Apple vs. Pandora: The Music-Streaming Duopoly

NEW YORK ( TheStreet) -- In only the first nine months of the year, shares of Pandora ( P) have already tripled.

While the Internet radio giant has done well, overcoming tough odds and growing despite stiff competition from the likes of Spotify and Sirius XM ( SIRI), Pandora has not shown that it can make enough money to justify investors' faith. With Apple's ( AAPL) iPhones now available with iTunes Radio, which comes at a much cheaper cost than Pandora's subscription service, Pandora's already weak margins are suddenly under more pressure. Will the stock hold?

With listening hours up 16% year over year and subscription revenue surging up 143%, I can't deny that Pandora is an exceptional growth story. As with Facebook ( FB), Pandora is also benefiting from a dominant showing in advertising revenue, which continues to outperform Street estimates, climbing up recently by 44%.

But eventually "the music stops." Given that content acquisition costs continue to rise, including a 35% increase in the recent quarter, Pandora will have to do better than the $8 million GAAP (generally accepted accounting principles) loss the company posted in the recent quarter.

Realizing that Pandora's dealing with liquidity issues in looking for ways to finance its operations, last week management announced plans to sell 18.2 million shares in an expanded stock offering at $25 per share. The offering, which is expected to close on Tuesday, is an attempt to attract advertisers away from terrestrial radio stations.

Given how the offering was structured, which includes a 30-day option for underwriters JPMorgan Chase ( JPM) and Morgan Stanley ( MS) to purchase 2.73 million additional shares, Pandora might be able to net a total estimated sum of $393 million, given that the underwriters exercised their option on Friday. Investors cheered the news, sending shares of Pandora to its highest level in more than two years. But I wouldn't get carried away just yet.

Assuming the local U.S. advertising market is a $15 billion industry, this seems like a good strategy for Pandora. Unfortunately, management has not shown that it can effectively monetize the 7.5% market it already owns of the U.S. radio audience. Plus, without knowing how Apple, which also plans to attract advertisers with iTunes Radio, will attack this market, Pandora may end up just throwing good money after bad, and diluting its own stock by as much as 9%.

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