Looking Close at Pandora's Rdio Dismantling: What Analysts Say, What Billboard Thinks

The monumental move by the number one internet radio giant will bring an already competitive market to a fever pitch.

Behind the aftermath of the terrorist attacks in Paris, the announcement on Monday of a Pandora-Rdio deal became the music industry's main topic of discussion this week. As Rdio files for Chapter 11 bankruptcy, Pandora has agreed to purchase some of the company's technology and intellectual property, pending court approval, and will hire of some Rdio employees. One service has died so another can rise in its place.

Pandora will use Rdio's failure as a springboard to launch its own subscription service in the U.S. some time in 2016. International expansion will surely follow, providing Pandora with revenue growth unattainable if it stayed put. Second, from a licensing and industry relations point of view, an on-demand service is fundamentally different from Pandora's non-interactive service. As a result, the cold war between Pandora and the U.S. music industry (see this Billboard cover story from August 2013) must improve for Pandora to acquire the necessary rights. Third, rights owners and creators will benefit from the emergence of an experienced and popular streaming service. If Rdio had to be replaced by anything, Pandora is the best option.

There are many more factors and issues to consider. Below you'll find analyses from both equity analysts and Billboard which provide insight -- and raise questions about the acquisition and monumental task Pandora has undertaken.

Overall Sentiment

What analysts are saying: Analysts tend to view this as a positive move that will result in long-term growth. Stifel analysts believe Pandora "could be a force in on-demand streaming." Credit Suisse analysts called the Rdio acquisition a "strategically sound" move and estimated Pandora would need to convert 1.4 percent of its current monthly listeners to the subscription tier to cover operational costs [that would generate revenue of roughly $130 million, with about $93 million going to rights owners]. Though not everyone has a rosy outlook. Albert Friend & Co. analyst Rich Tullo has "an open mind" while noting pessimists can say Pandora bought a subscription service "that went bankrupt in the biggest expansion of Internet content since 1999." Morgan Stanley is less optimistic, with in-house surveys leading it to believe ad-based listening will be the "strong majority" of audio listening in the future, predicting subscriptions won't reach the mass market.

Billboard's opinion: Considering the size of the ash heap of dead subscription services, Pandora's decision to create an on-demand service is a bold move. Even pessimists should commend it for not letting possible failure stand in the way of striving for a better product and a broader global footprint. Then again, Pandora may not have had a choice. Significantly increasing ad revenue would require playing more ads and turning off listeners. The other option, growth through international expansion, requires the cooperation of rights owners. Although it's not the company line, it's not unthinkable that rights owners have pressed Pandora -- or Pandora made a unilateral decision -- to create an on-demand service to appease demands for higher royalties. That's not a conspiracy theory, that's game theory.

In a sentence: Pandora isn't in Kansas anymore.

International Expansion

What analysts are saying: Opinions on international expansion were scarce, though expansion into international markets was a common theme in analyst notes. Canaccord Genuity analysts are encouraged by improved relations with rights owners and are "increasingly confident" Pandora will have "a heavy dose of international expansion" in late 2016 and 2017. 

Billboard's opinion: Obviously the Rdio deal will speed Pandora's creation of an on-demand service and international expansion. Rdio is available in over 80 countries, but there are three problems with that: not all of them are large markets, not all have the sort of mature online advertising market Pandora will desire, and Rdio's licenses with rights owners will not transfer to Pandora. That said, Pandora will gain Rdio's experience in foreign markets, and one can assume assets acquired from Rdio should help Pandora with backend functions like catalog management and royalties.  

In a sentence: Pandora can reach international markets faster, but will become a far more complex (and expensive) business as a result.

Royalties

What analysts are saying: Opinions are all over the place. Canaccord Genuity believes in the long term, Pandora will be one of the few dominant services, and that should help it get lower rates from rights holders. Other analysts were less optimistic about the impact higher royalty rates will have on margins. Nomura noted subscription margins could prevent Pandora from reaching its stated goal of 20 percent operating margin. BTIG analyst Rich Greenfield believes rights owners are likely to want Pandora to pay "a notable premium" for on-demand licenses to compensate for statutory rates they view as too low.

