Higher Losses and June Slowdown Overshadow Pandora’s Strong Q2 Sales

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Pandora Media (NYSE:P) recently reported its Q2 2014 earnings, that were slightly better than the consensus estimate. The Internet radio provider’s non-GAAP earnings per share for the second quarter came in at $0.04, which was marginally ahead of the expected $0.03. Pandora’s overall revenues grew by 38% year over year on a non-GAAP basis with 39% growth in advertising revenues and 35% growth in subscription revenues. [1] Despite reporting good results, the company’s shares declined by 12% in after hours on account of widening losses and growth concerns.

With continued investments in sales and marketing, Pandora’s losses in Q2 2014 increased by 72% on a GAAP basis as compared to the same quarter last year. Although the company reported solid 43% revenue growth on a GAAP basis in the second quarter, it was much slower than its growth in Q1 2014 and full year 2013, when sales grew by 69% and 54% respectively. Moreover, while Pandora’s active user count and total listener hours for the quarter increased annually and sequentially, there was a slowdown in these metrics in June. Also, the Internet radio provider’s market share in June declined to 8.9% from 9.1% at the end of Q1. This has raised some concerns among investors regarding sustainability of Pandora’s growth. Following its sluggish June performance, the company projected its Q3 earnings per share to be in the $0.05-$0.08 range, which is below analysts’ estimates. [1]

On the plus note, Pandora’s RPM (revenue per 1,000 listener hours) continued to improve during the quarter driven by improving monetization and increased sale of mobile ad inventory. This trend is likely to continue going forward with the expansion of the company’s new advertising solution, Promoted Stations.

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Our current price estimate for Pandora stands at $24, implying a discount of about 15% to the current market price. However, we are in the process of updating our model in light of the recent earnings release

See our complete analysis for Pandora Media

Losses Increase due to Aggressive Investments

Despite solid revenue growth in Q2 2014, Pandora reported $11.7 million in losses, much of which can be attributed to higher investments in sales and marketing. In line with its earlier announcement, Pandora continued to add new talent to its sales team, that pushed its sales and marketing expenses up by 50% year over year. The company increased its employee headcount by 40% year over year with the addition of 15 new quota bearing sales representatives during the quarter. Pandora now has a total team of 343 sales representatives, while it only had 252 representatives a year earlier. [2]

With royalty rates expected to rise each year, the company is focusing on improving its ad targeting in order to command better pricing and sell 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. It seems that growing the sales team is inevitable and a necessary investment. The company’s sales & marketing expenses also include the commissions on subscriptions it pays Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL). During the quarter, these commissions totaled $7.5 million. [2] Pandora appears to be investing a significant amount on the product side as well because its product development expenses soared by 65% during the quarter. [1]

June Slowdown Raises Growth Concerns

While Pandora’s total listener hours in Q2 2014 increased by a healthy 29% year over year and touched the 5 billion mark for the first time, there was a marginal slowdown in June. The company’s listener hours increased from 1.70 billion in April 2014 to 1.73 billion in May, but declined to 1.61 billion in June. Moreover, Pandora’s active user count declined to 76.4 million in June from 77 million in May. Although most of this decline can be attributed to the fact that June is seasonally weak, it is worth noting that Pandora’s active user count growth has decelerated meaningfully over the past several months. The figure stood at 75.3 million in February, remained flat in March, improved slightly to 76 million in April and rose to 77 million in May. Also, Pandora’s share in the U.S. radio market declined sequentially by 23 basis points to 8.9% in June, which was below its market share in the preceding four months.

Although Pandora’s listener hours, active user count and market share have increased significantly over the last one year, their growth is likely to suffer going forward due to rising competition from satellite radio provider Sirius XM (NASDAQ:SIRI) and music streaming services such as Spotify, Songza and Beats. The sluggish audience metrics of June 2014 have somewhat confirmed this threat.

Monetization Continues to Improve

Pandora’s ad RPM levels for PCs and mobile devices increased substantially during the quarter. Compared to $37.89 in the second quarter of 2013, overall ad RPM rose to $40.11 in Q2 2014. Interestingly, the company’s desktop ads delivered their best ever performance in Q2 2014 generating $62.43 per 1,000 listener hours, beating their previous best of $61.92 in Q4 2013. For mobile and other connect devices, RPM improved to $36 from $29.46 in Q1 2014 and $32.56 in Q2 2013. In terms of RPM, Q2 2014 was the second best quarter for Pandora after Q4 2013, when it generated $40.95 per 1,000 listener hours. [1] Considering that advertisers tend to invest the biggest portion of their annual budget in the fourth quarter, Q2 2014 RPM looks even more pleasing. There is no denying that Pandora has come a long way in terms of creating a sustainable business model.

As the company can precisely measure the usage metrics for every user, it can help advertisers in targeting right customers. During the quarter, Pandora rolled out the beta test of its Promoted Stations with 10% of its listeners, where it received good response. Despite the limited launch, the company’s Promoted Stations were responsible for 12.5% of its new brand station additions. Promoted Stations are native ad units built on the basis of listening experience brands want to create for the respective audience. Advertisers such as Kleenex® Brand, SKECHERS USA, StubHub, Taco Bel, and Toyota Motor featured on this beta test. [2] Going forward, as the company extends the reach of its Promoted Stations, it can attract several advertisers, which should have a positive impact on its RPM.

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Notes:
  1. Pandora Reports Q2 2014 financial results, Pandora, Jul 24 2014 [] [] [] []
  2. Pandora’s Q2 2014 earnings transcript, Jul 24 2014 [] [] []