July 13, 2011 / 9:15 PM / 7 years ago

Royalty payments dog Pandora's Westergren

SAN FRANCISCO (Reuters) - Two years ago, Pandora co-founder Tim Westergren fought the battle of his life, successfully working to get online music royalties cut to a level that would allow his burgeoning Internet music company to survive.

Joe Kennedy (2nd L), president and CEO, and Tim Westergren (2nd R), founder and Chief Strategy Officer of Pandora internet radio, ring the opening bell at the New York Stock Exchange June 15, 2011. REUTERS/Brendan McDermid

Now, royalties are again front and center at Pandora, with analysts saying the company’s ongoing royalty burden is the major drag on the stock, which closed down 0.7 percent on top of Tuesday’s 6 percent loss.

“Royalties are a reality for us,” Westergren, who spent years playing keyboard in a band before co-founding Pandora, told Reuters Tuesday evening. In the next round of negotiations, Pandora is going “to come to that fully armed with our arguments.”

Trouble is, that round won’t start until 2014, and new rates won’t kick in until 2016, leaving the company stuck paying huge chunks of its revenue in royalties for the foreseeable future. Last fiscal year, that was more than half of its revenue of $137.8 million.

“This is still a classic case of people can’t ... see a clear, immediate path to profitability,” said John Tinker, an analyst at Maxim Group, who rates the company a “buy” and compares it to Amazon.com Inc, which took years to become profitable.

The company did little to assure investors more interested in the short-term during its first analyst presentation on Tuesday, which fell short on detailed guidance on listener hours, advertising revenue or royalty fees.

Pandora Chief Financial Officer Steve Cakebread discussed reaching 20 percent profit margins, but did not give a timeline. Boosting advertising came up several times, but when Reuters asked Chief Executive Joe Kennedy what a good ratio of ads to music would be, he said the company was still working on the answer.

The unknowns dwarfed the good news Pandora announced. It said it had 36 million active monthly users, up from 34 million in April, and 100 million registered users total. It also announced an expanded relationship with Ford Motor Co that brings the service into 10 vehicles, and a new relationship with Toyota Motor Corp’s Scion unit.

But those relationships won’t bear fruit for years. Carmakers first have to integrate Pandora onto dashboards, and listeners have to buy new cars.

In the meantime, more online competition is entering the market, including upstarts such as Turntable.fm. Westergren told Reuters its biggest competitor was traditional radio rather than on-demand music services.

The company is optimistic about the royalty situation; unlike last time, Pandora will be involved deeply with negotiations from the start.

“Previous rate settings have involved relatively small players with unclear economics,” Kennedy told Reuters Tuesday evening. By 2014, judges will be dealing with an “established industry, established economics that will make their rate-setting process easier.”

And Westergren says his musician background, although it makes him something of an anomaly among the Silicon Valley elite, is helping him when it comes to running strategy at Pandora and thinking up negotiation tactics.

“Being in a band was great training to be in a start-up,” he said. “Being able to think outside the box. Sometimes that kind of capability lives in someone who doesn’t have that traditional background.”

Reporting by Sarah McBride; Editing by Richard Chang

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