Weak Guidance And Settlement Charges Pummel Pandora As The Royalty Board Verdict Nears

Pandora Media‘s (NYSE:P) stock is down more than 30% after the company reported middling results and offered revenue guidance for the December quarter that was well below the consensus estimate.  In addition, the company announced charges totaling $90 million resulting from the partial settlement of two different disputes with the music industry over the level of royalty payments. At this point, Pandora is looking to the Copyright Royalty Board’s (CRB) pending decision on royalty rate setting proceedings for hopeful news. In fact, in a last month update, the Internet radio company had mentioned that the Copyright office has agreed to consider its deal with Merlin as a valid benchmark for the rate setting proceedings. Although this was an indication that the decision could go Pandora’s way, royalty issues aren’t letting go of the company at the moment.

However, on the topline front, Pandora continues to do well. Its revenues increased 30% to $312 million, driven by 52% increase in local ad revenue. Adjusted EBITDA excluding the impact of settlement charges increased 27% to $30.6 million, which reflects a good organic performance. However after factoring in the one time costs, Pandora’s net loss increased 42 times. On the usage front, active listener count at 78.1 million was up just 2% from the year ago period and listener hours increased by 3% year over year. Given the lowered guidance, this weak growth, and the strong success of competing services (including the recently released Apple Music), Pandora’s outlook has dimmed.

Our current price estimate for Pandora stands at $21.44, implying a premium of close to 40% to the current market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Pandora Media

Dispute Settlement Takes A Toll On Pandora

Pandora spent a total of $81.8 million on royalty disputes in Q3, that included $57.9 million paid to record labels over pre-1972 recordings dispute and charges of $23.9 million as a result of the company’s decision to drop efforts to get lower royalty rates currently enjoyed by conventional radio stations. ^[1] Since the Federal copyright only protected songs made after 1972, players such as Sirius XM (NYSE:SIRI) and Pandora were not paying royalties for songs launched before 1972. Thanks to the case filed by the Turtles and others, older performers will get royalties in the future. Satellite radio provider Sirius XM had paid $210 million to settle this copyright lawsuit a couple of months back. Although Pandora is paying just one fourth the amount paid by Sirius XM, the impact of settlement charges is much severe on the Internet radio company due to its business model, that relies heavily on advertisement revenues as opposed to Sirius XM.

Royalty Case Needs To Go Pandora’s Way

Pandora’s recent crash in the stock market indicates how sensitive the company is to an increase in content related expenses. Content acquisition costs account for about 45% of the expenses for the company, which isn’t profitable at the moment. Hence, even a marginal increase in royalty costs can worsen Pandora’s bottomline situation. It is evident from the fact that despite being one time costs, the dispute settlement charges were able to dent investors’ confidence in the company. And it’s apparent what a permanent significant increase in royalty rates can do.

The ongoing royalty rates setting proceeding is a looming threat for Pandora. While it is evident that the company’s royalty rates will increase faster than they have increased before in 2016, the magnitude of increase is still unclear. Pandora and SoundExchange have both put in their best efforts to bend the verdict their way, which will be out by December 16th. Last month, the Internet radio company released an important update on the proceedings that improved Pandora’s standing in the case. Only July 29th this year, the Copyright Royalty judges solicited Register’s opinion on whether a specific direct-licensee deal benchmark can be presented as an evidence for the ‘Webcasting IV’ proceedings. As the deadline ended, the Copyright office proclaimed that Pandora’s agreement with Merlin can indeed be regarded as a valid benchmark for the ongoing proceedings. Following the update, the company has gotten optimistic about the rate setting proceedings. And with the recent settlements charges fresh in investors mind, Pandora would be desperately hoping for the new royalty rates to be near its proposal.

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1. Pandora Reports Q3 2015 Financial Results, Pandora, Oct 22 2015 [↩]