2 Tech Storylines to Close Out 2015

With December wrapping up the year, Motley Fool's tech team looks back on two stories left with dangling threads: Alphabet's Google's (GOOGL -1.23%) (GOOG -1.10%) battle with the European Commission for anti-competition claims for their practices on Google Shopping and their Android operating system, and Pandora's (P) case with the Copyright Royalty Board that had potential to drastically alter their cost structure.

Listen to this episode of Industry Focus: Technology for a regifted holiday present from Sean O'Reilly and Dylan Lewis -- old stories with new developments and where you can expect to see them go.

A full transcript follows the video.

This podcast was recorded on Dec. 18, 2015.

Sean O'Reilly: Do they have social media in Star Wars? And the year in review on this technology edition of Industry Focus. Greetings, Fools! I am Sean "Darth" O'Reilly, joining you from Fool headquarters in Alexandria, Virginia. It is Friday, Dec. 18, 2015, and joining me to talk is the man we're reasonably sure is a Jedi, Mr. Dylan Lewis.

Dylan Lewis: If you're Darth, am I Luke? Han? Anakin?

O'Reilly: You really actually don't know anything about Star Wars, do you?

Lewis: I don't.

O'Reilly: Oh, man. I'm actually not a die-hard fan like Michael Douglass upstairs, but I've seen all the movies. I enjoy it. I enjoy being entertained.

Lewis: And you'll see the new movie today, courtesy of the Fool.

O'Reilly: I will! For those of you who might not know, Dylan and I happen to work for the coolest company in the world, and one of the things that they did to be super cool is renting out an entire movie theater up the road here, and we're all going for free.

Lewis: And how many are going?

O'Reilly: Like 130 people. It's going to be a good time.

Lewis: Yeah. It'll be a historically unproductive Friday morning.

O'Reilly: You have 20 minutes to talk to me, and then I'm leaving.

Lewis: I'd say friendship is being willing to do the podcast two hours early so that you can go watch your Star Wars movie.

O'Reilly: True. So, really quick, before we do our year in review, which, I don't know, do you consider it regifting?

Lewis: Yeah, I think this episode is the podcast equivalent of regifting everything that we've done, because we are going to revisit a couple things. I've gotten some recent developments on some stories we talked about months ago. And, hopefully, we can bring some closure. We're not going to be able to bring entire closure to this, because...

O'Reilly: There are long-tale stories.

Lewis: Some of these are long-tale stories that are going to drag on for a while.

O'Reilly: So, before we dive in, I'm anxious to get your thoughts, do they have Facebook and Twitter in the Star Wars universe?

Lewis: Ooh, I don't know.

O'Reilly: Would Luke Skywalker tweet things?

Lewis: I want to make a joke so badly, but I don't know the universe well enough to even make a reference that would make sense to me.

O'Reilly: It just seems weird to me, because Star Wars has all the futuristic stuff and hyperspace in space travel and all this stuff, but ...

Lewis: Maybe they've moved beyond it.

O'Reilly: You think? 

Lewis: Yeah. Maybe they're at the Singularity level.

O'Reilly: I live for the day when mankind is not glued to their phones. That'll be wonderful.

Lewis: We'll see.

O'Reilly: All right. So, what is the first story we're talking about?

Lewis: The first story we're going to rehash is something we talked about in April. The name of the podcast was: "Is Europe Picking on Google?" And this was, of course...

O'Reilly: That was in April?!

Lewis: Yes.

O'Reilly: May, June, July...

Lewis: It was maybe a month into us doing the show together, because I took over for Nathan Hamilton...

O'Reilly: Has it really been eight months?!

Lewis: Something like that, yeah.

O'Reilly: Wow. 

Lewis: It's been a while. So, that whole episode really focused on the European Commission branch of the European Union's regulatory body, and their efforts to rein in Google, and what they perceived as some of the anti-competitive measures that Google is currently using with its shopping add-on product search.

O'Reilly: Don't they know that Google is in the Merriam-Webster dictionary? Once that happens, it's there. You can't stop it.

Lewis: But it's the verb, right?

O'Reilly: Yes. It's not the proper noun.

