Why Google should acquire Pandora

commentary If Google is weary of waiting to license music from the top record companies and wants to wade into digital music without delay, then acquiring Pandora could be the answer.

The online radio service has the kind of brand recognition and audience (80 million registered users) that YouTube had when Google acquired the video-sharing site in 2006. Pandora also possesses an established advertising business, something that YouTube lacked and something Google understands. In the first nine months of 2010, about 85 percent of Pandora's revenue, or about $78 million, came from ad sales. Another $12 million was generated from the fees that people pay to join a premium subscription service.

Most importantly, Pandora has music.

According to recent reports, Google is frustrated over the terms the top record labels are asking for music licensing. Wayne Rosso, a long-time digital music industry exec who has recreated himself into a sharp-tongued industry critic, wrote last week on his blog that sources told him Google is "disgusted" with the four major labels and the inability to acquire music licenses. While my sources say Google managers haven't indicated that they're ready to pull out of talks with the labels, there's no denying that something is holding up the service.

Nearly a year ago, Google had told label execs that it hoped to launch before the end of 2010. Then, Google executives set their sights on debuting the service at the South By Southwest festival last month. That event came and went, with no Google Music. Meanwhile, the technology for Google's service is ready to go.

Two weeks ago, software leaked to the Web that appeared to be an upgraded version of Android Music, equipped with cloud-music features. Sources told CNET that Google recently launched its new music service internally, a process that typically occurs late in the product development stage.

Web radio wasn't what Google was interested in when it began speaking to the record labels about a music service. Managers talked about creating digital lockers, a way for people to store existing music libraries on Google's servers and then accessing tracks from Web-connected devices. Using a third-party's servers to complete computer chores is a process often referred to as "cloud computing."

Pandora doesn't store users' songs. The company's automated recommendation system selects tunes to stream to people based on their favorite songs and artists.

Cloud music is supposed to be where the industry is heading and three weeks ago Amazon.com beat Google and Apple by launching a bare-bones cloud service, one designed to allow people to upload their music collections to the company's servers but also wouldn't need licensing from the labels. Google is unlikely to try the same strategy due to government scrutiny the company faces about its alleged lack of antipiracy efforts. Google denies this, but a copyright fight now with the labels would be ill-timed.

If Google is determined to launch a cloud-music service, a Pandora acquisition might improve its negotiating position. Wouldn't it be better to be bargaining for cloud rights as the Web's top radio service?

Pandora paid $45 million in content acquisition costs for the nine-month period ending last October 31, according to documents the company filed in February with the Securities and Exchange Commission. The Web radio service is preparing for an initial public offering and said it wants to raise as much as $100 million.

The $45 million in acquisition costs, while not a huge sum, is only the beginning. That figure was twice as much as the $22.5 million Pandora paid during the same period in 2009. In that time, the company's total revenue almost tripled, going from $31 million in 2009 to $90 million last year.

Certainly, Pandora comes with plenty of risk. The company has been around 10 years, much of that time spent teetering on the edge of collapse. Pandora said that it would not have survived had the Copyright Royalty Board not set new rates for streaming music two years ago. Even reduced rates won't allow Webcasters, such as Pandora, to generate profits, argues Michael Robertson, a well-known technology entrepreneur and the founder of MP3tunes.com, a cloud-music service.

As for the cost of an acquisition, Pandora wouldn't come cheap but would unlikely set Google back too much. If you value Pandora by multiplying annual sales by 10, that would make the company worth somewhere around $1.2 billion. Google doesn't flinch at amounts like that. The company paid $1.65 billion four years ago for the then 18-month-old YouTube.

It's interesting to note that just prior to the YouTube acquisition, Google poured money and resources into its own video-sharing service. The YouTube acquisition showed that Google is willing to scrap its own efforts if someone else has a better plan.