Morgan Stanley On Pandora: 'We Know What We Don't Know'

In a report published Monday, Morgan Stanley analyst Benjamin Swinburne commented that a "wide range" of Copyright Royalty Board (CRB) royalty rate outcomes later this year makes valuing shares of

"challenging." "Our gut is despite the rhetoric, labels do not want its $450 million (and growing) royalties to go away – so direct deals may result if the CRB ruling is onerous," Swinburne wrote. "With no CRB visibility, top-line trends drive our view." Swinburne noted that under the most bearish case, the CRB takes its existing rate structure (not Pandora's current lower rate) and grows it 10 percent in 2016 and 5 percent per year from 2016 to 2017. This essentially eliminates any adjusted earnings at Pandora until 2021 and creates a funding need of around $350 million until reaching free cash flow positive. Under this scenario, the analyst suggested shares of Pandora could be valued at $2 to $3 per share. However, in the event of an onerous CRB outcome, various labels could "allow" Pandora to have modestly better margins to keep it in business and protect its royalty payments. SoundExchange Distributions represents more than 10 percent of total digital and physical music industry revenue and is growing by around 30 percent per year. Swinburne concluded that the labels' argument of "if not for Pandora, some material percentage of its 80 million active listeners would pay $10 per month for subscription services," with two thirds of that going to the labels may not be that compelling. The analyst added that his recent survey work suggested that 80 percent of Americans prefer ad supported "free" radio, and Pandora's royalties are vastly superior to terrestrial radio. Shares remain Equal-weight rated with a price target increased to $18 from a previous $17 due to positive comScore data that indicated continued active user growth.