How Long Can Pandora Afford These Generous Payouts?

Pandora Media (NYS: P) just released some payment details on musical performers large and small. The numbers make Pandora look like a working musician's favorite paycheck generator, whether you're an established superstar or a small-time act struggling to make a living.

On the top end, rappers Drake and Lil Wayne are closing in on $3 million of direct payments from Pandora in 2012. Coldplay and Adele aren't far behind, collecting million-dollar annual royalty checks from this outlet.

On the lower end, a relative unknown such as Mexican Cumbia band Grupo Bryndis is expected to receive $114,000 in performance fees over the next year. That's not too shabby for a group that (NAS: AMZN) ranks behind 183,000 other groups in music sales.

Pandora founder Tim Westerberg waxes poetic about these payments: "We're talking here about the very real possibility of creating, for the first time ever, an actual musicians middle class," he said. But Pandora represents just 6.5% of all radio listening in America, lumping satellite and FM radio together with pure online entities. It's pretty obvious that most acts don't make 15 times these sums from radio royalties right now.

Left unsaid in Westergren's blog post is the fact that Pandora is currently lobbying for sweeping changes to American radio royalty rules. You don't have to be a Pandora executive or shareholder to see that the current system is grossly unfair.

Satellite radio monopolist Sirius XM Radio (NAS: SIRI) pays about 6% of its gross service revenues as content royalties. The company also pays up the nose for premium content from Howard Stern and others, but that's by choice -- the government has set a very low rate for Sirius' basic content rights. By contrast, Pandora's royalties add up to roughly 50% of its revenue stream.

Oh, but it gets better. AM and FM stations don't pay royalties at all.

The playing field is heavily tilted in favor of traditional radio, while Sirius gets a far better deal than Internet services like Pandora, Spotify, or Rdio. Do you think it's fair to charge different royalty rates for the same song, depending on what medium handled the transfer from (virtual) turntable to eardrum?

I'd buy Pandora shares in a heartbeat if this favoritist policy was ever reversed, but then I'm not holding my breath for politicians to stop playing favorites. The current rules expire in 2015. Talks over a new rulebook are slated to begin in 2013.

Old-line media giants have deep pockets, but are even richer in Washington connections. FM radio is under attack, but heavily fortified behind these cushy royalty arrangements. This state of affairs cannot last forever, but Pandora may not make it into the next era. Just look at this depressing chart:

P data by YCharts.

Take note that these trailing cash flows are negative, and not getting any stronger. In other words, the company is bleeding cash.

Pandora desperately needs royalty reform. Any investment in this stock is a bet that politicians will do the right thing, across party lines and all.

Pandora may be out of luck, but all hope is not lost for forward-thinking media mavens. Despite being one of the market's biggest winners since bottoming out three years ago, there is still some healthy upside to be had if things go right for Sirius XM -- and plenty of room to fall if things don't. Read all about Sirius in our brand-new premium report. To get started, just click here now.

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