How Pandora’s Active User Base Growth Impacts Its Stock

At the end of January 2013, Pandora Media (NYSE:P) had close to 175 million registered users, covering more than 55% of the U.S. population. However, the company’s active user base stood at 65.6 million, implying that close to 37% of the total registered users were actively using Pandora’s Internet radio service. The company defines active users as the number of unique registered users that have used its service within the trailing 30 days from the end of each calendar month. It is these active users that are generating revenues for the company and it is important to understand their growth trajectory.

From 7 million in 2008, the number of active users rose to to 65.6 million in 2012, implying a whopping average annual growth rate of 78%. Pandora’s radio service has gained immense popularity in the U.S., due to its personalization algorithm and the increased usage of mobile devices. However, we believe that the growth will slowdown as the company has already covered most of the addressable market in the U.S., and is likely to face increased competition in future. Besides this, we expect Pandora to shift its focus towards profitability instead of user base growth. Overall, we expect Pandora’s active user base to reach close to 115 million by the end of our forecast period in 2019.

See our complete analysis for Pandora Media

Looking At Market Potential In The U.S. & Other Markets

Pandora is currently present in the U.S., Australia and New Zealand. We can safely assume that the company will refrain from aggressive international growth and may limit its expansion to one to two new markets over the next few years. This is because we expect Pandora to focus more on becoming profitable in its current markets first. It could take several years since despite the company’s efforts to improve its mobile monetization, increasing royalty rates will make any immediate turnaround unlikely.

The total population in the U.S. is close to 314 million according to U.S. Census Bureau data. If we look at the demographic details for 2011, we find that close to 13.7% of the U.S. population was under 10 years of age. ^[1] In addition to this, close to 12.8% of the population was over 64 years of age. ^[1] We’ll assume that citizens falling under these age brackets are unlikely to use Pandora’s service.

That leaves us with remaining 73.5% of the population. Assuming that the U.S. population grows at an average annual rate of 0.8%, Pandora’s addressable market size in five to seven years from now will be close to 240 million (using the 73.5% figure we calculated before). Given that the company already has 175 million registered users, it is not outrageous to think that it can reach a total of 240 million registered users in long term in the U.S.

What does this mean for Pandora’s active user base?

We note that for the last two years, Pandora’s active user base has stayed within the range of 37-38% of total registered users. We believe that it will be difficult for the company to increase this percentage due to shift in focus towards monetization and competition from other Internet music services such as Spotify, Sirius XM (NASDAQ:SIRI), Apple (NASDAQ:AAPL) and others. Therefore, 240 million registered users will imply close to 90-95 million active users in the U.S. alone.

Australia and New Zealand have a combined population of close to 26 million. If Pandora can replicate the success that it has received in the U.S., it can gain another 8 million active users in these two markets over long term. This gives us a total of 98-103 million active users. Another 10 million or so can come from potential expansion to other markets.

Growing Smartphone Market & Pandora’s Push In Cars Will Aid Growth

Its mobile platform now accounts for close to 80% of Pandora’s listener hours. The proliferation of smartphones and other connected devices is one of the reasons why Pandora has gained such immense popularity in the U.S. These devices make it convenient for users to access the internet radio service anytime and anywhere. According to Gartner’s estimates, about 172 million smartphones were sold in 2009, implying a growth of 24% over 2008. The growth accelerated in 2011, when Gartner reported that Q3 2011 smartphone sales amounted to 115 million units, registering an increase of 42% over Q3 2010. For the full year 2011, smartphone sales stood at over 430 million units. The growth continued in 2012 as smartphone sales rose by 47% and 38% in the third and fourth quarter respectively. We expect the global smartphone market to continue to grow at a healthy pace. Pandora’s music app, which is available on iPhone, Blackberry, Android and Windows Mobile, is already one of the most popular apps. As the smartphone market grows, Pandora will expand its active user base.

The company’s push in the vehicle market is also aiding its growth. In January 2010, Pandora joined hands with electronics manufacturer Pioneer to provide Internet radio enabled music systems for cars. The device can detect Pandora settings when a phone is connected with the system. Since then, Pandora has struck several deals with world’s leading automotive manufacturers like BMW, Ford, Mercedez-Benz and Toyota. Pandora availability on PCs, smartphones and automobiles, hereby provides full connectivity to users.

The Significance Of Active User Base Growth

We currently forecast Pandora’s active user base to increase from close to 66 million in 2012 to 115 million by the end of our forecast period. However, if Pandora garners huge success within in-vehicle market, stays ahead of competition and expands more aggressively in international markets, its active user base could rise to 140 million.

Such a scenario would result in an upside of 25% to our price estimate. On the other hand, if growing competition from Clear Channel Radio, Sirius XM, Spotify and others slow down the company’s growth, and Pandora is only able to reach 90 million active users by the end of our forecast period, there could be downside of about 25%.

While it is clear that Pandora’s stock is quite sensitive to the growth in its active user base, the primary concern and uncertainty still remains around its ability to churn profits. The company continues to battle high royalty costs and needs to improve the monetization of its mobile platform substantially.

Our price estimate for Pandora Media stands at $9.70, implying a discount of about 25% to the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. U.S. Census Bureau [↩] [↩]