In recent weeks, news reports have suggested that music streaming service Spotify is in the process of raising another $400 million. The proposed cash injection values the firm at a rumored $8.4 billion. That’s a seemingly rich valuation, but these days, fast-growing companies that are transforming industries are meriting such interest in the venture capital community.

Yet Spotify’s valuation got me thinking: Why is it worth $8.4 billion, while publicly-traded rival Pandora Media, Inc. (NYSE: P) is valued at less than $4 billion? In early 2014, Pandora had the market value that Spotify now seems to merit. What gives? Surely a closer look is warranted. 

To understand the distinctive market valuations, a few issues need to be covered.

First, Pandora is public, which means that its valuation is solely a reflection of supply and demand for shares. The company may be worth a lot more, (as I’ll note in a moment regarding analyst sentiment), but a potential change to its royalty deal has kept demand for shares at a low point. Spotify, which doesn’t yet need to cater to the fickle whims of public markets, can garner a valuation that solely pleases a small group of investors: its venture capital backers.

Second, both of these companies are facing a key event that may be seen as a potential industry setback, or an overhang that will soon be resolved.

Next week, a court case begins that focuses on the amount of royalties music streaming services must pay to record labels, who in turn reimburse artists. Pandora’s current reimbursement rate is likely to rise from $0.13-to-$0.14 per 1,000 songs streamed, to $0.20 or even $0.30, according to a recent New York Post article.

The key takeaway: A figure closer to $0.20 would trigger a relief rally in the stock and $0.30 would likely keep shares stuck below $20. That’s because Pandora would generate solid cash flow in the first scenario and much lower cash flow in the second one. As analysts at Merrill Lynch note, “Our upside case is Pandora receiving its low end proposed rates reducing content costs by $175mn in 2016, while our downside case is… increasing content costs by $400mn in 2016.”

These analysts think that Pandora is well-positioned in its arguments, noting that the Copyright Royalty Board realizes that any move above $0.20 per 1,000 songs would devastate the streaming music industry and result in a return to the days where consumers had no choice in terms of streaming music services. “We see Pandora coming out relatively unscathed with small increases in rates from 2015 levels at roughly 4%” annually, they write, reiterating their $27 price target (which represents 47% upside).

To be sure, Spotify deserves a slightly higher valuation than Pandora. Spotify likely had around $1.3 billion in revenue last year, while Pandora had around $920 million. So Spotify is 40% larger, but worth twice as much. Either Spotify is overvalued by a considerable margin, or Pandora is quite undervalued.

Pandora just released Q1 results, making this a good time to get a sense of business trends, along with current thinking from the analyst community about the stock’s valuation.

Q1 revenue rose 28% (from a year ago) to $231 million, which was slightly ahead of the $225 million consensus. Taking a broader view, analysts believe that Pandora’s development of local radio ad spots will help fuel steady top-line growth. Sales are expected to rise around 27% this year (to around $1.17 billion) and reach $1.8 billion by 2017.

The projected growth in ad sales is coming from investments in the sales force. Pandora hired 74 new sales people in the first quarter. In contrast, most terrestrial radio networks are freezing or cutting their sales forces. “This suggests a strong competitive position for the company versus other traditional and digital radio services, as well as the potential for faster-than expected revenue growth as productivity of the new hires ramps later this year and into 2016,” note analysts at Pacific Crest Securities, who have a $22 price target.

Notably, after a history of mostly negative free cash flow, Pandora is now on a path to generate more than $150 million in free cash flow by next year, and roughly $350 million the following year. These forecasts assume that royalty reimbursement rates will rise, but not to a severe extent.

#-ad_banner-#To be sure, the royalty reimbursement rates will be an overhang for shares in the near-term, but not a company killer in the long-term. And shares do appear to be too cheap in the context of various scenarios. “With [price] at a sales multiple not seen since late 2012, when there were questions (now answered) about sustainability of the model, we remain Buy-rated,” write analysts at Goldman Sachs, with a $24 target price.

Analysts at Cannacord/Genuity, who have a $26 price target, have a similar view. “While the stock may not achieve full investor sponsorship until we gain clarity on content costs, we believe the current price will ultimately seem like a bargain.” Their view on the Copyright Royalty Board and content costs: “We continue to believe expectations are overly bearish regarding this issue.”

Risks To Consider: Boosting the reimbursement rate to $0.30 per 1,000 songs streamed would be a worst case scenario for this stock, as it would likely remain range bound for several years until Pandora can grow its way into more meaningful operating leverage against its expense base.

Action To Take –> It’s not clear that Spotify is worthy of an $8.4 billion valuation. It’s also unclear why investors continue to price in a worst-case scenario for Pandora Media with regard to reimbursement revisions. Shares could experience a robust relief rally when the Copyright Royalty Board finally establishes a five-year reimbursement scheme later this year. It increasingly appears that any increases will be manageable, and investors would likely grow much more comfortable with expectations that Pandora’s free cash flow is on a path to rise at a rapid clip in 2016 and 2017. If investors choose to own this stock, it’s crucial to stay abreast of the upcoming hearings, as well as other progress toward a Copyright Royalty Board resolution.

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