78 Million Reasons to Like Pandora's Big Music Deal

By Markets Fool.com

Image source: Pandora Media.

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The amped-up chatter about Pandora Media (NYSE: P) negotiating direct licensing arrangements with the leading record labels became reality yesterday. Pandora announced deals withMerlin Network, Sony Music, and Universal Music Group yesterday. It also lined up direct licensing partnerships with The Orchard and dozens of other indie labels and distributors.

It's a big deal. As Pandora itself points out in the press release announcing the deals, this now opens the door for the streaming music pioneer to roll out new subscription services that rival the on-demand offerings provided by Apple (NASDAQ: AAPL) and Spotify. It will also drum up new advertising opportunities, a feather in the cap for a company that's already doing a decent job of milking more revenue out of every stream it cranks out.

The licensing arrangements apply only to Pandora's stateside business. That may sour the bullish hopes that Pandora was about to throw a wider global net with its platform the way that rivals Spotify and Apple Music have been doing.

Wall Street's mixed reaction

Analysts are generally positive on the move, but there's at least one Wall Street pro that sees it as a negative. Pacific Crest'sAndy Hargreaves feels that these deals and the push for on-demand streaming find Pandora entering a niche where there's little control over its content costs. Its operating costs go up based on revenue, eating away at the incremental leverage that investors like to see in scalable online platforms. This finds Hargreaves concerned about its future profitability, but to be fair he was bearish on the stock even before Tuesday's news. He is sticking to his underweight rating.

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Hargreaves is the exception to the rule. Most of the analysts are upbeat on the call.

  • Piper Jaffray's Stan Meyers concedes that the direct label agreements will sting Pandora's contribution margin in the near term, but he feels that it's the price that one has to pay in pursuit of the premium subscription growth opportunity. He has an $18 price target and an overweight rating. He still sees it as a compelling acquisition target.
  • Canaccord'sMichael Graham is sticking to his bullish rating. He's bumping his price target from $14 to $18, matching where Meyers is parked. He feels that it's just a matter of time before Pandora signs a similar deal with Warner Music Group, the last of the major labels that has yet to hop on board.
  • Another Wall Street pro with an $18 price target is SunTrust's Robert Peck. He's encouraged by the monetization potential of the pricier ads that the new deals can draw. The hope here is that it will help offset the higher royalties that it will have to shell out.

We will have to wait and see what Pandora's on-demand offering will look like, and it's just a matter of when and not if Warner Music Group joins its peers. This is a cutthroat market, but you can never ignore Pandora's 78.1 million active listeners. They're a devoted lot, spending more than 24 hours a month streaming the app. A big advantage that Apple had over other tech giants that have have largely faded in this market is that it had a large built-in audience through iTunes. That has helped it convince 17 million people to pay up for Apple Music.

Apple is generating more revenue with its 17 million premium accounts than Pandora is with its entire business as it presently stands. This could be the game changer that takes the stock to the next level -- if it doesn't get bought out first.

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Rick Munarriz owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Pandora Media. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.