Pandora Media’s (NYSE:P) stock suffered a significant drop last week when the company announced its fourth quarter and full year fiscal 2012 earnings. As the company fell short of analysts’ expectations both in terms of quarterly results as well as its future outlook, the stock sank by 25%. However we should shift our focus away from the expectation miss to the actual fundamentals driving the business. The revenue and subscriber growths have been stellar but careful inspection reveals that costs, especially content costs, have grown at a higher rate. Below we take a quick look at what growth metrics tell us. Pandora competes with other radio players such as Clear Channel Radio, CBS (NYSE:CBS) Radio, Spotify which has expanded via Facebook (FBOOK) and to some extent, Sirius XM (NASDAQ:SIRI)
The above figures tells us a few insights about Pandora’s fiscal 2012 results.
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1) The growth in revenues was much higher than the growth in active listeners. The growth in advertising and overall revenues was almost same as that for listener hours. This implies that an average Pandora listener is spending more time listening to Pandora’s songs and that bodes well for advertising revenue growth. These figures further imply that Pandora has maintained the ad monetization levels.
2) The subscription revenue growth was slower than ad revenue growth, implying that keeping the content free and selling ad slots remains the preferred choice for Pandora.
3) Total costs, especially content costs, grew at a higher rate compared to the revenue growth. This is the fundamental issue with Pandora’s current business model.
The company will need to improve its ad monetization or push subscription services in order to stop these content costs (as % of revenues) from rising. For fiscal year 2012, these costs stood at around 54% of revenues. If Pandora is not able to get these costs down, there can be about 25% downside to our price estimate. You can gauge this by modifying the forecast above.
Overall while the growth looks good, content costs still remain a concern. We are in process of updating our pricing model in the light of recent earnings.
Our price estimate for Pandora stands at $9.48, implying a discount of about 20% to the market price.