Pandora Faces Big Challenges Though Strong Growth Expected

Pandora Media’s (NYSE:P) last quarter earnings reflected better mobile monetization as the company continued to deliver on its promise of selling more ads and surprised investors by reporting a substantial jump in the number of subscriptions. The momentum is likely to carry on into the second quarter as Pandora continues to invest in building a strong sales force in many regional radio ad markets to improve direct ad sales on its mobile platform. Additionally, the renewed focus on subscription service and the increase in listener hours will drive Pandora’s revenue growth.

The monthly operating metrics released by the company suggest that the total listener hours stood at 3.88 million for Q2 fiscal 2014, up 18% from the same quarter a year ago. ^[1] In addition to this, the number of active listeners averaged 71 million for the quarter, registering a gain of 31%. ^[1] While these are impressive figures, the growth rate is declining which is not unexpected. As the business matures in the U.S. market, it will be easier for the company to focus on cost control and turn around its losses.

The stock has gained substantially in 2013 thanks to Pandora’s efforts to improve monetization and analyst upgrades that forecast improving profitability on mobile and Pandora’s growing presence in new vehicles. However, the company is not devoid of some significant risks that need to be considered before investing in the stock. Although Pandora’s radio service is immensely popular in the U.S., the gap between the levels of monetization on mobile and desktop is too big to ignore. Moreover, the company is going to face tough competition from Apple (NASDAQ:AAPL) and others as the market for Internet radio attracts more suitors over time.

See our complete analysis for Pandora Media

Monetization Will Continue To Improve

Pandora’s mobile revenues grew by 97% during Q1 fiscal 2014, whereas the mobile listener hours growth stood at only 47%. ^[2] If we look at overall revenues (including desktop), we see a similar trend. The primary reason behind this growth is not the higher number of active listeners but improved mobile RPM (revenue per 1,000 listener hours). This figure increased from $20.15 in Q4 fiscal 2012 to $25.31 in Q1 fiscal 2014, which is commendable. We expect this trend to continue as the decline in listener hour growth is helping Pandora in direct sell-through of its mobile ad inventory. Earlier, the mobile usage grew at a rate higher than what Pandora could sell ads. However, the company has invested significantly on building its sales force which seems to be paying off. Radio ad buyers are for the most part indifferent about placing their ads on the mobile or desktop platforms since traditional radio has forever been a mobile platform. Therefore, the company is confident about its ability to improve mobile monetization to sustainable levels in the future.

Subscription Business Will Become More Important

Pandora has realized that in order to become profitable, it will need to promote its subscription service which currently accounts for a very small portion of its revenues. The company made significant progress on this front last quarter when it added close to 700,000 subscribers to its ‘Pandora One’ subscription service, taking the total to 2.5 million. ^[3] We expect this momentum to carry on into the remaining part of the year, and there is a good chance that Pandora doubles its subscriber base by the end of 2013. Higher dependance on the subscription business will reduce cost pressures and help the company control content costs over the long run.

Competition May Inhibit Future Growth

Apple has announced its Internet radio service that will directly compete with Pandora. Under the name iTunes Radio, Apple will offer many features similar to that of Pandora, including personalized radio stations, free ad-supported service as well as the ad-free subscription option. While Pandora has over 1 million songs in its library, Apple’s service will give users access to its entire iTunes catalog which boasts of over 26 million songs. In addition, the subscription fee for iTunes Radio (at $24.99 per year) is lower than that for Pandora, which charges $36 per year for its Pandora One service.

The competition will not just come from Apple but also from Sirius XM as Pandora steps up its effort to tap the in-vehicle market, which has traditionally been the territory for Sirius XM (NASDAQ:SIRI) and terrestrial radio services. In addition to this, we expect Spotify to further expand its Internet radio service and Clear Channel’s iHeartRadio to gradually entice users. There is a good chance that other big names such as Microsoft (NASDAQ:MSFT) might jump on the Internet radio bandwagon if Apple is successful. The market is going to get crowded, which will make it difficult for Pandora to become profitable.

Our price estimate for Pandora stands at $12.60, implying a large discount the market price.

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

1. Pandora’s Press Releases [↩] [↩]
2. Pandora Media’s SEC Filings [↩]
3. Pandora’s Q1 fiscal 2014 earnings transcript [↩]