Billboard's opinion: There is no evidence that rights owners will consider lowering royalty rates for on-demand services. To the contrary, there is a great unhappiness within the music industry about royalties from streaming services. Labels are unlikely to budge from their current rates -- 70 percent of revenue, although it can end up higher for various reasons -- if they don't get the non-interactive rates they want from the Copyright Royalty Board's upcoming announcement. Greenfield is correct in believing labels are likely to demand a premium. The same goes for the publishing side of copyright. Expect songwriters and publishers to demand a premium to compensate for the rates set by ASCAP and BMI rate courts for Pandora's non-interactive service.

In a sentence: Getting rights owners to lower their subscription rates would be the biggest win since Steve Jobs convinced labels to unbundle the album -- but don't hold your breath.

Music Recommendations

What analysts are saying: Choosing the next song is critical action for an Internet radio service. On-demand services, with their 30 million-plus catalogs, win or lose on their ability to guide users to music they are likely to enjoy. Stifel analysts believe Pandora's "best-in-class music discovery" will help differentiate it from other on-demand services. The Bank of America/Merril Lynch presciently noted that Pandora's Ticketfly acquisition allows it to make concert recommendations to listeners.

Billboard's opinion: Ten years of listening data and feedback (thumbs up, thumbs down) may give Pandora an edge in recommendations, but the edge would be slight. Its doubtful anybody but the true aficionados -- small in number -- would be able to differentiate the recommendations of most services. Spotify, the most popular subscription service, has greatly improved its recommendations since it acquired The Echo Nest, while concurrently making improvements in its human-generated playlist creation. Given the trend in human curation at on-demand services, Pandora will need to merge its recommendation technology with old fashion human decision-making.

In a sentence: Beware -- recommending songs to subscribers isn't the same as picking songs for radio listeners. 

Competition

What analysts are saying: Analysts have showed concern about competition for years. The threat from existing and yet-to-be-launched services has been a constant refrain from BTIG's Greenfield over the years (Apple and YouTube have launched subscription services over that time).

Billboard's opinion: The on-demand market has gained both strength and momentum in that last few years. Spotify has gained market dominance and cultivated a high "switching costs" by encouraging both free and paying users to build a collection of playlists that subsequently act as a "soft lock." Apple has launched a formidable competitor, and Amazon appears to be successfully reaching a more middle-of-the-road consumer. While in its infancy, the streaming market has numerous other contenders: Amazon Prime Music, YouTube Red, Google Play Music, Rhapsody, Tidal, Simfy, Slacker and Microsoft Groove, plus some smaller players.

In a sentence: Pandora owns the Internet radio market, but is joining a host of companies battling for the top one or two spots in the subscription market.

Marketing

What analysts are saying: Little was said about the type of product, pricing and upselling Pandora could employ. Stifel analysts believes Pandora will be positioned "as a one-stop-shop for music listeners looking for radio, on-demand, and concert listening experiences." As such, Pandora should be able to attract additional users and upstream some percentage of free users to the subscription service. Nomura mentioned Pandora's ability to offer more products as a way to improve growth in listeners and listener hours, although it sees those gains being tempered by competitors like Spotify and Apple Music. 

Billboard's opinion: Pandora's 79 million monthly listeners, including 3.8 million subscribers to the ad-free service, already using the platform (as well as over 250 million registered users) present an unmatched marketing opportunity that should result in low acquisition costs. The question mark is the composition of those 79 million listeners. Pandora is a radio product, and radio is a free and low-investment way to consume music. Subscription services don't always require high investment (following friends, creating playlists, searching the catalog) but they cost $9.99 per month (excluding family plans and market-specific pricing). Historically, a low percentage of consumers are interested in paying.

In a sentence: How many people will pay $9.99 per month?

The User Experience

What analysts are saying: BTIG's Greenfield wisely raised concerns that Pandora will have to abandon its single-minded focus on providing Internet radio. He ends the paragraph with humorous well-wishing: "#goodluckpandora." Stifel thinks Pandora could achieve a better-than-average conversion rate if it "can provide on-demand services in a more user-friendly way."

Billboard's opinion: The user experience has been an overlooked variable in Pandora's decision to launch an on-demand service. A major factor in Pandora becoming a successful streaming service was its simplicity. While others services added bells and whistles, the Pandora app and web-based service remained simple, intuitive and effortless. No streaming service can be successful without a user experience that feels something close to effortless. Apple understands this. Netflix and Amazon do, too. Pandora cannot have a successful subscription service unless its user experience nears or matches that of the radio service.   

In a sentence: User experience is often forgotten -- until it's poor. 


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