Apple Inc. (Nasdaq: AAPL) has intensified talks with major music labels to start an advertising supported streaming-radio competitor to Pandora Media Inc. by early next year, according to people with knowledge of the negotiations. told Bloomberg news.

Pandora (NYSE: P) shares fell $1.09, or 11.7 percent, to close at $8.20 on Thursday. They rose 37 cents to $8.57 in after-hours trading. Shares have swung in a big range between $7.32 and $15.97 in the last 52 weeks.

Discussions are centered in part around how to share ad revenue and a deal could be reached by mid-November, with Apple starting service in the first three months of 2013, said the people, who sought anonymity because talks are in progress.

With sales of music downloads slowing, Apple and record companies want to create new ways for customers to discover and buy digital music. To challenge Pandora, Apple is seeking licensing pacts with labels that allow more flexibility about what listeners hear. Pandora, the Internet radio leader, relies on a compulsory license that limits how often users can skip tracks and how many times an hour an artist can be played. Apple is also pushing for earlier access to new releases.

“Radio is a natural step for Apple,” Rich Greenfield, an analyst with BTIG LLC in New York, said in an interview. “This helps Apple dominate in cars, where people listen to an average of two hours of radio a day.”

Pandora shares have lost 18 percent this year.

Apple Impact

Executives from Vivendi SA’s Universal Music Group, Warner Music Group, and Sony Corp.’s music division visited Apple’s headquarters in Cupertino, California, in recent weeks to learn more about its radio plans, the people said. Apple, the world’s biggest music retailer with more than 400 million iTunes accounts, wants listeners to be able to buy tracks as music streams or revisit what they’ve heard in auto-generated playlists, they said.

Apple is looking to create an app tailored for its iPhone, iPad and iPod Touch, the people said. They said it won’t be focused on delivering music through a Web browser.

Pandora, which creates music stations based on users’ tastes, has whipsawed based on reports of Apple’s plans. The shares fell 17 percent on Sept. 7, then gained 8.4 percent on Oct. 23 after Apple didn’t introduce a radio service during an event it held to unveil the iPad mini, a smaller version of its tablet computer that will start shipping in November.

“We don’t comment on our stock price or rumored competitive moves,” Eric Brown, vice president of communications at Pandora, said in an e-mailed statement. “We remain focused on our listeners and delivering the best Internet radio experience for them.”

Prominent Ads

Online digital music sales grew 8 percent in 2011 and 6 percent in 2010, compared with annual growth between 12 percent and 200 percent in the preceding five years, according to the London-based International Federation of the Phonographic Industry.

Apple’s negotiations with record labels have centered around advertising, the people said. In addition to an upfront fee, record companies are seeking a percentage of ad sales and the ability to insert their own commercials for artists, they said. Apple sees the service as a way to grow its iAd mobile advertising platform, and is exploring ways to integrate iAd with iTunes to steer customers back to iTunes.

Tom Neumayr, a spokesman for Apple, declined to comment. Apple fell 1.2 percent to $609.54 yesterday, before reporting quarterly profit and forecasting results this quarter that fell short of analysts’ estimates. The shares had climbed 51 percent so far this year.

Ad Push

The advertising initiative is part of broader flexibility Apple Chief Executive Officer Tim Cook is giving the company’s mobile advertising group to lure new business and integrate ads with other Apple services, according to people familiar with the matter.

As Apple competes with Google Inc. for mobile ads, Cook is giving more leeway than late co-founder Steve Jobs allowed on how much Apple charges and how much data is shared with marketers, said the people. That already won Apple multimillion- dollar contracts from Procter & Gamble Co. and others for ads that appear inside thousands of applications available to iPhone and iPad users.

“If Apple offers a radio product, it will be far superior to anything else on the market,” said Greenfield, who recommends selling Pandora shares and doesn’t cover Apple. “They’re seeking direct licenses to avoid all the restrictions that come with a compulsory license.”

The Competition

Several companies such as Sweden’s Spotify and Rhapsody in the U.S. offer subscription music plans for $10 a month that allow unlimited playback of songs on mobile devices. Subscribers don’t need to pay individually for downloads, but lose access to the music once they stop paying the monthly fee.

Microsoft Corp. even offers such unlimited song selection and playback for free on its new Windows 8 devices, including those on tablets such as its own Surface, which is available in its stores on Friday.

A variety of new digital music entrants have spooked investors in Pandora, which runs a free music streaming service on computers, mobile devices, stereos and car audio systems and is the leading provider of so-called online radio in the U.S.

Pandora’s streaming radio business relies on government-regulated licenses with music companies. To qualify for the mandatory licenses, the company must prevent the listener from being able to pick the exact song or album they want and limit the number of times an artist can be played each hour.

Apple would not need to discuss anything with music labels to start such a service since such licenses are issued through regulations if the playback conditions are met.

Its reported direct talks with the record labels suggest it is seeking a service with more active user involvement along the lines of Spotify, Rhapsody, MOG and others.

(Bloomberg and The AP contributed to this report.)