1 Acquisition Apple Doesn't Want to See: Samsung Buying Pandora

When Apple (NASDAQ: AAPL  ) first conceived the iPhone, one concept was to use the cumbersome iPod click wheel as the central control of the phone. After using the touchscreen interface that Apple finally decided upon, that idea seems ludicrous. However, it does show how intertwined the iPod and the iPhone have long been. 

When the iPhone was first launched, Steve Jobs stood in front of a sign that had three soon-to-be iconic buttons behind him: "iPod, Phone, Internet." The inclusion of the iPod was just as important as an access point to holding a full-featured and easy-to-use Internet in your hand. 

Yet the nature of how music is consumed is changing. Streaming services such as Pandora  (NYSE: P  ) and Spotify might struggle to become profitable, but they're more and more popular with users. Apple has taken note of the trend and is reportedly working on a Spotify competitor. Yet while Apple works on its homegrown competitor in the space, the cagiest move of all could be Samsung making a move for Pandora. Let's take a look at the digital music space and see why a Samsung and Pandora tie-up could make sense. 

Digital music: Apple's domain
Apple rode booming iPhone sales to more success in the digital-music world. While gaudy numbers about the billions of apps downloaded began to steal the show at Apple's presentations, its dominance of music continued expanding. Competition over digital-music sales has increased markedly in recent years, with Amazon.com (NASDAQ: AMZN  ) aggressively pricing digital music and building out its cloud player. Likewise, after relying on third-party music services such as Amazon when Android first launched, Google  (NASDAQ: GOOGL  ) unveiled Google Music in 2011 to better compete with iTunes as a central music hub.

Yet this increased investment in the digital-music space from competitors hasn't done much to dent Apple's dominance. Asymco's Horace Dediu recently pegged Apple's iTunes as paying out $3.4 billion in digital payments to publishers in 2012 -- 60% of industry totals. That's consistent with past research from NPD, which has shown iTunes maintaing roughly 66% of U.S. digital sales. 

With Android now controlling roughly 70% of worldwide smartphone sales, it'd be easy to conclude it'll begin chipping away at Apple's music dominance. Yet market-share figures don't always tell the full tale. Apple's iOS has higher market share in countries like the United States, where legal digital-music sales are much higher. Not only that, but getting the right licensing to sell music globally is a time-consuming affair. Google Music launched as U.S.-only, finally moving to Europe just last November. Apple has a large head-start in setting up global music sales. 

Not only that, but Apple has a dominant grasp on peripherals such as sound bars and alarm clocks to turn smartphones into music systems. Walk into a Bose store, and you'll find nearly every piece of audio equipment working in conjunction with an iPod or iPhone. 

Music matters beyond music sales
While Apple probably collected roughly a billion in sales for its cut of iTunes music sales last year, that's never been the value of the service to the company. Instead, the real value has been the value to the overall Apple platform. Users who have large music and media libraries centered on iTunes have a strong reason to stick with new Apple products, whether they be a tablet, phone, or MP3 player. The $4.3 billion in gross revenue Apple collected last year in music sales stacks up nicely against the $118 billion the company collected in iPad, iPhone, and iPod sales in fiscal 2012 alone. 

This all matters because music is a key component of mobile-device usage. Research from NPD shows that 56% of smartphone users and 40% of tablet users listened to music on their devices. On smartphones, 39% of listeners play music on a daily basis. 

A new battleground?
Competing with iTunes in the digital-download space is hard to do. While companies such as Amazon and Google have failed to break Apple's grasp by attacking Apple in digital download and matching services, another opportunity in the next transformation of digital music could provide a new way to compete: streaming.

Streaming services are becoming increasingly popular. Most users might be familiar with Pandora and Spotify in the space because of their popularity in the United States, but the space is extremely competitive. A study by website PaidContent mid-last year found 73 digital music services in the United Kingdom alone. 

Why is there so much competition? Well, user interest is shifting in this direction, and money has been quick to follow. A study by IFPI found that while download music sale units increased 12% last year, paying for subscription music services increased 44%.

