Can Pandora Media (NYSE:P) carry the momentum it built during the first half of 2013 into the third quarter?
The company registered strong revenue growth in Q2 primarily on a surprising jump in mobile monetization and better cost control. However, it has removed the 40-hour cap on mobile listening which fueled growth in the subscription business during the first half of the year. In addition to this, its active listener growth is slowing down, which is evident from the disclosure of its monthly operating metrics. As a result, we believe that it might be difficult for Pandora to sustain the monetization level it saw in the second quarter.
Our price estimate for the company stands at $14.50, implying a significant discount to the market price. The company has raised the bar high, but may not be able to deliver the same punch this time. We will find out when the company reports on November 21st but note analysts’ consensus is below the midpoint of company guidance. Further clouding the picture is the company’s intention to move the fiscal year end from January to December, which will introduce a two-month stub period in filed results.
The Active Listener Growth Is Slowing Down
Pandora regularly releases its monthly performance metrics including the number of listener hours, active listeners and the share of total U.S. radio listening. We have been looking at the pattern for the past few months and it is clear that growth in the number active listeners is slowing. For Q3 2013, the average active listener count stood at 71.9 million, which represents a healthy jump of 24% over the same period a year ago.  However, the sequential growth tells a completely different story. The active listener count increased from 72.1 million in August 2013 to just 72.7 million in September, registering growth of merely 0.8%.  In October, the figure actually declined to 70.9 million which suggests that the company may be nearing the ceiling for the active listener base in the U.S.  The growth is going to be difficult as competing services make inroads into the online radio market.
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. There will also be new competition from Sirius XM, as Pandora steps up efforts to tap the in-vehicle market, which has traditionally been the territory for Sirius XM (NASDAQ:SIRI) and terrestrial radio services. In addition, 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 sustain rapid growth. In sum, competitive pressures see set to increase.
Monetization Growth Will Remain a Key Focus
Pandora’s RPM (revenue per 1000 listener hours) had been growing gradually, but saw a substantial jump in the most recently-reported quarter. The company’s focus on increasing audio ads and expanding its ad business among local clients, along with the continued ramp up of its sales force, are fueling this growth. Radio ad buyers are usually indifferent about placing their ads on the mobile or desktop platforms since traditional radio has forever been mobile. Therefore, the company is confident about its ability to improve mobile monetization to sustainable levels in the future.
Local advertising remains a big opportunity for Pandora as radio services have an edge in this area. The revenue generated by local ads increased four-fold in Q2 fiscal 2014 compared to the prior year.  The company is also building momentum in audio ads, which accounted for more than 60% of total ad revenue during the second quarter. There is an opportunity to increase the number of audio ads as users listening to radio with in-vehicle platforms are accustomed to higher ad frequency.Notes: