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The Globe and Mail

Pandora Media could get major boost from new U.S. legislation

Traders work at the kiosk where Pandora internet radio is traded on the floor of the New York Stock Exchange June 15, 2011.

Brendan McDermid/Reuters

Pandora Media Inc.'s income potential could soon be set loose. New U.S. legislation proposes to recalibrate how music royalty payments are made for online radio companies. Such costs lock up about half of Pandora's revenue.

The Internet Radio Fairness Act, a rare bipartisan proposal in Congress, seeks to revise digital laws enacted almost 15 years ago when the medium was less developed and understood. Judges would be directed to impose royalty rates for online services using the same standard historically applied to other forms of radio. U.S. satellite radio monopoly Sirius XM, for example, pays a proportion of revenue that's more than 80 per cent lower than Pandora's.

Even terrestrial broadcasters support the measure. Powerhouses such as Clear Channel stream their stations over the Internet these days, so pay higher fees to musicians and other copyright holders for distribution over the Web than over the airwaves. But Pandora is one of the clearest beneficiaries.

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If its royalties-to-revenue ratio were to fall from last year's 54 per cent to Sirius XM's 8 per cent, its bottom line, by extension, would soar. That would almost certainly revalue the company's shares in a meaningful way.

Using consensus estimates for next year's sales, applying the lower royalty rate, taxing the resulting earnings at 25 per cent and putting them on an industry average price-earnings multiple of 24 would lift Pandora's shares from around $11 (U.S.) apiece to more than $28, according to Breakingviews' calculations. Even supposing the royalties fell more modestly, to between what Pandora pays now and Sirius XM's rate, the stock should be worth about 24 per cent more than where it currently trades.

The legislative proposal has a long way to go. For one thing, entertainers and their powerful lobbyists in Washington will fight back. MusicFirst, a coalition of labels and artists, also wants to level the playing field, but by raising royalty rates for other services, not shrinking them for the likes of Pandora. Nevertheless, with a plan now on the congressional playlist, there's greater option value to Pandora's income streaming.

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