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Pandora's (NYSE:P) ability to analyze data and use it for marketing purposes appears to be growing by leaps and bounds. The company has actually created music recommendation software that can tailor music playlists to specific fans. The San Francisco Chronicle reported that Pandora can now tell the age of listeners by using its recommendation software.

That way, an older fan of a band could get a playlist of classic hits, while a younger fan might get recent hits. It is easy to see how these capabilities could be for advertising and to create new streams of revenue for the digital radio service. A music fan in her 30s might be targeted with advertisements for minivans or real estate ads for houses near good schools because she would be more likely to have kids. A younger fan might get an advertisement for a hot new club or a new brand of tequila.

This capability or social discovery could give Pandora the edge in selling advertising. Its sales people could show a car dealer how to reach the most likely buyers in his immediate area. An example of this might be targeting ads for Cadillac to playlists of classic 60s and 70s hits, which would appeal most to middle-aged professionals.

This strategy obviously is not proven, but it could be what makes or breaks Pandora. The company needs an edge when faced with a competitor like Spotify that can sign up Heineken and Chevy as advertisers for a service it has not even launched yet. Pandora needs to prove that it can generate advertising dollars to maintain its stock value.

There's a lot of pressure on Pandora, particularly with the recent inability of Facebook (NASDAQ:FB) to prove it can retain advertisers. Pandora could be in a better position to do this than Facebook because it is offering simply one product, namely music. It only has one kind of data to analyze and established parameters in the form of genres and musicians. That makes the job a lot easier and faster.

The big problem, of course, will be correlating that data to sales at businesses. How will Pandora be able to prove that somebody bought a new car because he saw an ad for a dealer while looking for a Beatles song on a Pandora playlist? That challenge could be far greater than the technical issues involved.

If Pandora can demonstrate that it can actually use Social Discovery to create effective advertising, its shares could shoot up in value. That would give a potentially vast stream of revenue that Spotify might not be able to touch. This could enable Pandora to steal a large percentage of the local advertising market from terrestrial radio operators such as Cumulus Media (NASDAQ:CMLS) and CBS Radio (NYSE:CBS).

So Where Does This Leave Sirius XM?

Where does all the competition or potential competition leave the biggest and most profitable player in digital radio, Sirius XM (NASDAQ:SIRI)? The answer is in a pretty good position, because neither Pandora nor Spotify is necessarily a direct competitor to Sirius.

Music, the only product offered by the digital radio upstarts, is only part of Sirius' offerings. The digital radio companies are like specialty retailers, selling only a product to one group of people. Sirius is like Wal-Mart, trying to sell as many products to as many people as possible. That means Sirius' market is potentially far bigger than any of these upstarts.

Pandora and its competitors, such as Spotify and Songza, might lure some music fans away from Sirius, but they will still have to tune into Sirius if they want to listen to Howard Stern, the ballgame, or the NASCAR race. That means Sirius may not actually lose any market share or revenue to these services. At the end of the day, it will still be the biggest player in the game and probably the most dominant.

Something else that must be pointed out is that Songza and/or Spotify could benefit by teaming up with Sirius. Songza's business model is to share revenues with other services. If it could get on Sirius, it would have millions of new listeners overnight. A Songza deal with Sirius could boost Sirius' stock value by proving it can appeal to younger demographics and somebody besides drivers. Sirius could also help Spotify by helping it tap the all-important drive time market.

Another possibility is that Liberty Media (NASDAQ:LMCA), which is trying to take over Sirius, may try to buy up Songza or Spotify and fold such a service into Sirius. Both of these services are privately held, and Songza seems to have a limited amount of cash. Combining such a service with Sirius would make a lot of sense because it could greatly expand Sirius' digital reach and give Sirius additional content and sources of revenue.

Beyond Songza and Spotify, Liberty, which has tons of cash, might also be interested in Pandora. Combining Pandora with Sirius would make a lot of sense. The deal would get Sirius onto all those office computers and mobile devices that Pandora is on, and get Pandora into all those cars that have Sirius radio sets.

That could boost Pandora's stock in the short run, but sink it in the long-run. Liberty's big boss, John Malone, has a long history of using complex maneuvers to water stock and destroy share values in order to get companies cheap. He's already been doing it with Sirius for some time. Pandora would be another logical target for Mr. Malone, particularly if it gets into trouble and needs cash fast.

It goes without saying that a merger with Pandora would push Sirius stock up several values. Such a merger would create a digital radio giant that could be unbeatable.

Sirius is Still the Leader in Digital Radio

No matter what happens, it still looks as if Sirius XM is the biggest and most successful player in digital radio. At the end of the day, Sirius, and not Pandora, will be the company that newcomers such as Spotify and Songza will have to deal with.

The truth is that no other company in the digital radio market can do what Sirius can. It offers a full lineup of programming that includes music, comedy, news, talk shows, and sports. Its closest real competitor is iHeartRadio.com from Clear Channel Communications. All iHeartRadio does is rebroadcast Clear Channel's shows; it doesn't have any original programming and can't approach the variety of Sirius.

Even though competitors such as Pandora may have better technology, Sirius still has enough of a lead in programming to give it a sizable moat. The only way Pandora could cross that moat is to spend several hundred million dollars on programming, something it could only do with a deep pocketed owner.

What this means for stockholders is that Sirius' stock is posed to grow whenever the Liberty takeover issue is settled. The company is still the only real success in digital radio and it is making money. Its potential competitors seem to lack the capability to challenge it in any area except music.

This puts Sirius in an enviable position. If its competitors want to grow, they have to come to it for help. If Pandora, Spotify, iHeartRadio or Songza bite the bullet and make a deal to put its app on Sirius, Sirius XM shares could dramatically grow in value. Such a deal would demonstrate that Sirius has real value and the market has improperly valued it.

It is easy to see why John Malone is so interested in Sirius, the company has real value. The kind of value that the other digital radio stock Pandora lacks, despite its much higher price.

Source: Why Pandora Needs Sirius To Grow