Bad Government Policy is Choking Pandora

By Daniel Ferry - June 18, 2012 | Tickers: P, SIRI | 0 Comments

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Last week, the nation's largest radio network, Clear Channel, struck a deal with Big Machine Label Group to pay its artists, including Taylor Swift and Tim McGraw, for playing their songs on its stations. This brings into stark relief a government policy that hugely disadvantages young disruptors in the radio space like Pandora (NYSE: P), Spotify, and Sirius XM Radio (NASDAQ: SIRI). While it made headlines that a terrestrial radio provider like Clear Channel had decided to pay for radio content, Internet and satellite radio providers have always paid for every song they play. This creates a massive cost disadvantage that will make it difficult for Internet and satellite providers to thrive.

Since the 1909 Copyright Act, legislatures and courts have held the view that because musical acts get a lot of publicity from being played on the radio waves, the performers should not need to be compensated with royalty money. Of course, neither in 1909 nor when the legislation was updated in 1976 were lawmakers really thinking about alternatives to terrestrial radio, and therefore the relevant laws don't apply to firms like Pandora or Sirius XM. While I cannot blame these legislators for their failure to predict the Internet or satellite communications, the fact remains that the U.S. Copyright Royalty Board enforces a system in which terrestrial radio may play songs without compensating the performer, and Internet and satellite competitors are forced to pay per play.

Due to unfair application of existing rules, though terrestrial radio gets the best deal of all, Internet radio takes a much bigger hit than satellite. In Pandora's case, founder Tim Westergren testified earlier this month before the House Subcommittee on Communications and Technology that performance royalty fees cost his company $137 million in 2011. With only $274 million in revenue, that accounts for half of the firm's annual income. The comparable figures for Pandora's competitors are 7% for Sirius XM, and of course 0% for Clear Channel and other land-based radio providers. MusicFIRST, an advocacy group devoted to supporting performing artists, has estimated that in other nations, performance royalties account for 3 – 6% of terrestrial radio revenues.

What if Pandora were under the same regulatory regime as the the traditional radio stations, and paid nothing to performers? Instead of losing $16 million in its most recent fiscal year, it would have earned $121 million. For a company with a market cap of only around $1.7 billion when their fiscal year ended in January, this would yield a valuation of just above 14 times earnings. With the average price-to-earnings ratio of the S&P 500 being 14, this alteration recasts Pandora from being a speculative, risky, cash-burning, aggressive growth stock into a profitable company that is fairly valued on its current earnings.

Unfortunately for Pandora, legislative relief doesn't seem to be forthcoming, as gridlock is the order of the day in Congress. Pandora has powerful lobbying enemies to both sides of it. The National Association of Broadcasters, led by Clear Channel, has stymied any effort to force them to pay performance royalties. They have put forward a counter-proposal in which they would pay a trivial amount to performers (between 0.25% and 1% of revenues) if and only if Congress mandates that all smartphones come with radio-activated chips. This seems like more of an insult to the music industry than a serious proposal. The music industry, for its part, is focused on capturing more compensation for artists, not less, and it has no interest in giving Internet radio a free pass. As long as Pandora and its Internet peers remain on such drastically unfair footing, it is difficult to see how the young upstarts can find their way to profitability.

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