Apple is assuredly tuned into this opportunity. The newest version of iOS has hidden radio buttons that appear to be part of Apple's efforts to build a new Pandora-like service within iTunes. Yet it does seem behind in the space. While it tries working on the right approach to creating a Pandora-like experience, news recently broke that Google itself is working on a Spotify-like service that could launch this year. 

Streaming music is the ultimate platform play
The interesting part of the streaming-music gold rush is that the economics of the industry are terrible. In fiscal 2009, Pandora had sales of $19.3 million and a loss of $32 million. Sales have since soared to $383 million across the past 12 months, but losses have remained at ... $32 million. 

The problem is that advertising revenue barely covers the content costs that streaming companies have to pay labels. Throw in necessary increases to pay more employees as companies grow and the infrastructure costs for streaming all that music, and costs scale almost directly with increasing sales. 

In spite of efforts from the industry to move to more subscription services and decrease its music licensing and royalty fees, it's a lousy business as it currently stands. Yet what these services lack in profitability, they make up for in influence. A recent Goldman Sachs study found 62% of iOS users ranked Pandora a top-three music service they listen to on their phones, versus 59% who ranked their iTunes library as a top-three service. 

With Apple having gained so much over the past decade-plus of iTunes dominance, having third-party applications begin to take up more importance in users' minds is clearly a threat to the company. 

Enter Samsung?
So how could an Apple rival profit from these changing trends in music? I'd put forth that Samsung has the most to gain. Android fueled Samsung to 215.8 million smartphone shipments last year. The next-closest rival in the Android space was Huawei, which captured just 4.9% of the smartphone market in the fourth quarter. Samsung collected 29% of all smartphone sales. 

Samsung's dominance has been stunning, but there are a couple of troubling long-term threats to the company:

1. It's hard to control a market with such dominance when you're relying on a platform like Android that's open for hundreds of handset vendors to use. So far, the company has used superior marketing spend and better product design to keep its lead. However, Samsung's wariness over using Android is shown by its development of its own mobile operating system, Bada, and its recent leadership in another OS, Tizen. 

2. Google's fear that Android will become dominated by Samsung has recently been splashed across the news. The company is rightfully nervous that Samsung controls such much of the platform. This is especially troubling for Samsung, since Google owns its own hardware unit in Motorola that it could use to push out designs and wean Android off its Samsung reliance. 

One way Samsung could try decreasing the first threat is to create some differentiation. For example, HTC has created its "Sense UI" to give it a different feel from other Android phones. Samsung has made its own Android changes, but there's only so much change you can add to the stock Android experience. 

Instead, a better use of Samsung's money could be to invest in differentiation via the streaming-music trend. Consider that Pandora currently has a market value of $2.1 billion. Samsung could probably buy the company, even with a healthy premium for $3 billion. That would represent about 14% of the company's profitability last year, and it has net cash of more than $21 billion in the bank to facilitate such a purchase. 

The key idea would be that users gain tremendous value from streaming media, but the industry has lousy economics. Apple solved the puzzle by making music a complement to high-margin hardware sales. Samsung could do the same and in the process could further differentiate itself through having the most popular music-streaming platform in the United States. It's a cagey move for a company with little potential on its own but huge potential as part of a platform. 

A slam-dunk deal?
No such deal is imminent between Pandora and Samsung; this is purely my speculation on a deal that is extremely intriguing. It's worth also noting that the complications of international copyright law means Pandora's brand currently only holds value in the United States and has yet to expand internationally. 

Yet the United States is also a market where Apple is strongest and Samsung could use more of a competitive edge. With the company paying out a whopping $12.2 billion in marketing expenses alone last year, Pandora's recognition could be a huge edge in the marketing space. Eventually, the company could expand overseas if it chose to and fold Pandora into its Music Hub software. 

