Could Amazon and Google Be Interested in Pandora?

During Jim Cramer’s “Lightning Round” on September 5, he told a caller that Pandora’s (NYSE:P) stock, “had too many shorts in it already and I’m seeing a lack of earnings momentum.”

When the Internet radio company’s stock price is examined, Cramer’s point is evident. Shares of Pandora have slumped throughout September and since Pandora went public in June 2011, its stock price has fallen from its $20 IPO price. Shares closed on Wednesday at $9.49.

Pandora, which has never turned an annual profit, has seen its revenues eaten away by the price of music royalties. Any radio station broadcasting copyrighted material over the airwaves has to pay royalties, however, the standard under which Pandora’s rates are determined are different than those of satellite radio stations or traditional terrestrial stations.

Last year, according to a press release issued by the company, Pandora paid approximately 50 percent of its total revenue in royalties, more than six times the percentage paid by Sirius XM Radio (NASDAQ:SIRI).

“Royalty rates for different formats of digital radio are astonishingly unequal,” said Chief Strategy Officer Tim Westergren in the statement. “Currently, internet radio shoulders the largest royalty burden, far higher than any other form of radio.”

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While the royalty rates for most other uses of copyrighted sound recordings fall under section 801B of the Copyright Act, standards set for streaming radio providers like Pandora come as a result of the 1998 Digital Millennium Copyright Act, which made Internet radio an exception to the original act. The exception required judges to set rates according to what a hypothetical “willing buyer, willing seller” would agree.

However, a proposed House Resolution, the Internet Radio Fairness Act, could cut content costs for Pandora by as much as half. If this bill becomes law, the company’s cost to do business would drop from 50 percent to 10 percent.

Furthermore, if law comes into effect, Pandora may become an acquisition target for such companies as Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG), or even Clear Channel Communications (NYSE:CCO). As market analysis publication, Seeking Alpha, wrote, “Pandora may be a better component to a currently profitable media conglomerate’s stable of holdings than as a stand-alone, independent Internet radio streaming service.”

Both Pandora’s September metrics and Apple’s (NASDAQ:AAPL) rumored interest in a Internet radio service of its own makes the company’s position even more powerful.

According to the company’s statistics, listener hours for Pandora during the month of September were 1.15 billion, an increase of 67 percent over last year. The company also increased its share of the U.S. radio listening market from 4.03 percent to 6.53 percent, and its number of active listeners rose from 39 million to 58.3 million. Further evidence of the company’s growth can be found in its fiscal second quarter earnings report, which showed the management’s guidance for full year revenue rose 50 percent over last year.

In early September, several reports indicated that Apple was planning on entering the Internet radio market. The reports, if true, would up the ante for Google and put Pandora in direct competition with Apple. In light of the recent skirmish between Apple and Google over mapping applications, according to Seeking Alpha, “there is no doubt that Google is heavily evaluating the Internet radio growth space and how they can get a foot in the door.”

Amazon is another contender. With the launch of the Kindle Fire, being able to integrate an Internet radio service, like Pandora with its Music Genome Project, could boost sales. Currently, Pandora is the number one referral source to iTunes, but that could change to Amazon.

“Given that the share price of Pandora has been roughly cut in half since the IPO, and they have the largest presence in internet radio, bidders may be lining up to grab an attractive company,” reports Seeking Alpha.

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