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Apple (NASDAQ:AAPL) recently announced its Internet radio service that will directly compete with Pandora Media (NYSE:P). Under the name iTunes Radio, Apple will offer many features similar to that of Pandora, including personalized radio stations, free ad-supported service, as well as the ad-free subscription option. While Pandora has over 1 million songs in its library, Apple's service will give its users access to its entire iTunes catalog, which boasts over 26 million songs. In addition, the subscription fee for iTunes Radio (at $24.99 per year) is lower than that for Pandora, which charges $36 per year for its Pandora One service. While it appears as if Pandora is going to face strong competition from Apple in the near future, there are certain areas where the company can still be a clear winner. These include a wider device reach and a strong sales force that focuses on local advertisement opportunities.

One area where the Internet radio service in the U.S. faces a challenge is in royalties earned. The royalties are fixed by intermediary bodies, and Internet webcasters do not have much flexibility to negotiate. This has made it difficult for Pandora to be profitable on its ad-based business. Apple previously tried and dropped the idea of Internet radio for the same reason. It is unclear whether Apple can really build a profitable business this time, unless a large number of its users sign up for the subscription service.

Pandora's Advantage

1. Strong Sales Force Specializing in Local Advertising

We believe that Pandora's experience in managing its radio advertising business gives it an edge over Apple. Radio advertisements differ from those on other media channels in the sense that they are much more localized in nature. It means that a radio company needs a strong and large sales force where sales representatives can go to individual local businesses and shops and sell ad slots. Pandora has put a lot of effort into this area. Despite stellar revenue growth, its marketing and sales expenses (as a percent of revenues) increased last year and seem to be on a similar track in 2013 as well. Monetizing the mobile platform with ads is not easy, and that's exactly what Apple has to figure out as it doesn't have much expertise in this area.

Pandora's mobile listener hours have grown tremendously over the past few years, leading to an increase in the mobile ad inventory. Close to 75%-80% of the company's total listener hours now come from the mobile platform. Therefore, the company has been investing substantially in building a large sales force in many regional radio ad markets. Establishing a strong sales force will be key to higher sell-through rates for its mobile ad inventory. Radio ad buyers are for the most part indifferent about placing their ads on the mobile or desktop platforms, since traditional radio has forever been a mobile platform. Therefore, the company is confident about its ability to improve mobile monetization to sustainable levels in the future.

2. Wider Device Reach

While Apple's service will be available on PC and iOS devices, Pandora's app is available on desktop and all mobile platforms including iOS, Android, BlackBerry, and Windows Mobile. This limits Apple's potential user base and can provide room for Pandora's growth. However, let's not overestimate Pandora's advantage here. Apple's iPhone is the most popular smartphone in the U.S., and its iPad is already dominating the U.S. tablet market with the majority share. Despite its limitation to iOS based devices, Apple's iTunes Radio can still create a large base of loyal users.

Despite some of the advantages that Pandora may enjoy, we believe that Apple's entry can certainly affect the radio company's user base and listener hour growth. But that also has a silver lining to it. The problem with Pandora has been that its listener hours have grown at a very fast pace over the last few years, and the company's sales department hasn't been able to keep up with the growth in terms of selling ad inventory. As Pandora's listener hour growth slows down, its monetization could increase and the company could become profitable sooner than we expect.

Our price estimate for Pandora stands at $11.85, implying a discount of 20%-25% to the market price.

Disclosure: No positions.

Source: Should Pandora Be Worried About Apple's iRadio Launch?