Pandora Earnings Preview: Growing Market Share and Improving Monetization in Focus

Pandora Media (NYSE:P) will report its Q2 2014 results on July 24th. We want to remind investors that the company has changed its fiscal year to a calendar year end and that the upcoming results will indicate its performance for the three-month period ending June 30. Given the recently disclosed operating metrics, we expect steady revenue growth and an improvement in margins driven by growing listener hour share and improving monetization. However, the slowdown in active listener count growth might be a concern for the company.

Pandora’s ad monetization is expected to go up, both sequentially and year over year, driven by the continued uptick in its mobile ad business. Second quarter is seasonally better for Pandora as compared to the first quarter, which will be reflected in its Q2 RPM (revenue per member). Pandora has a come a long way in terms of creating a sustainable business model and we expect the Q2 results to reinforce this development.

Our current price estimate for Pandora stands at $24, implying a discount of about 10% to the current market price.

See our complete analysis for Pandora Media

Market Share Gain is Accelerating Driven by Increased Listener Hours

Pandora reports certain operating metrics on a monthly basis. The figures reported for April and May suggest that the company continued to gain share in the U.S. radio market. Even though there was a decline in the number of listener hours in April as compared to March, much of that can be attributed to seasonality. While Pandora’s listener hours declined from 1.71 billion in March 2014 to 1.70 billion in April 2014, its market share increased from 9.11% to 9.28%, indicating higher engagement. In May 2014, the figure declined slightly to 9.13%.

The company’s monthly metrics have revealed an interesting fact about its market position. The Internet radio provider’s year-over-year market share gain in terms of listener hours appears to be accelerating. While the company saw a year-over-year improvement of just 1.43 percentage points in its market share in the two-month period of April-May 2013, the figure increased by 1.89 percentage points in the same period this year. Since Pandora did not report its June audience metrics, we will have to wait for the quarterly results to better understand what happened during the month. It may be worth noticing that June is seasonally weaker for the company as compared to April and May.

Pandora’s total listener hours in April 2014 increased 30% year over year on top of 24% growth witnessed in the same month last year. The company’s listener hours in May 2014 grew 28% year over year to 1.73 billion, while they improved by just 23% year over year in May 2013. This indicates that Pandora’s listener hour growth is also picking up.

However, Active Listener Count Growth is Decelerating

In April last year, Pandora’s number of active listeners increased by a sizable 35% year over year to 70.1 million, while they improved by a mere 8% this year. The company saw a similar trend in May with just 9% year-over-year growth this year, compared to 33% growth last year. Even the sequential gain was marginal as Pandora’s number of active listeners increased from 75.3 million in March 2014 to just 76 million in April and 77 million in May.

The slowdown in listener count growth indicates that Pandora’s listener base might be nearing saturation. However, international expansion can help the company sustain steady growth in this metric. Pandora is doing well in Australia and New Zealand, where it has reached the landmark of two million listeners in less than two years.

Ad Monetization will Continue to Improve

We expect ad RPM levels (revenue per 1,000 listener hours) to be up compared to the second quarter of 2013. There will even be some sequential gain in this quarter as advertisers tend to divert a disproportionate amount of their annual budgets to the fourth quarter, followed by a lull in the first quarter. In 2012, Pandora’s RPM improved from $22.45 in the first quarter to $29.33 in the second quarter. The company saw a similar trend in 2013 when its RPM in the second quarter shot up to $37.89 from $24.85 in the first quarter. Pandora has done exceptionally well in ramping up its mobile ad business, which has resulted in substantial year-over-year gains in its quarterly RPM. This paints a very pleasing picture of the company’s Q2 2014 RPM, which is expected to be significantly higher than $33.40 (Q1 2014).

Pandora is improving its profitability, which has remained one of the biggest concerns around the company’s business. With royalty rates expected to rise each year, the company will focus on improving its ad targeting in order to command better pricing and selling more mobile inventory slots. Pandora states that its royalty rates have increased by 53% in the last five years and will go up by another 9% in 2015. Its subscription service under the name ‘Pandora One’ is also seeing some traction and the company raised the monthly pricing earlier this year. The incremental profits from higher pricing, assuming that it doesn’t deter subscriber growth significantly, will further add to the bottom-line.

Price Hike will have a Slight Positive Impact on Profits

Pandora has raised the monthly price of its Pandora One service by $1 to $4.99, making it the first price revision since the service’s launch in 2009. However, this move will not have a significant impact on Q2 2014 results but will have a moderate impact on the company’s full year performance. Most subscribers choose the annual billing cycle and hence, increased revenues from price hike will not be reflected in Q2 results.

Subscriber ARPU (average revenue per user) will definitely go up meaningfully next year as most subscribers migrate to the new pricing structure. The price increase will directly flow down to Pandora’s bottom line. Currently the company has about 3.3 million paying subscribers, which represents a small fraction of its overall user base. If the price increase of $1 were to be rolled out to all subscribers immediately, it will result in incremental revenues of close to $40 million. This will lead to cash flows jumping by a similar amount. This is a huge improvement considering that the operating cash flow was negative in 2013, according to our calculations. Going forward, these incremental revenues will see strong growth as we expect Pandora to continue gaining subscribers rapidly.

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