Apple Will Kill Pandora, But Must Play Sirius

Includes: AAPL, NFLX, P, SIRI
by: Richard Saintvilus

By Richard Saintvilus

It's never a good omen to have the evils of the world associated with your name. Nevertheless, Pandora (NYSE:P) thought this was a good idea. The company has done well overcoming tough odds and growing where others said it can't to the extent that it has quickly established itself as the dominant Internet radio platform.

Facing the music

Remarkably, Pandora has grown despite threats from satellite radio giant Sirius XM (NASDAQ:SIRI) and other streaming platforms like Spotify. Unfortunately, for Pandora, whose business model is based on advertising and has been chronically pressured with music royalty payments, the company was unprepared for "when the music stops."

On Friday, shares plummeted almost 8% when more rumors surfaced that Apple (NASDAQ:AAPL) may be shaking hands with two of the four largest record companies in the music industry. This is not news, however. Rumors about Apple coming up with its own music streaming service to compete with Pandora have been ongoing for almost a year.

However, despite these persistent threats, Pandora continued to march to its own tune - the company's been ignoring the noise. But Pandora investors can no longer tune-out the "fat lady." Unlike Sirius, which has the advantage of offering premium content and is growing subscribers at record levels, Pandora has no leverage.

Investors realized this when, last month, in a blog posts on its website, Pandora announced that it is installing a 40-hour monthly limit on anyone listening for free via a mobile device. The company said it will charge 99 cents for the remainder of the month to those that exceed the 40-hour limit. But here's what's troubling about this; Pandora said this would affect only 4% of its user base.

That's all well and good. But it also reeks of desperation. But more importantly, it continues an issue that is beyond Pandora's control -- it doesn't own the content that's at the center of its business. A case can be made that neither does Sirius. But Sirius has been diversifying its content with its own individual programming and talk channels. Sirius is not just about the music.

Content can't be king, yet free

Lately, there's been a rash of articles that have placed Pandora in the role of a "victim." However, though, Pandora knew the nature of this industry when it decided to pursue its model. As I've said before, if "content is king" it can't be free, which is the only way Pandora's model could be sustainable.

This is what Netflix (NASDAQ:NFLX) has also started to understand. Like Sirius, Netflix has begun to diversify itself with original content with shows like "The House of Cards." Granted, Netflix is also dealing with rising costs. But the company has been growing both its domestic and international subscribers to help offset these costs.

In other words, Netflix will be able to monetize its users by raising rates periodically. Unless Pandora figures out a way to raise advertising revenue, it's going to die. Meanwhile, once Apple enters the market, Pandora loses all of its leverage with advertisers. This is despite having 7% of the radio market. Why would advertisers make long terms commitments to Pandora without learning what Apple has to offer?

It makes perfect sense. After all, with Apple's popularity, advertisers should get "more bang" for their advertising dollars. This is how Joe Kennedy, Pandora's former CEO, failed. The big winner here will be Sirius. Not only should Sirius gain some additional market share from a Pandora death, but Sirius now looks more attractive as a buyout candidate to Apple and possbily Google.

Where it stops, nobody knows

It's only the beginning folks. This is the first domino is a long string of possibilities that's going to start falling, because unless Apple looks to diversify itself as Pandora failed to do, Apple will (at some point) find its music streaming business failing the same way as Pandora. Apple has no choice but to call Sirius, which now has plenty of leverage.

Do you remember that content-sharing agreement that Sirius signed with Google (NASDAQ:GOOG) last year? I never really liked the idea at first, but now I see this was a pre-emptive move by Google to capitalize on what it envisioned would be an end to Pandora. Google (then) realized that Sirius would be "In Play." Now, the question is, which of the two companies, Apple or Google, will play Sirius? My bet is on Apple. And if so, will Google turn its attention to Pandora?

Google should at least consider it. You have to realize, despite all of this, Pandora is still a valuable brand. Pandora's revenue growth is still an attractive asset that Google can benefit from, even if it is just strictly from an advertising point of view. If nothing else, Pandora can be another streaming tool to help Google leverage the strength of YouTube. If Google doesn't jump on Pandora, Facebook (NASDAQ:FB) is another option.

Here's making sense

Without a doubt Sirius is the big winner here, regardless of how all of this plays out. The question, though, is to what extent a music streaming service can help Apple. It's not as if iTunes has been at the center of Apple's profitability. The company has only operated iTunes at slightly above break-even.

Not that Apple is desperate for cash, but if Apple were to acquire Sirius, which has become a cash-flow machine, Apple would immediately become the most dominant music provider in the world, given Sirius' 24 million subscribers. What's more, Apple could then place Sirius' user interface on iOS instead of Google's Android, further weakening Google. All of this, however, assumes that Liberty media (NASDAQ:LMCA) would freely sell Sirius. Didn't I say stay tuned?

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: SaintsSense is a team of financial writers. This article was written by Richard Saintvilus, one of our tech analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.