Anthony DiClemente, Barclays Equity Research Analyst, gave his take on “The Internet Radio Fairness Act,” which House lawmakers introduced 9/21. The idea of the bill is to bring royalties paid by services such as Pandora in line with those paid by satellite and cable audio services. Theoretically, that should include internet radio streams operated by broadcasters.
Pandora has endorsed the bill because it avoids the thorny issue of terrestrial radio royalties. It wants a clean vote on whether it should be at parity with other digital platforms without having the bill dragged to its doom by AM and FM broadcasters.
DiClemente thinks it will help Pandora’s bottom line, but with a warning: “The Internet Radio Fairness Act, which proposes to lower the royalties that Internet radio services pay by placing it under the same rate standard of the Copyright Act as cable and satellite radio. The bill is unlikely to be voted on before year end, however. We believe that new legislation could benefit Pandora’s profitability profile, and thus improves the outlook for shares. We do note, however, that improved economics for Internet Radio could also effectively spur new and more vigorous competition from large established technology companies.
Internet Radio Fairness Act adds risk to being Underweight. Since early spring, we have been cautious on Pandora on three points: 1) difficulty in monetization owing to a advertising mix shift to mobile; 2) higher relative variable content costs limiting profitability; and 3) extended valuation multiples. While Pandora’s current agreement with SoundExchange is long term in nature, if Pandora’s lobbying efforts with Congress continue to gain traction at an accelerated pace, content costs as a percentage of revenue (we estimate 59% of 2013E revenue) could decline before expiry of the current agreement with SoundExchange, improving margins.
New legislation could put Internet Radio content costs on the same plane as cable/ satellite radio. Currently, satellite radio provider Sirius XM pays 8% of gross revenue, but is in the process of renegotiating its royalty rates with SoundExchange for 2013-2017, with the outcome uncertain. If Pandora’s royalty rates were lowered to meet the levels of cable/satellite (and not vice versa), Pandora’s future profitability would improve. We do, however, believe that improved Internet Radio economics could also drive more intense competition from heavyweight players in the technology world.”
