Pandora's Moment of Truth Arrives

Last week was supposed to be the week Pandora (NYSE: P  ) was brought to its knees.

On Wednesday, Apple (NASDAQ: AAPL  ) finally released iOS 7, and with it the long-rumored iTunes Radio, its own Internet radio service, which some have considered a Pandora-killer since its inception. When the idea first landed on Wall Street on Sept. 7, 2012, Pandora shares fell 17%, closing at $10.47. However, its stock has come roaring back, more than doubling since then, as the chart below shows.

P Chart

P data by YCharts.

What Wall Street once feared was the Grim Reaper waiting in the closet seems to be nothing more than a mouse in the house. Pandora shares have even spiked nearly 50% in September alone as the online DJ named a new CEO, won a favorable court ruling, and pulled off a successful secondary share offering despite a record-high price. In the three days since iTunes Radio came out, Pandora shares are actually up more than 5% following the share dilution. Clearly, the market doesn't believe the new Apple product is a serious threat even with mostly positive reviews.

The breakdown
On Twitter, dozens of posters gleefullly announced their defection from Pandora to iTunes Radio. Apple's key advantages seem to be a lower price tag for the commercial-free version ($25 versus $36), which is free if users pay $25 for iTunes Match, and a much larger library of songs (27 million versus 1 million). Both of these are significant. Pandora, meanwhile, is starting with a 70 million-user advantage, and the switching costs built in from subscriptions and customized stations. Pandora also presumably has the better predictive algorithm due to its history, data collection, and origin as the Music Genome Project, but this is a highly subjective category. (Based on my short sample of iTunes Radio, I found its predictions to be weaker than Pandora's.) Pandora also has wider distribution, available on Apple devices and PCs, as is iTunes Radio, but also on Android, Blackberry, and vehicle dashboards. Pandora also seems to be the more sophisticated of the two, offering lyrics, band histories, and analyses of musical components, while iTunes Radio presents a novel feature allowing the user to customize the predictive algorithm between "hits" and "discoveries." A side-by-side comparison of the two reveals the interfaces to be essentially the same. Apple's star key offers users the "thumbs-up" and "thumbs-down" options.

iTunes Radio's interface is essentially a clone of Pandora's. Source: My phone.

With the larger library, lower price tag, and smoother iOS integration, Apple certainly seems to offer an appealing value proposition. As the new arrival, however, being equal to Pandora won't be enough. iTunes Radio will have to be significantly better for there to be a mass exodus from its competitor.

What else is in Pandora's box?
With the release of iTunes Radio, it appears clear that Pandora cannot remain successful standing still. The company recently updated its iPad app, and a new survey sent to subscribers indicated the company was interested in testing ideas including different pricing models, visual effects, and features such as a double "thumbs-up" button that would make the weight of a given song stronger. The survey suggested that Pandora, after focusing on listener growth for years, is shifting toward profitability as that once-meteoric growth has moderated. The company said in its recent follow-on offering that it may use some proceeds for "potential acquisitions or businesses, products or technologies," any of which could help give the company a better product. With nearly $400 million added to its war chest from the secondary offering, and minimal debt on its books, I'd expect Pandora to put its newfound cash to good use.

Finally, new CEO Brian McAndrews appears to give the company additional strength in the advertising department. McAndrews was previously the CEO of aQuantive, which he made into the fastest-growing digital-marketing company before it was bought by Microsoft for $6 billion in 2007. Pandora clearly sees its future in mobile ad revenue, its fastest growing revenue stream, and McAndrews seems to be an excellent fit to hone that channel.

Even if Pandora continues to struggle, iTunes Radio has the contrarian benefit of making the pioneer a more attractive acquisition target. While shares are dearly priced right now, if they come down the company could make an appealing target for Google, Samsung, or another one of Apple's rivals looking to keep pace with the iPhone-maker. In this market, the added success of iTunes Radio only makes Pandora look better for a potential acquisition. Additionally, the success of iTunes Radio could also drive greater attention to Internet radio advertising, boosting Pandora's revenue along the way.