Lewis: Sorry, I had to get editorial there for a second.

O'Reilly: We'll talk about this later, but all I'll say is Bing is not in there.

Lewis: So, just as a refresher, the European Union was plotting a fine as large as $6.4 billion against Google, and this was roughly about one-tenth of their annual revenue.

O'Reilly: That apparently slipped my mind. That's actually quite large.

Lewis: It is, yeah. And just a refresher, and this is a quote from the E.C.: "Google give systematic favorable treatment to its comparison shopping products, currently called Google Shopping, and its general search result pages, e.g., by showing Google Shopping more prominently on the screen ... it may therefore artificially divert traffic from rival comparison shopping services, and hinder their ability to compete on the market."

O'Reilly: Wow.

Lewis: So, this is an anti-competitive claim against them. Not much more to it than that.

O'Reilly: They are more than willing to use Russia's Yandex, I would think. They're more than capable of doing that, if they want.

Lewis: We talked about this on the show. There's the counterargument to all of this. Yes, they have a 90% market share in desktop searching in Europe, but they built a really great product. Why wouldn't they want to feature some of the really great stuff in there?

E.C. is also currently looking into some issues with Google Android, and this has to do a little bit more with app bundling and whether Google is doing some anti-competitive measures based on forced app bundling and crowding out potential competitors with things like Maps that are forced on to the platform when they enter an agreement with a smartphone manufacturer, because their operating system would power the device.

O'Reilly: Let's do the "What's Up Now" portion, because it seems like you might have a better case with Android, because they run the actual operating system. And that has a Microsoft-y feel to it. So, what's going on with this stuff now?

Lewis: This was one of the more interesting, in-the-weeds tech things that I've read in a while. I was talking with Vince a couple weeks ago, when he filled in for you about the patent disputes back and forth between Apple and Samsung and how those have been put to bed recently, but it was a side of tech that a lot of investors don't get a sense for unless you seek it out.

O'Reilly: Tech wars!

Lewis: It's one of these things that can drag on and on. It's like the dark underbelly of tech. That's something I joked about before we started the show. And this is along the same lines, where it's really in the weeds, and it's kind of insider-y, but if you like that, then this is a really fun story to watch. And there was this scathing article put together by The Guardian that went out earlier this week, the headline was "Revealed: How Google Enlisted Members of U.S. Congress It Bankrolled to Fight $6 Billion E.U. Anti-Trust Case." So, that may be a little harsher than the reality, but that's still pretty loaded. 

O'Reilly: So, they're calling Congress to call up their counterparts in Europe?

Lewis: Yeah, calling in the cavalry to help them out. Some of the bullet points from the story: between Dec. 2014 and June 2015, according to The Guardian, Google help more high-level meetings with commission officials than any other company. From 2010 to 2014, Google has more than quadrupled (...)  any (...) lobbying spend in Brussels, which is where the E.C. is based. It's up to over $4 million, which really isn't that much, given the scope of Google, but I think that ramp-up is a testament to what they're looking to do in terms of influencing policy there, and the decision of the regulatory body. Google has employed several former E.U. officials as in-house lobbyists, and has funded European think tanks and university research favorable to its position as part of a broader campaign.

O'Reilly: Whoa, whoa. What are they doing with universities? This is crazy.

Lewis: Yeah. So, this is looking for research and information, academic publishing that is favorable to your positions...

O'Reilly: You, you're an economics professor, come up with a good paper.

Lewis: Yeah. Last year, Google spent twice as much on lobbying in Brussels than Apple, Facebook, Yahoo, Twitter, and over, and Uber combined.

O'Reilly: I don't buy that Uber thing, because they have that whole Paris altercation thing with the tax. Anyways.

Lewis: So, it's very clear -- and we talked about this when we first brought it up. Google sent out a memo to everyone around in-house, "We're going to fight this. We think there's no grounds for this, we're going to battle." And I think that this scale up here is a testament to... they are rounding up the cavalry, like I said, and coming at them with everything they've got.

