The Future of Internet Radio Won't Come Cheap


Pandora Media (NYS: P) is growing, but not just in terms of revenue and listenership.

Morgan Stanley analyst Scott Devitt is downgrading the music-discovery website operator this morning -- from "overweight" to "equal weight" -- on the fear of a near-term escalation of costs.

Pandora has grown to the point where it can begin targeting local radio ads, and ramping up that sales team won't come cheap. Devitt now doesn't see the company returning to positive EBITDA until 2015, a year later than Wall Street's consensus estimate.

The shift to local advertising is naturally in the company's best long-term interests. Right now, Pandora is primarily leaning on mobile advertising speedster Millennial Media (NYS: MM) to monetize its booming smartphone usage. There is a premium ad-free subscription that's available, but most of the service's users are freeloaders that put up with the ads for the sake of free tunes.

Now, there's nothing inherently wrong with Millennial Media. The stock soared 46% last week after reporting an encouraging quarterly report. CEO Paul Palmieri stunned CNBC viewers by claiming that the click-through rate on mobile ads is actually higher than conventional online ads.

However, Pandora knows that the real money lies in taking a page out of the terrestrial radio playbook and reaching listeners with the local ads that will be both more relevant to the user and more lucrative to the streaming service.

Pandora served up 1.12 billion hours of music to its 54.9 million active users last month, a 76% increase from the tunes dished out last July. Pandora's share of the total U.S. radio listening market is now up to 6.1%. It has reached the critical mass where it doesn't need to serve up ads for national apps or artist releases. Pandora's ready to get local, and the shift to a demand-side ad platform will result in near-term pain for the sake of long-term gain.

Everyone is trying to emulate Pandora's success. Even terrestrial radio giant Clear Channel (OTC: CCMO) and satellite radio monopoly Sirius XM Radio (NAS: SIRI) have been beefing up their streaming offerings to cash in on Pandora's popularity growth.

Fortunately for Clear Channel and Sirius XM, they won't have the same challenges that Pandora is experiencing. Clear Channel's iHeartRadio is a streaming sensation. Millions of users can check out hundreds of Clear Channel FM and AM offerings, but the media giant already has the local sales teams in place. Sirius XM is a premium service where folks are already paying for commercial-free music.

However, Pandora and other online streaming upstarts will ultimately get to the point where the costly push to go local won't come cheap. Pandora's getting there now. Investors should be rewarded in the long term, but things will get rocky along the way.

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The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story, except for Millennial Media. Rick is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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