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Why Pandora Bought an FM Station in South Dakota

Internet radio stock Pandora (P) just made a ripple in the world of FM radio … but the splash will be felt throughout its business.

On Tuesday, Pandora purchased old-school FM dial station KXMZ in Rapid City, S.D. The reason wasn’t to take a step back into the golden age of radio, but rather to improve profitability through a strange loophole in royalty laws.

Even if the radio station simply keeps doing what it’s doing and Pandora never grows in the “terrestrial” radio biz, it will save millions on what it pays for music.

Presuming regulators sign off on the scheme, of course.

Consider that iHeartRadio, a competitor to Pandora in the streaming radio biz, is owned by privately held Clear Channel Communications — which has a vast network of 800 radio stations on the FM and AM dial.

Clear Channel gets to pay lower royalty fees on the iHeartRadio music it plays thanks to its old-school radio network that shares the tunes. Through a quirk in royalty structures with the American Society of Composers and the overall confusion between the economics of old and new distribution channels, the KXMZ acquisition would let Pandora play the same game.

In a regulatory filing Tuesday, Pandora said this scheme could save it roughly $7 million a year.

A Pandora spokeswoman told The Wall Street Journal that the new station plays “adult contemporary” music by Justin Timberlake and Bruno Mars, among others. WSJ reports “an average listenership of roughly 18,000 as of early last year, the most recent data available.”

Pandora should hope that the regulators come down on its side … not just because it spends about 80% of its total revenue simply on music for its catalog, but because without that strategic benefit, this station adds very little to shareholder value.

Pandora has had a rocky road since its 2011 IPO. P stock debuted at $16 after raising the offer price to rake in $235 million in total, then briefly topped $20 in its first few days … before crashing to about $10.

It has only recently reclaimed that $16 mark, with tremendous earnings that included a 55% leap in revenue as well as future growth plans that include streaming radio to TVs to expand audience.

But profitability is still elusive, as the company burns everything it makes in revenue on content and operations.

The FM radio scheme to reduce royalty payments is as good a move as any to reduce the burden and increase margins.

But whether it passes muster with regulators or makes enough of a dent to boost profits … well, that’s the multi-million-dollar question.

And after a nearly 65% run year-to-date, I’d be reluctant to put new money into this stock based on such uncertainty.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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