Some publicly elected officials from the U.S. also seem to have been involved. There were some memos that The Guardian got a hold of, one of them in particular, some U.S. members of Congress, many of whom have received campaign funding from Google, wrote to the E.C. in November, basically called some of the acts that they're going after one that would deter continued innovation and investments from U.S.-based Internet companies.

O'Reilly: OK.

Lewis: Yeah. So, there's a lot going on there. I think it's just really fascinating to see how big a tech companies combat an unfavorable regulatory environment. So, that's kind of what's going on in the Google Shopping side. Unfortunately, we're not going to have any resolution on this for years. So, as much as I'd love to wrap this up and put a bow on it for the holidays ...

O'Reilly: Next holidays, maybe.

Lewis: Yeah, maybe we'll check in on it then. On the Android issue that we mentioned earlier, not a ton to update on there. There was a Reuters' report in September that said the E.C. is still yet to determine whether it will charge Google with market abuse with its Android mobile efforts. So, that is another ongoing thing.

O'Reilly: Refresh everybody's memory, was this as bad as, remember in the 90s, when Microsoft was charged with blatantly blocking Netscape and putting Internet Explorer on their operating systems? Is this that bad?

Lewis: Do you mean in terms of the fine itself?

O'Reilly: Yes, and in what Google was doing.

Lewis: Yeah. So, for total dollars, I think the original sign that was levied against Microsoft was like $600 million or something like that. So, adjust for inflation.

O'Reilly: Even then, it'd be like $700-800 million now.

Lewis: But I think what they wound up paying with multiples of that, because I dragged it out and weren't compliant for a long time.

O'Reilly: Oh, that's fun.

Lewis: They thought they were being compliant. I think the final settlement was 1.5 or 2.

O'Reilly: Wow.

Lewis: Still, about 1/3 of what Google is looking at, in terms of unadjusted dollars at least.

O'Reilly: Cool. Before we move on, I want to the point our listeners to the newly redesigned focus.fool.com. All loyal IF listeners have access to a special discount on the Motley Fool Stock Advisor newsletter that works out to $129 for a full two-year subscription. Just go to focus.fool.com to take advantage of this offer.

So, Dylan, we have eight, 10 minutes left before I go out and run to the movie theater. What's the other story we're going to be talking about?

Lewis: The other thing I wanted to provide a refresher on, thankfully this is something that we can tie up in a nice little bow for the holidays. This one, we talked about in November in the episode "Beat-Up Tech Stocks: Can Pandora, FireEye, and HP's New Business Segment Turn Around?" We're going to focus on the Pandora side of the beat-up tech stocks discussed in that episode.

O'Reilly: I was going to say, there's no resolution to the other stuff.

Lewis: As a refresher, what we were talking about on that show was the volatility surrounding Pandora because of the impending Copyright Royalty Board decision on webcasting IV, and a large impact that that would have on the company's cost structure.

O'Reilly: Yeah, and if memory serves, this is a big deal for Pandora.

Lewis: Huge. And in the two months or so leading up to mid-December, there have been some pretty wild price swings on the stock, and a lot of it was related, too, at first, C.R.B. admitting that the agreement that Pandora had with Merlin, which is an independent label representative body, would be inadmissible benchmark for the negotiations with SoundExchange, SoundExchange being a more major label representative. So, that was one major thing that's moved things around. 

Secondly, there was also a comment from the C.R.B. that there wouldn't be any distinction between labels and major labels in terms of the ability to collect higher royalty rates on songs. So, there was no strength position therefore SoundExchange. So, because of these two things, it seemed, going into mid-December, when we were expecting this C.R.B. decision, the things would be playing out in a more favorable way for Pandora. As it turns out, that's what happened.

O'Reilly: Yay! It was entirely speculative at the time, though.

Lewis: Yeah, a lot of people started reading the tarot cards and saying, "This looks like how it's moving." But there was always the possibility that there were going to be disappointing results, and I think that's why you saw so much volatility with the stock in the lead-up to this. So, earlier this week, C.R.B. released its official ruling on royalty rates for web IV. Ad-supported free streams will cost Pandora $0.0017. So, that is, 17% of a cent...

O'Reilly: Not quite one-fifth of a penny there.