Is the music over?
The competition between Pandora and iTunes Radio isn't the first time we've seen modern music rivals square off. Since Pandora's IPO, many analysts have argued that its arrival, and Internet radio with it, would bring the demise of satellite-radio provider Sirius XM (NASDAQ: SIRI  ) . However, that's been anything but the case thus far as Sirius shares have gained 30% this year, and have more than doubled in the last two years.

Music is a huge space, and Internet radio is still growing at a robust pace. There's plenty of opportunity for both iTunes Radio and Pandora to survive and thrive, but with iTunes' lower price tag and bigger library, Pandora will probably have to step up its game to ensure long-term success. I'd look for McAndrews to drive improvement in the mobile ad revenue model, and for the company to make an acquisition in the near future or a serious R&D investment. We'll get our first sign of Pandora's continuing health when it reports September listening metrics in the beginning of October. In August, the company reported a 16% year-over-year increase in listening hours to 1.35 billion hours, a radio-listening market share of 7.46%, and 72.1 million active listeners. A sequential decline in any of those categories could indicate a rush toward Apple.

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Read/Post Comments (8) | Recommend This Article (3)

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 September 23, 2013, at 10:55 AM, monolocogb99 wrote:

    Having used both services, I can say that iTunes radio is vastly superior, I'm really impressed with how good it is right out of the gate, there is no reason for a paid subscription, the commercials are so unobtrusive and so few, I hardly notice, and you don't have to put up with ads in the UI. Apple hit a home run with iTunes radio, it's easily the best feature of ios7.

  • Report this Comment On September 23, 2013, at 11:03 AM, DFCAMF1216 wrote:

    Pandora vs. Apple from The Streetcom

    Apple has lots of work to do. It's idea of personalized radio, at this stage, appears to be little more than providing covers of songs originally performed by your favorites. As expected, even in discovery mode, iTunes Radio cannot live up to the intuitive precision of Pandora's Music Genome Project, particularly once it gets to know you well.

    11 million tried it out of 200 million using IOS 7. Not a big success. How many are new to internet radio and how many will go to Pandora when they try the BETTER product.

  • Report this Comment On September 23, 2013, at 11:23 AM, Cuftbll wrote:

    Just a matter of time. I downloaded my ios7 and promptly deleted my Pandora app. I'm sure I wasn't the only one nor the last. 11 million unique users have already used iTunes Radio with 700 million iOS devices....pandora in trouble.

    I wish Tim would release how many times the Pandora app has been deleted since the ios7 release. You know he has the data.

  • Report this Comment On September 23, 2013, at 11:28 AM, hthussein wrote:

    I was one of the 11 million initial users of iTunes radio this weekend....

    And to sum it up, Itunes Radio is a winner. It does not lack histrory data since iTunes has been the default music player for hundreds of millions for the past decade. It used your purchase histrory to cater to your taste.

    1. I skipped less with iTunes Radio.

    2. I purchased more music since it's intuitive and easy react.

    3. I purchased the $24.99/year iTunes match to eliminate the ads. Worth it.

    4. Pandora bombards you with crappy ads constantly.

    5. 11 million users in 2 days will turn into 200 million in the 1st year.

    6. Pandora is dead money. Unfortunately!!!

  • Report this Comment On September 23, 2013, at 2:32 PM, Jason91789 wrote:

    More is coming for Pandora, this is just begining. All you Bulls should by the stock at the DIP. Nothing to worry about APPLE really?

  • Report this Comment On September 23, 2013, at 9:36 PM, NeuroProf wrote:

    Love Pandora but 30 min with iTunes Radio and I deleted Pandora too. Now just have to to cancel my subscription. I've been thinking AAPL should buy Pandora, but now i think the iTunes Radio app should be available on all phones...Is it ??

  • Report this Comment On September 23, 2013, at 9:42 PM, NeuroProf wrote:

    Really, AAPL must open iTunes Radio to devices that don't run iOS7... Then it will take all...

  • Report this Comment On September 23, 2013, at 11:08 PM, herky46q wrote:

    It's nice having choices. Still too soon for me to prefer one to the other, but I like what I see so far with ITunes Radio.

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