If I had to encapsulate the strategy shaping Pandora Media's (NYSE:P) recent deal with Rdio, I'd use this quote from classic rock band America: "I need you, like the flower needs the rain."
In case you missed it, things haven't exactly been coming up roses at Pandora of late. Amid dwindling subscribers, long-term product mismanagement, and increased competition from myriad sources, Pandora's unscalable business model has finally begun to show its true limitations in recent quarters, much to the consternation of its investors.
However, with its deal to acquire key on-demand assets from the now-defunct Rdio, can Pandora craft a comeback that few, including myself, thought possible?
Pandora addresses a major need
According to a press release last week, Pandora reached an agreement to acquire key assets and intellectual property from now-bankrupt streaming music provider Rdio. The deal paves the way for Pandora to integrate Rdio's on-demand streaming radio service with its own digital radio product, a feature I long personally admonished the company for having ignored.
In sifting through the scant additional details we know of the deal, Pandora will pay $75 million in cash for Rdio assets. According to reports, Pandora plans to keep a sizable chunk of Rdio's staff, as well.
Also in its press release, Pandora makes a passing reference that buying Rdio will likely involve some kind of new licensing negotiations. This could be a boon, as Pandora's licensing rates have long been a thorn in its never-ending journey toward profitability. However, bigger picture, this is clearly the right move for Pandora, and one that decidedly strengthens its hand against the likes of Apple Music, Alphabet's multiple on-demand music service, and the privately held Spotfiy.
Pandora back from the (nearly) dead?
Even as a longtime Pandora bear, I'd be remiss not to concede that this could be a watershed moment in Pandora's corporate history. The operative word there is "could," though, because several important risks are also embedded within this fluid storyline.
The first is execution risk, although it isn't immediately clear how much of Rdio's service Pandora will need to reengineer to integrate it with its own product. Pandora said it plans to launch its revamped music player by late 2016, and history also suggests a fair amount of work lies ahead before Pandora can reap the benefits from Rdio.
A full 14 months elapsed between Apple announcing its $3 billion buyout of Beats and the launch of Apple Music at the end of this June. This leaves an awful lot of time for on-demand competitors from Spotify to Apple Music and Alphabet's two on-demand streaming services to pursue their respective international expansions before Pandora enjoys a chance to compete for on-demand users and subscribers.
The second risk here is financial. While Pandora will unquestionably have a more-competitive product once it adds on-demand, on-demand streaming business models have yet to demonstrate consistent profitability. Assuming Pandora uses the same kind of free-to-premium -- colloquially referred to as "freemium" -- model as Spotify and Apple Music, Pandora will have to face and overcome the same recurring profitability problems that have caused so much skepticism for the likes of Spotify.
Freemium services like Spotify lose money on customers upfront to make up on those users once they convert to full-paying subscribers. According to purported documents from its 2014 tax filings in Luxembourg, Spotify is still working to bridge its profitability gap. It can do so by either increasing the rate at which it converts subscribers, or making more money from each free subscriber.
Because there's so much in flux between possible changes in royalty rates, possible listener streaming time caps, and more, there are simply too many unresolved variables to predict how Pandora will fair financially once it adds its on-demand feature. As such, let's simply focus on the high-level point that profitability hasn't been an overnight occurrence for companies that operate in the on-demand streaming space.
Is this a marked move in the right direction for Pandora? Absolutely. But is this the silver bullet that will correct all of the company's many issues? Probably not.
Pandora is undoubtedly heading in the right direction in buying Rdio, but investors would do well to understand that the online radio pioneer still has a long way to go before it becomes a sustainably profitable enterprise.