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Did You Miss This Great Apple Music News?

By Jamal Carnette, CFA - Dec 22, 2015 at 10:29AM

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A positive ruling for Pandora may have drowned out the news that Apple Music is estimated to end the year with nearly 8 million paying subscribers.

Can a company sneakily create a $1 billion business? Apparently Apple can. Image source: Apple.

Recently, the cacophony surrounding Apple (AAPL -0.14%) has been filled with negative overtones. A host of bearish estimates for the company's most important product, the iPhone, have weighed on the company's stock. Year to date, the company's shares are down 1% versus the 9% gain from the tech-heavy Nasdaq 100 index.

To be fair to these new bears, Apple's iPhone is an important part of the company's revenue haul. In Apple's last fiscal year, the iPhone contributed nearly two-thirds of the company's total revenue, so any decrease will be difficult to replace by the rest of the company.

Outside of Apple's iPhone line, the product category that has experienced the most growth during the last two years is the company's services category. And if the newest report from Music Business Worldwide is correct, Apple may just have another billion-dollar service: Apple Music. However, this good news about Apple's streaming-music service may have been overshadowed by a positive ruling for competitor Pandora (P).

Nearly 8 million subscribers, with more on the way
According to music industry analyst Mark Mulligan from Midia Research, Apple is expected to have nearly 8 million paying subscribers by year's end. Assuming each subscriber is paying the individual rate -- the most conservative estimate -- this puts Apple on path for a nearly $960 million run rate.

Apple's been sort of a black box in how it records Apple Music revenues, but if the company reports Apple Music revenues on a gross-revenue basis -- like it reports iTunes song downloads -- and not a net basis -- like the company reports App revenues -- this should show up in the company's results as soon as next year.

The news gets even better for Apple investors. Mulligan expects the company to grow to 20 million subscribers by the end of 2016, putting Apple Music on a run rate of more than $2.4 billion in the following year.

The competition is getting squeezed
In a big week for streaming-based music providers, Apple-competitor Pandora jumped on Thursday from a better-than-expected ruling from the Copyright Royalty Board. This year, the company pays $0.0014 per ad-supported song. The digital rights collective that represents artists, SoundExchange, wanted to increase this figure to $0.0025, a nearly 80% increase. Pandora, on the other hand, actually wanted this figure to drop to $0.0011 on a per-stream basis.

After hearing both sides, the CRB appeared to split the proverbial baby, and increased the per-stream cost to $0.0017 -- a 21% increase over current costs, and essentially the midpoint of the two requested figures. Music Business World estimates this will increase Pandora's music-related content expenses $94 billion next year, a tough pill to swallow for a company already struggling with profitability. For Pandora, this appears to be mostly a relief rally rather than one based on fundamentals

What this shows is that it appears the current business model of free-to-consumer, ad-supported streaming music is nearly uneconomical. Not only for Pandora, but also for large-streaming-service Spotify, which has problems with consistent profitability.

Apple's subscription-based model appears to be the best path forward, and Apple's doing well with subscriber growth. Will this replace lost iPhone revenue if it occurs? No -- but the service looks like it's a success.

Jamal Carnette owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Pandora Media. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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