Pandora’s Plummet: Is Apple’s iTunes Taking Over Internet Radio?

Investors reacted strongly to Pandora’s (NYSE:P) first-quarter earnings last Thursday as the Internet radio company’s first-quarter results missed analyst expectations. Shares plunged over 16 percent by Friday and brought this month’s losses to more than 20 percent.

Pandora’s marketing revenue rose 45 percent to $140.6 million as the company continued to lure advertising dollars from terrestrial radio, while subscription and miscellaneous revenue increased 94 percent to $39.4 million. However, its 8 percent increase to 75.3 million subscribers, representing 9.1 percent share of U.S. radio listeners, missed analysts’ 77.2 million listener expectation. Pandora, which went public in 2011, has faced increased content costs along with its growing subscriber base, and its posted losses are mostly due to higher royalty payments, which jumped 26 percent, as listener hours increased 12 percent to 4.8 billion.

Still, the Oakland, California-based corporation managed to grow earnings thanks to increased ad and subscription revenue, totaling $180.1 million, narrowing its loss to $28.9 million (14 cents per share) from $38.7 million (22 cents per share) over the same period last year.

Pandora’s second-quarter outlook was lower than expected, and shares immediately began to drop as the company predicted its second-quarter earnings would be between $213 million and $218 million (zero to 3 cents per share), missing analyst expectations of $218.3 million in revenue (5 cents per share). To increase revenue, Pandora will be raising fees for new subscriptions to its ad-free plan, Pandora One, in May.

The company said it would be spending aggressively on advertising this quarter to maintain its first-place position in the industry. Along with rising royalty payments, the company raised its advertising budget by 63 percent to $61.9 million last quarter and will continue to increase marketing costs as part of its subscriber growth strategy. Pandora, which has its service confined to the U.S., Australia, and New Zealand due to licensing limitations, is currently being sued by Capitol Records and Sony Music in a New York court. It is being accused of copyright infringement by not paying royalties on music recorded before 1972.

Pandora was the first and is still dominant in online streaming radio, with a 31 percent share of all listeners, according to Edison Research’s 2014 Infinite Dial survey, with Apple’s (NASDAQ:AAPL) iTunes Radio far behind, at 8 percent. However, there are indications that the audience gap might narrow, as Apple is rumored to soon introduce a feature Pandora doesn’t offer.

As reported by Bloomberg, sources close to the project say Apple will unveil a song discovery feature during a preview of its mobile software update, iOS 8, at the company’s annual developer conference in June. Partnering with music identification service Shazam, the app will be able to capture a song via the iPhone or iPad’s microphone using its voice-activated search feature, Siri, and match it in Apple’s iTunes database, which the company has expanded even as song download rates have gone down.

Trailing behind is Spotify, with 8 percent of the U.S. market, which is rumored to be mulling an IPO this fall after its latest round of funding in November raised $250 million, putting the company’s value at $4 billion. The streaming music service has no plans to directly compete with Pandora yet, as the company has a broader global reach. The Swedish-based company added more than 1 million new users in the U.K., its largest market, in the past three months. As currently projected, it is poised to outpace iTunes across Europe within a year, although Apple’s expected new song recognition software might change the game.

Apple and Pandora have been stepping on each other’s toes for years, but the competition appeared to shift into higher gear last September, when the iPhone maker launched a music streaming service with iTunes Radio last September.

In a recently filed court ruling that settled a royalty rate dispute between Pandora and the American Society of Composers, Authors and Publishers (ASCAP) the presiding judge echoed the sentiment of some in the market, saying that “Pandora has continued to grow despite the presence of iTunes Radio.”  Whether or not Pandora will be able to continue to grow at the fast pace it managed through February of this year is less clear. Shares are down more than 30 percent over the past three-month period and down more than 12 percent this year to date. Over the past two years, however, shares are up more than 160 percent, making the recent decline look as much like a correction from an over-inflated valuation as anything else.

Still, Apple is a real threat. The possible introduction of an official iTunes app for the Android mobile OS could increase the radio service’s footprint enormously. A record label source told Billboard in March that Apple is mulling just that. Such an expansion would allow Apple to engage more directly with would-be iTunes users who use Android, instead of forcing them to go through third-party apps.

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