It doesn't look like Pandora Media (P +0.00%) is going to win any popularity contests anytime soon. The Internet DJ is going up against a who's-who of music icons in its bid to lower the royalties it has to pay to artists. Everyone from Billy Joel to Katy Perry to Ted Nugent has signed an open letter asking Congress not to interfere with the negotiated rates between the artists and Pandora, which is urging Congress to pass the Internet Radio Fairness Act. The act would make its royalty rate more in line with satellite and cable providers such as SiriusXM Radio (SIRI +0.00%), which pays just about 8% of revenues in royalties.
The battle heated up Wednesday as the two parties, with royalty rights organization SoundExchange representing the artists, met before a House subcommittee. Pandora CEO Joe Kennedy pleaded for fairness, telling the committee, "While Pandora and other Internet radio services compete directly with all of the other forms of radio for listeners in every place you find music, we are subject to an astonishingly high royalty burden that is unique to Internet radio." Kennedy went further, blaming the "piecemeal and isolated manner" in which Congress has made decisions about radio and copyright law, setting different standards for different technologies.
SoundExchange president Michael Huppe countered Kennedy, insisting that Pandora could pay lower rates if it changed its business model. "The fact that Pandora may currently pay 50 percent of its revenues in performance royalties simply reflects Pandora's (deliberate) choice on building its audience -- and thus its usage -- while keeping its advertising load and subscription fees low." As a remedy to the discrepancy, SoundExchange and its allies say royalty rates on Pandora's competitors should be raised rather than the other way around.
The market seemed to like what came out of the hearing, sending Pandora shares up 7.3% Thursday. Canaccord Genuity analyst Michael Graham reiterated his buy rating, saying Apple's (AAPL 1.25%) entrance into the market is already reflected in the recent drop in Pandora's stock, and that mobile revenue should improve significantly. A comScore report released Thursday discussing its Media Metrix index of top Web enterprises also found that Pandora had the greatest percentage of users accessing via mobile among digital media properties.
Some have already begun counting heads in support of the bill in Congress. According to one report, several Congressmen were skeptical of the bill. Rep. Ted Deutch said the artists' take per Pandora listener could get slashed from $4 to $0.70, while Rep. Mel Watt said "90 percent of the problem" is that broadcast radio pays no royalties whatsoever. The possibility for a settlement between the two parties also remains, which Kennedy said he favors.
Foolish takeaway
Whatever the outcome of the Internet Radio Fairness Act, this will remain on Pandora investors' radar in the months to come. If the company fails to get its rates lowered, it may have to take the steps suggested by SoundExchange's Huppe and increase advertising time or subscription fees. We'll learn more about Pandora's status when the company reports earnings next Tuesday. Analysts are expecting a penny in earnings per share, up from a $0.03 loss in the second quarter, and are eyeing revenue of $117 million. As always, content costs will be carefully watched. In the second quarter, Pandora paid out 57% of its revenues as royalties.
