Over the past year, the idea of Apple (click ticker for report: ) launching an internet streaming radio has been in the back of our minds. In fact, we think it’s the one of the few interesting features that could make the Apple ecosystem even stickier. According to reports, iRadio could be introduced next week. Pandora (click ticker for report: ) shareholders are clearly worried, sending shares tumbling over the past few days, and we believe they should be.
While Apple has (wisely) been unwilling to sell its phones or hardware at lower prices in order to win market share, we do not think this logic necessarily applies to iAds/iRadio. For one, Apple’s hardware presents advertisers with an enormous installed base. Thus, Apple has a leg up in attracting listeners. This is even without the fact that it’s much easier to sync Apple products through Apple applications (some applications won’t stream through speakers). An iRadio product would also make it easier for listeners to purchase on-demand consumption; something that is not possible for Pandora users or Spotify (free) users. Assuming advertisers are immediately attracted to the idea, Apple could compete for advertising budgets at similar prices to Pandora and Spotify.
However, if it wants, Apple can simply offer more favorable terms to advertisers, and even offer enticing deals for exclusive radio content. With its enormous cash hoard, not only could Apple buy all the music studios (it won’t), but the company could price content out of reach for competitors. The only company that could possibly compete would be Google (click ticker for report: ). This is textbook “Amazon” (click ticker for report: ) behavior. Amazon is famous for entering an industry, blowing up the cost structure, and waiting for its competitors to flounder before increasing profits.
The best part? Unlike Amazon, which posts anemic operating margins, we don’t think ad sales and radio streaming would have a meaningful impact on the company’s profitability. Our fiscal year 2015 revenue estimate for Pandora ($874m) represents less than 1% of Apple’s current revenue. However, it could be worth much more to Apple if iRadio was able to strengthen the Apple ecosystem. Therefore, fighting Pandora would be relatively inexpensive with a potentially large pay off. It may make sense for Apple to lose money on iRadio to make money on iTunes and hardware sales.
Since we include Apple in the portfolio of our Best Ideas Newsletter, we’d like to say iRadio will be a slam-dunk success. Yet, success is not guaranteed. Apple, believe it or not, has had failures in the past, and the recent rendition of iTunes hasn’t received praise. Pandora, Spotify, and even smaller apps like iheartradio and TuneIn have already worked to build followings, and there is no guarantee consumers will flock to the Apple product.
Nevertheless, we think this is what value investor Mohnish Pabrai would classify as a “Dhando” situation for Apple. Heads Apple wins a lot; tails Apple loses, but not too much. Though it’s a small battle for Apple, iRadio could be a war that substantially alters the future of Pandora. We’re not confident enough to put our faith in Pandora, even if its share price continues to decline.