During an investor conference in early 2013, Pandora Media’s (NYSE:P) management had stated that the company expects to lower its content acquisition costs (as % of revenues) to 40% over the next few years. Pandora seems to be on the right track as evident from the recent jump in its mobile monetization. Mobile ad revenues stood at $104.9 million in Q3 2013, growing 58% over the same period last year and accounting for more than 70% of overall advertising revenues. The mobile ad RPM for the quarter stood at $36, up from $33.90 in Q2 2013 and $25.59 in Q3 2012.  We currently forecast content costs to decline to 38% as a percentage of revenues resulting in price estimate of $24. However, there exists additional upside potential for the company if the rules that govern the royalty payments were to be altered to make them consistent across broadcast, satellite and Internet radio.
The company had earlier been lobbying for a bill called the “Internet Radio Fairness Act”. This bill is aimed at bringing Internet radio business under the same roof as terrestrial and satellite radio. The basic issue is that Pandora pays much higher royalties (as a % of revenues) for music compared to traditional radio companies such as Sirius XM (NASDAQ:SIRI). Part of this has to do with higher rates and partly with the fact that Pandora is an under-monetized service due to its almost sole dependence on advertising revenues. However, the company recently gave up its legislation efforts and will instead seek other resolutions for reducing royalty rates. Nevertheless, it is worthwhile to see how Pandora’s value could be impacted if the royalty rates (as % of revenues) were to reduce to the level that Sirius XM currently enjoys.
Our price estimate for Pandora stands at $24, implying a discount of about 15% to the market price.
About 30% Upside To Pandora’s Stock If Its Content Costs Decline To Sirius XM’s Levels
For 2012, Pandora’s content acquisition costs stood at close to 60.6% of its total revenues. In comparison, Sirius XM’s revenue sharing and royalty costs stood at around 18.6% of its subscription revenues for the same year. However, this is not a true comparison. Sirius XM spends additional money on acquiring and producing the content, the costs of which do not come under the revenue sharing model. Keeping this in mind, the overall content related costs for Sirius XM stood at close to 28% of its subscription revenues in 2012. This still puts Pandora’s content spending (as % of revenues) at a much higher level compared to Sirius XM. For the current year, we expect the figure for Pandora to reduce to 52.6% and decline to 38% in the long run. If the company’s content spending was to come down to a level similar to that of Sirius XM, there could be close to 30% upside to our current price estimate of $24.Notes:
- Pandora’s SEC Filings [↩]