Credit Ramin Rahimian for The New York Times
Since it began 10 years ago, Pandora Media has become one of the most popular digital music services in the world, with around 80 million regular users. But it has never had a profitable year, its user growth has slowed and lately Wall Street has become impatient.
Now Pandora is steeling itself for a legal decision that may have huge consequences for its business and for the evolving economics of digital music.
The Copyright Royalty Board, made up of three federal judges in Washington, is set to rule by Tuesday on the royalty rates that webcasters like Pandora will pay record companies for the next five years. These royalties are Pandoraâs single biggest expense â they amounted to 44 percent of the companyâs revenue last year â as well as its biggest hurdle to profitability.
âThe core problem of Pandora is that under the existing rate structure theyâre not making any money,â said Alice Enders, a media analyst with the firm Enders Analysis.
Michael S. Herring, Pandoraâs chief financial officer, said in an interview last week that the company expected the judges to âcome out with a rate that is reasonable, that is in the ballpark of about what Pandora is paying today.â
The copyright judges have given no clear signals of how they might rule, but analysts expect that their decision might well add to Pandoraâs burden. Pandora wants its rate lowered, but those representing the music industry are asking for a significant increase.
âAnything other than the status quo is going to be dreadful for Pandora, because it means that the challenge for monetizing content is going to be that much higher,â Ms. Enders said.
On-demand services like Spotify, which let people choose exactly which songs to hear, must negotiate directly with the music industry to license the music they play. But Internet radio companies like Pandora â which let people listen to âstationsâ tailored to their tastes, but do not let them pick specific songs â often use a statutory licensing system under federal copyright law, with rates set by the copyright board.
Pandoraâs current rate, 14 cents for every 100 songs, âhas been a proven rate structure both for healthy royalty payments,â Mr. Herring said, âand so that distribution arms like Pandora are able to function and be successful businesses.â
This system has let Pandora develop at armâs length from the music industry. But the uncertainty around the rate litigation has long depressed its stock, and years of lobbying and behind-the-scenes battles over the laws and rate-setting procedures have also led to lingering ill will between Pandora and the music world.
Recently, however, Pandora has taken steps to become less dependent on the statutory licensing system, and repair its conflicts with the music industry.
âPandora was very aggressive in pushing back on what many on the label side saw as fair compensation,â said Robert A. Jacobs, an entertainment lawyer at the firm Manatt, Phelps & Phillips in Los Angeles who is not involved in the copyright board litigation. âOver time, Pandora has recognized that they may get more by simply being cooperative.â
In October, Pandora paid $ 450 million for the online ticketing system Ticketfly, and last month it made a deal to pay $ 75 million for the assets of Rdio, a struggling competitor to Spotify. The company also recently agreed to pay $ 90 million to settle a long-running royalties dispute over recordings made before 1972, and has begun to strike direct deals with music publishers, which represent songwriting rights. (Pandoraâs songwriting royalties are not decided by the copyright board.)
In announcing the Rdio deal, Pandora executives said they would begin making more extensive licensing deals with record companies, signaling that the company would soon begin to compete directly with Spotify and expand around the world. Largely because of its current licensing system, Pandora now operates only in the United States, Australia and New Zealand.
âWe seek to be the definitive source for music enjoyment and discovery globally,â Brian P. McAndrews, Pandoraâs chief executive, told investors last month.
These deals, along with new efforts to promote artists and share data, have been seen as part of a strategy by Mr. McAndrews to mend fences with the music industry. Mr. McAndrews, the chief executive since late 2013, is also a director of The New York Times Company.
Yet as eager as Pandora has been to strike new deals, it has also been engaged in intense litigation since early 2014 as part of the copyright board proceedings. SoundExchange, a nonprofit licensing agency that is representing the music industry, has asked the board to raise the rate that Pandora and similar webcasters pay record labels by almost 80 percent, to 25 cents per 100 plays, while Pandora wants it lowered to 11 cents.
Both sides have filed mountains of contentious, heavily redacted documents. In one filing, Pandora mocked SoundExchangeâs arguments as a quest to reach a âpromised rate-land.â
The rates paid by services like Pandora have become a focal point for musicians who believe they are not being compensated fairly for their work, and the record labels argue in their filings that higher rates are necessary to cover their production and marketing costs for new music.
âThe rates we proposed reflect what would happen in a true free market, which is what artists deserve under both the law and as a matter of fairness,â Michael Huppe, the chief executive of SoundExchange, said in a statement.
Pandoraâs current rate is already low, the labels argue. In 2007, the copyright board set webcasting rates that Pandora â then a struggling start-up â said were so high that they would have been ruinous. After a high-profile publicity campaign by Pandora, Congress authorized settlement talks to set temporary rates, and the payment structure for âpure playâ webcasters, which includes Pandora, was set in 2009.
In filings with the copyright board, Mr. Herring has argued that if Pandora had not gotten lower rates through that settlement, the company âalmost certainly would have been forced out of business years ago.â
But Pandora has been publicly traded since 2011, and is now a major force in digital music. Many analysts, as well as both technology and music executives, doubt that Pandora will receive another rate discount, whether from the copyright board or through another settlement. If Pandora or the other parties involved in the case are displeased with the boardâs decision, they can appeal it.
For Wall Street, Pandoraâs flurry of recent deals may indeed help it survive an unfavorable ruling, and an expansion around the world could vastly increase the companyâs audience and advertising base. But its immediate costs may still increase, further depressing its stock, which is down about 29 percent this year.
Richard Tullo, an analyst at Albert Fried & Company, said that he expected Pandoraâs operating expenses, including music costs, to increase almost 13 percent next year to $ 1.42 billion, from what Mr. Tullo estimates as $ 1.26 billion in 2015.
Pandoraâs move into direct deals, Mr. Tullo said, is âan indication that theyâd rather negotiate a price today than negotiate a price tomorrow,â when those rates may be higher.
And if Pandora gets its way with a lower rate?
âThen,â Mr. Tullo said, âthe stock explodes.â