Whether or not Samsung buys Pandora, this is a space where the standalone economics of start-ups pales in comparison with the value of being part of a larger platform. I'd expect to see some consolidation in the space this year, and it'll be targeting Apple's dominance over the music space.

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Read/Post Comments (20) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 03, 2013, at 5:57 PM, mikesdroiddna wrote:

    thinking of switching from my iphone 4 to a droid dna next thursday when i become eligible.

    stopped by the verizon store today to check them out (and the s3 - seems too cheap, like a toy, even with the price drop)

    the dna seemed really nice and ive read on cnet how fast it is.

    tried out the browser though and couldnt get to my favorite website - rotoworld.com. it kept pushing me to the m.rotoworld.com site, and i couldnt access any articles. i tried the dropdown on the top right hand corner that said "request desktop site" and it got me nowhere. the employees at that location are never helpful.

    never have any problems like this on my iphone, and i tested out the 5, it worked just fine

    someone step in here and save me a hundred bucks and tell me how to fix it! would i need to download firefox or dolphin or something?

  • Report this Comment On March 03, 2013, at 6:21 PM, hiddenflem wrote:

    In a world with Spotify in it there is no reason to use Pandora. Pandora is irrelevant.

  • Report this Comment On March 03, 2013, at 6:25 PM, mikesdroiddna wrote:

    unless you're interested in new music you haven't already heard

  • Report this Comment On March 03, 2013, at 6:41 PM, cchadp wrote:

    switched from iphone3gs (HORRIBLE call quality...hey if it is purporting to be a phone then at least do basic calls properly!) to android...never looked back...all the 'issues' these folks report...bs bogus...xperia then htc hd2 then samsung infuse then samsung skyrocket then note 1 now note 2...even tried lg optimus g in between..no issues...well as for the rotoworld issue..it is all in the browser..nothing to do with android..or ios...use opera..it goes straight to the desktop site...the iphone uses safari that also does it right...opera on android no issues

  • Report this Comment On March 03, 2013, at 6:43 PM, cchadp wrote:

    I use OPera Mobile version 12.10 on android..awesome speed dial and all

  • Report this Comment On March 03, 2013, at 7:09 PM, oneslocamaro wrote:

    Just a couple things I have had no problems with any websites on my Note2 using the stock browser or opera. Chrome is still a bit buggy. As for the big music collections on Itunes I have both Itunes and Google music and my entire Itunes music collection was copied over to Google play music and is now usable on all my android devices. Don't expect to see your Itunes app collection copy over though and I assume some of the older Itunes music with copy protection may not copy over I am not sure when the copy protection ended but I have heard it is like 30 cents per song to have it removed.

  • Report this Comment On March 03, 2013, at 7:11 PM, hiddenflem wrote:

    Spotify does new music you haven't heard too...the only reason to use Pandora is if you haven't tried Spotify. I have no vested interest in either. The premise that Apple would care if Samsung bought pandora is pretty silly too, given there are android apps that run pandora and spotify anyway.

  • Report this Comment On March 03, 2013, at 8:12 PM, mikesdroiddna wrote:

    i'll try spotify, didnt realize it selected stuff for you, thought it was more like itunes in that it just played things from your library

    also not a huge fan of spamming my friends with updates every time i click next

    as far as the real issue, with rotoworld- it happened on a droid and 2 samsung s3's on chrome and on a regular stock browser. not sure what the browser was but my coworker with an htc one sv or sx or something also couldnt pull it up.

    i'll have to see if i can get someone to download opera for me so i can check it out before i buy one

  • Report this Comment On March 03, 2013, at 8:13 PM, mikesdroiddna wrote:

    i think if apple was that scared of pandora being bought, they might have enough cash to buy it first or outbid samsung

  • Report this Comment On March 03, 2013, at 8:55 PM, hiddenflem wrote:

    @mike you can change the settings so you don't spam your friends and do private browsing too but unfortunately it resets after a while. if you buy premium i'll bet you can get around having friends see it.

  • Report this Comment On March 04, 2013, at 12:48 AM, LordSquidworth wrote:

    Pandora makes money?

