NEW YORK – There is no doubt that shares of Pandora (NYSE:P) outperformed the market this year. As of Wednesday’s close, shares were just off the all-time high of $ 26.99 and year-to-date the stock is up almost 200 percent. All of this in spite of looming legal battles regarding licensing costs and royalty payments – irrational exuberance indeed.
However, what most investors are not aware of is that the Copyright Royalty Board (CRB) could issue a decision, which would effectively seal the fate of Pandora, for the better or worse. According to sources with knowledge of the proceedings, the CRB is expected to decide where the licensing and royalty payment dispute should remain a one-step decision process; this would not be good for the company and would trigger a sell-off. On the other hand, the CRB could choose a two-step decision process; this would be viewed as positive for the company.
Sometime in 2014, the CRB will begin hearings regarding ‘fair’ compensation for compulsory licensing. The rate will determine Pandora’s profitability, anywhere better negative and 30 percent, and as such will have tremendous influence on share prices.
Basically, every piece of recorded music involves two copyrights, the composition itself (the musical work) and the actual recording (the master). By and large, the licensing costs for the musical work are significantly lower than the master. In Pandora’s case, the cost of this content has remained seven hundredths of a penny – this is usually paid to SESAC, ASCAP, or BMI.
Today, Pandora is essentially an American company as 95 percent of their revenue is generated in the U.S., and if the CRB decides that the company must sign direct licenses for the master, the company’s licensing cost could increase ten-fold. For reference, Spotify directly licenses music from artists and labels. Not only would the license cost increase, but also the cost of managing licenses would increase as Pandora would have to negotiate with individual record labels or the artists themselves.
For Pandora, they would favor compulsory licensing, which is what they use today. However, the CRB has been charged with determining the fair rate, and before they can do that. If the CRB decided on a one-step process, which is what other internet radio companies’ pay, then only the transaction price will be considered. If the CRB decides on a two-step process, an additional component, ‘economic health of music playing companies’ will be considered, and this may reduce the applicable rate set in step one.
For a company operating at near breakeven, the decision could significantly influence their future prospects as such it is expected that volatility in Pandora share will increase as the market tries to predict which way the CRB will rule.