Lewis: And subscription streams will cost $0.0022.

O'Reilly: OK, that's a fifth of a penny. And this is going to the labels.

Lewis: Yes. Well, it's going to SoundExchange to distribute to the labels. 2015 rates, what they were operating under in their current cost structure, had Pandora paying $0.00014 and $0.0025, respectively.

O'Reilly: We're sorry, folks, we're not used to this many decimal points.

Lewis: It's a lot to get through. They usually state these as 100 play metrics... and that probably would have been smarter for the show. 

So, on the surface, this looks kind of disappointing. You look at it, and you say, "OK, these ad-supported free streams are going to cost more, the subscription streams will be costing less, maybe it's a wash." But you saw the stock move, I think, 10%-15% to the upside this week. So, obviously, favorable market reaction. And I think that really gets into what the bear side of this negotiation could have looked like. Really, I think anything that came in at less than a fifth of a penny per play was going to be good for Pandora, on the free side. So, that's why analysts in the market have had this really favorable reaction.

One of the interesting aspects of this -- and I know you had a particularly interesting take on it, the 1/1700 of a cent rate on non-subscription rates being tied to inflation, and that being the escalator year to year.

O'Reilly: Why? How did they pick that?!

Lewis: I don't know.

O'Reilly: The Consumer Price Index is what the federal government uses to figure out people's Social Security checks every year.

Lewis: Yeah, and cola for raises.

O'Reilly: It's dumb! Janet Yellen talks about it when she's talking about her inflation targets. Correct me if I'm wrong, tech actually usually experiences deflation. Computers get cheaper, software gets cheaper, this stuff gets cheaper!

Lewis: Talent gets more expensive.

O'Reilly: Well, fine. It seems like they picked that in the absence of any other better option. 

Lewis: Yeah. But it plays out extremely well for Pandora. If you look, basically, the escalation of their costs, if you're tying it to CPI, let's say inflation looks like it might be 1.5%.

O'Reilly: No.

Lewis: 2%?

O'Reilly: No.

Lewis: Maybe? In a rising interest rate environment?

O'Reilly: OK, fine.

Lewis: It's probably less. So, that's what you'd anticipate their ad-supported streams will go up by year over year.

O'Reilly: So, we have tons of clarity here. Oodles of clarity.

Lewis: And they were experiencing year-over-year royalty increases of like 9%, prior to this. So, this adds a smoother cost structure for them, which is great. And it's a much more favorable reaction, if you look at what SoundExchange was hoping for in terms of royalty rates, they were looking for about a quarter of a penny...

O'Reilly: Oh, so they were 40% off the mark?

Lewis: Yeah. And, of course, SoundExchange was not pleased. They released a comment saying this will erode the value of music in our economy.

O'Reilly: I almost wonder if the regulators -- who made the decision?

Lewis: Copyright Royalty Board.

O'Reilly: I almost wonder if they looked at -- because they probably want to engender competition, they want to make this work, and I almost wonder if they were like, "OK, what does Pandora need to not die?"

Lewis: Yeah, I think that's an element of it. The online Internet radio business leans on the terrestrial radio model. The royalty rate agreements are slightly different than what you have for the on-demand business. And it will be interesting to see how this plays out for Pandora's rumors on-demand service via the Rdio acquisition. That's something that's tough, because they had this really great ruling here, but they're going to have to go back to those same labels without the C.R.B.

O'Reilly: "Hi, guys!"

Lewis: And say, "Hey, guys, you know how we have this awesome royalty rate agreement now? So, what do you want to do on an on-demand basis?" So, that's certainly something to watch. I think rumors have that possibly being in the late 2016, when that comes out. They'd have to set up the entire infrastructure for that. They didn't acquire any of the label agreements, when they acquired Rdio. So, it's a little bit tougher. I don't know that we'll see an on-demand screening option from them anytime soon.

O'Reilly: Cool. Well, Dylan, we'll see you in the New Year. Happy holidays!

Lewis: Happy holidays to you.

O'Reilly: If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at [email protected]. As always, people on this program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I am Sean O'Reilly. Happy New Year, and may The Force be with you!