  • Report this Comment On March 04, 2013, at 1:23 PM, DigitalMediaView wrote:

    Several big problems with this speculation...1, Samsung is global and Pandora is US-only, licensed by government statute and absolutely nowhere in international expansion talks. 2, If Samsung buys Pandora and integrates the service into its business, Pandora loses its lower "pure play" rate in the US and content costs soar. 3, Samsung already bought another streaming music platform last year (http://www.fiercemobilecontent.com/story/samsung-acquires-ms... and is still working to integrate the acquisition.

  • Report this Comment On March 04, 2013, at 1:26 PM, DigitalMediaView wrote:

    link broke in posting. here's more recent one on Samsung integration of mSpot acqusition

    http://www.fiercemobilecontent.com/story/samsung-plans-expan...

  • Report this Comment On March 04, 2013, at 2:28 PM, blake303 wrote:

    Hiddenflem is correct regarding Spotify. The only people that defend Pandora are those that have never used Spotify.

    Why do announcements about new streaming applications come out on almost a monthly basis? Because Pandora is extremely overvalued and it is cheaper to build a similar service in-house.

  • Report this Comment On March 04, 2013, at 6:54 PM, TMFRhino wrote:

    DigitalMediaView

    Thanks for reading.

    1.) Mentioned above, Pandora is US-only... Would be more of a U.S. play out the gate.

    2.) Valid point. I left open how they could use Pandora partially because I was waaaay over my word count :) and partially because I could see Sammy leverage several ways... They've aimed to "open up" other music services and I see this more of a marketing push for the Samsung brand. That being said, if they did fold Pandora completely into their brand... Let's say content costs about doubled... That'd be ~$200-$250 million to Samsung a year in costs. That's expensive, but if you thought of Pandora as a complement to marketing (where they're paying billions a year in the US already)... Its a manageable cost.

    3.) That's an $8.8 million acquisition... So targeting different functionality. Pandora would be a separate concept, IMO.

    Thanks all.

    -Eric

  • Report this Comment On March 04, 2013, at 8:09 PM, rizno wrote:

    Does the Samsung phone not have an Android App for Pandora like the iPhone does? I don't get it.... If Pandora was so disruptive it would already effect iTunes music sales today no matter who owns it.

  • Report this Comment On March 04, 2013, at 8:15 PM, StarWitchDoctor wrote:

    Ho-Hum, another Pandora argument, yawn....Yawn....ho humpity dumpity, all the kings horses and all the kings men, couldn't put humpity together again....

    Ho Hum zzzzzzzzzzzz........

    someone had a nightmare (googles fear and apples "dont want to see"), that won't come true. but it got my click.... and my comment.

    New low in fool articles.

    ho hum, yawn.......

  • Report this Comment On March 04, 2013, at 8:46 PM, DR1P wrote:

    "1.) Mentioned above, Pandora is US-only... Would be more of a U.S. play out the gate. "

    TMFRhino... Then can you explain to me how I can listen to Pandora on my iPhone 3GS when I'm 7650ft up in the Hindu Kush mountains? It is annoying though, with all of the pauses for buffering because the Afghan Wireless service sucks here. I'm not a real big Pandora fan but, yes, you CAN listen to Pandora outside the US.

  • Report this Comment On March 05, 2013, at 4:57 PM, stevencravis wrote:

    A few things to note: Apple has recently upped music availability to 111 countries, from about 22 countries.

    The increasing interest in streaming the music from Pandora-type services is oddly challenged by the limits mobile service providers place on the bandwidth.

    Steven

    http://www.StevenCravis.com http://www.facebook.com/stevencravismusic http://www.pandora.com/station/play/1160016976161159741

    http://smarturl.it/downloads

  • Report this Comment On March 16, 2013, at 11:12 PM, actsrevolution wrote:

    What is this? No comments on upcoming Whitespace bandwidth auctions?

    There may be something in this spam after all...

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