a more accelerated time frame for deployment and leverage their existing user base and proprietary technologies to provide products and services that our listeners and advertisers may view as superior. Our current and future competitors may have more well-established brand recognition, more established relationships with consumer product manufacturers, greater financial, technical, and other resources, more sophisticated technologies or more experience in the markets in which we compete.”

I think this recent report from The Verge is the culmination on these fears for Pandora.

The one thing that could be Pandora’s saving grace would be if Apple decided to make its service available only on its iOS devices. This would obviously hurt Pandora greatly as the majority of its listeners use their service on mobile devices, many of which run on the iOS platform. In Q1 2013 Apple sold over 75 million iOS mobile devices. Iphone sales came in at 47.8 million for the quarter with iPad sales totaling 22.9 million. At the end of Q1 Apple held roughly 21% of the smart phone market (IDC Worldwide Mobile Tracker). Depending on the success and appeal of iRadio a policy such as this could help to drive apple hardware sales, indirectly helping the company maintain its attractive margins. I imagine that this is the ultimate goal of the iRadio, to give competitive advantage to its iPhone and iPads moving forward.

As far as Pandora goes, this policy would at least give the company breathing room and allow for them to come to possible agreements with Apple’s competition creating further polarity in the mobile tech sector. Pandora’s 2012 annual shareholder report is quoted as saying,

” More than half of all radio listening happens in the automobile, so we’ve invested in our auto partnerships, now numbering 23 major brands. We’ve greatly expanded our footprint in connected devices to allow greater ease of access to Pandora in the home. Pandora is now available on more than 450 connected devices, including connected televisions, blu-ray players, set top boxes, and even refrigerators. We’ve also completely redesigned the site in HTML5 – establishing a foundation for future innovation.”

when speaking about its overall market appeal. The company’s exposure to a broad source of devices makes it a formidable foe to the iRadio. I find the automobile statistic interesting and cannot help but wonder if Pandora poses a threat to Sirius Satellite Radio if forced into a more specific niche market by the potential broad success of an Apple iRadio. I can also imagine P coming to an agreement with Google to promote the Android OS as direct opposition to the potential exclusive iRadio summer push.

The true elephant in the room when looking at the potential risks and success of Apple entering the internet radio market is a report made by The New York Post, saying that Apple wants to pay 6 cents per 100 song streams; a rate that would majorly undercut the current rates paid by the market with Pandora paying 12 cents/100 song streams and Spotify paying as much as 35 cents.

Pandora doesn’t negotiate directly with record labels; instead, the company has chosen to pay royalties at the rate set by Congress for all internet radio providers. Now, however, Pandora complains that there rates are too high for a company paying them to be profitable. Pandora has recently tried to fight these rates by proposing that the “Internet Radio Fairness Act” (IRFA) be passed by congress, giving such companies a fighting chance at profitability. This bill was quickly shot down. Analysts expect that Pandora is not finished with this fight and will try again to bring the IRFA up to the politicians. If Apple was to secure rates similar to those reported by The New York Post, then Pandora and the other companies in the internet radio sector might have added firepower to their IRFA argument. With this being said, I think that if Apple is able to secure rates in line with The New York Post numbers, that will essentially mean that the game is over for Pandora or any other internet radio player unless they are able to find a power partner to stand with against this potential profitable Apple onslaught.

But what could it mean for Apple shareholders if the iRadio is able to push Pandora out of the internet radio space? Remember, in 2012 Pandora hit a record high of active users totaling 47 million. During 2012 and Q1 2013 Apple sold 253.9 mobile devices running on the iOS platform: 172.8 million iPhones and 81.1 million iPads (as reported in the company’s quarterly earnings reports). Assuming that the vast majority of these devices would be synced with a free internet radio app offered by the company, Apple would already dominate the market as far as total users go. Being that Pandora made 274.3 million in revenues off of its 47 million active users, Apple would make nearly 1.5 billion off of their recently sold iOS devices even if the tech giant wasn’t demanding a higher advertising premium than its much smaller competitor. I understand that this conservative 1.5 billion in revenue is a drop in the bucket for a company as successful as Apple but this is just the tip of the iceberg when considering all of the summer release rumor surrounding Apple. Consumers are always looking for a new piece of innovation; for extended battery life, a slightly larger screen, for a camera that tracks the movement of the eye. Well, if Apple is able to launch its new iPhone 5s with an exclusive iRadio app that consumers are excited about, I believe the company could swing the smartphone momentum back into its favor. Its human nature to want something that you can’t have and while the iRadio seems like a low margin play, Tim Cook and his team might be onto something that could change market perception of their iOS products, making them overly exciting, hip, and exclusive ag



Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s