• by Erik Sass  @eriksass1, June 15, 2011

Investors see the rise of Internet-based audio services as a real threat to companies delivering audio content via other channels, even if they're still just a fraction of the size in financial terms -- at least, that seems to be the implication of stock market movements following Pandora's initial public offering on Wednesday.

The Pandora IPO appeared to put downward pressure on the share price of Sirius XM, which dipped 5% from around $2.00 on Monday to $1.90 at the lowest point on Wednesday before recovering to close at $1.95. Taking a somewhat longer view, the Sirius XM stock price has been declining steadily since mid-May, when it reached a one-year peak of $2.44.

While these aren't huge variations, they reflect underlying investor unease about the fortunes of the satellite broadcaster -- which makes most of its revenue from paid subscriptions -- in the face of competition from Pandora's free Internet audio service.

Even if Pandora somehow manages to unseat Sirius XM to take the top spot in digital music -- it is still a long way off. Sirius XM currently dwarfs Pandora in terms of revenue and profitability. In fiscal 2010, Pandora brought in just over $55 million, mostly from ad revenues, and posted a $16.7 million loss. That compares to Sirius XM revenues of $2.82 billion and profit of $43 million in 2010.

The picture is reversed when it comes to total number of users, however, as Pandora's 90 million users dwarf Sirius XM's current subscriber base of 20.6 million.  Pandora's free service also appears to be growing much faster than Sirius XM's paid service. With this disparity in mind, the key question for investors is whether Pandora's mostly ad-supported business may someday rival Sirius XM's subscription revenues -- and if the rise of free, ad-supported digital music could eventually undermine Sirius XM's value proposition to consumers, leading to the loss of subscribers.

On that note, not everyone was enthusiastic about the prospects of Pandora following its IPO. Analysts from Morningstar Inc. cited by The Wall Street Journal assigned Pandora's stock a fair value of just $6 per share, while GreenCrest pegged it at $7-$8 -- less than half of its closing price of $17.42 on Wednesday.