Pandora Media‘s (NYSE:P) shares were down 10% following the announcement of financial results for Q4 2013 stub period (November and December). Although the company reported positive earnings and strong monetization growth, the outlook for 2014 fell below consensus estimates, indicating that market may have been overvaluing the stock. For full-year 2014, Pandora expects its revenues to be in the range of $870 million to $890 million, with mid-point of this guidance representing year-over-year growth of 36%.  This figure is notably below that for the calendar year 2012, and could be a result of an expected slowdown in the growth of the number of active users and ad RPMs (revenue per 1,000 listener hours). While market valuation is certainly under doubt, Pandora’s transformation into profitable business is encouraging considering the losses it experienced in the past few years.
We are reviewing our price estimate for Pandora in the light of recent earnings and will have an update ready soon. Our current price estimate for the company stands at $24, implying a discount of about 25% to the market price.
Turning Profitable Is Worth More Than A Weak Outlook
For the stub period of November and December, Pandora’s overall RPM (revenue per 1,000 listener hours) stood at $44.71, which is an all-time high.  The figure benefited from seasonal strength due to the exclusion of January results, when the ad spending tends to go down. Ad RPM and total RPM for mobile and other connected devices reached $36.38 and $40.14 respectively, again an all-time record.  Given that Pandora pays royalty costs to record labels and artists based on the number of songs played and not the revenue earned, any improvement in monetization (revenue per song) is going to add to the margins. The company has been ramping up its sales force to sell more mobile ad inventory slots to advertisers who are directing some ad budget to Pandora because of its local appeal and targeting ability. The additional selling and marketing costs have offset the margin growth to some extent.
What’s worth considering is that Pandora seems to have addressed the biggest concern of investors — whether or not it can create a profitable business? And the business seems sustainable as the company expects to continue generating profits for the full-year 2014, despite expecting some loss in the first quarter. However, this wasn’t enough to impress the market, which placed higher value on the expected slowdown in the growth next year. That’s bound to happen as the company grows in the U.S., where it has already covered a lot of ground. What’s important is that it has started generating profits, and could use its cash flows to fund overseas expansion in the longer run. That said, the market’s reaction is an indication of inflated valuation. The service is impressive and the business model has started to make sense, but that may not be enough to support the kind of valuation multiples that the stock is getting. We’ll have more to say once we revisit our valuation model.Notes: