How Valuable Is Pandora’s Subscription Business?

One of the reasons why Pandora Media (NYSE:P) has been doing better lately is the surge in its paying subscribers. The company primarily relies on audio and visual ads to monetize its business, though subscriptions still form a small proportion of its overall revenues. However, the first half of 2013 has seen a surprising jump in this business due to the 40-hour listener cap that the company introduced earlier this year. Although Pandora plans to remove this cap in September, the important message is that it certainly has an option to tilt towards the subscription model if it remains unsuccessful in making the business profitable with ads.

We currently estimate that the subscription service under the brand ‘Pandora One’ constitutes roughly 15-20% to the company’s value. This is based on our expectation that Pandora will have roughly 10 million paying subscribers by the end of our forecast period. The monthly revenue per paying user stands at around $2.60, which includes the impact of promotions and trial periods. Compared to this, the average monthly ad revenue per active user stands at just around 60 cents. This implies that the paying subscribers are generating more than four times the revenue generated by free users. If the subscription business expands to 20% of the company’s active users, there can be 25% upside to our price estimate.

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Listener Hour Cap Drove Subscriptions In The First Half Of 2013

The total number of listener hours for Pandora dropped 12% in April compared to March, amounting to 1.31 billion for April. ^[1] This happened because the company implemented a cap on free mobile listening. Pandora’s mobile users can listen up to 40 hours of free music every month and will need to pay 99 cents to continue listening for the exceeding hours in the remainder of the month.

The company has stated that the listener hour cap has started to help it control content costs. As it turns out, this is working. The listener hours cap led to substantial growth in the number of subscriptions for ‘Pandora One’ service, which now boasts of around 3 million subscribers. The company added close to 1.2 million subscribers during the first half of 2013, and if the momentum carries into the remaining part of the year, it could double its subscriber base. That’s good news since higher dependance on subscription business will reduce the cost pressure and help the company in controlling content costs over longer run.

Higher Mobile Usage And International Expansion Will Help

According to research firm Gartner, global smartphone sales touched 225 million during Q2 2013, registering growth of 46.5% over the second quarter of last year. The second quarter also marked the first time in history when smartphones accounted for more than half of total mobile phones sold worldwide. Pandora’s music app which is available for the iPhone, Blackberry, Android and Windows Mobile is one of the most popular apps. As the smartphone market grows, there will be a direct positive impact on paying subscriber growth. The company has also struck deals with the world’s leading automotive manufacturers. This move is expected to result in more subscriber growth as Pandora will not only be available on PCs and cellphones but also automobiles, thereby providing a complete solution to a consumer.

In addition, the company launched its service in Australia and New Zealand in 2012, and we expect it to launch in additional market in the coming years once it shows signs of profitability in the U.S. This geographical expansion will fuel the growth in paying users for Pandora

Our price estimate for Pandora stands at $14.50, implying a discount of about 30% to the market price.

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

1. Pandora Media’s Press Release [↩]