Where Pandora Needs To Keep Pushing

Pandora Media‘s (NYSE:P) stock has fallen by more than 30% over the last year, driven by a significant slowdown in the company’s subscriber growth. Its long term sustainability has also been under question, given its business model that relies on advertisements for a bulk of the revenues. The Internet radio provider is barely profitable as it is, and things can get worse going forward, on account of scheduled increases in royalty rates.

With the future looking grim for Pandora, there are a couple of aspects, which it can leverage to justify its sustainability and win back investor confidence. In order to propel its subscriber growth, the company is looking to target the car market, where terrestrial radio services hold over 80% of the share. ^[1] With effective penetration, Pandora can ensure a continued growth in its subscriber base, even if it is at a slower pace than the historic rates. Secondly, the company’s monetization has improved considerably over the past several quarters with the effective selling of inventory slots, which is likely to continue in the future backed by a revamped sales force.

We believe that if Pandora keeps pushing aggressively on the aforementioned two aspects, it can eventually have a notable impact on the company’s topline growth. With a weak control over its margins, the Internet radio provider may have to rely only on robust topline growth to remain profitable.

Our current price estimate for Pandora stands at $24, implying a premium of over 45% to the current market price.

See our complete analysis for Pandora Media

Focus On The Car Radio Industry

In 2010, Pandora joined hands with Pioneer to provide Internet radio in cars that have Pioneer music systems installed. The device detects Pandora settings when a phone is connected with the system and automatically plays Internet radio. Since the launch of its services in cars, Pandora has struck deals with the world’s leading automotive manufactures such as BMW, Chevrolet, Ford, Mercedes-Benz, GMC, and Lincoln and with suppliers of major automobile manufacturers to integrate the Pandora service into current and future automotive sound systems. This move helped Pandora expand its service network beyond PCs and Mobile devices, thus providing a more complete solution to its customers.

In the middle of last year, Pandora’s vice president of strategic solutions, Heidi Browning, stated that about 135 models from 26 different automobile makers coming out in 2014 would have pre-installed Pandora services. This figure was roughly one-third of all the new models of 2014. Browning claimed that all the best-selling passenger vehicles in the U.S. had Pandora services installed. This clearly indicates that the company has a tremendous opportunity to increase its share of total radio listening in the U.S. with an aggressive foray into the new vehicle space, given that it currently holds just 9% of the market. ^[2] While there are no clear signs that Pandora will be preferred over satellite radio provider Sirius XM (NASDAQ:SIRI), it is likely to take away some listening time share from terrestrial radio services, who currently dominate the market.

However, just by increasing the number of subscribers and listener hours, and not monetizing them effectively, the company runs the risk of losing further money, given that it pays royalties on per performance basis. Nevertheless, since Pandora has made significant progress on improving its overall monetization, we expect it to remain on top of the opportunities presented by the car radio ad industry. The radio ad industry, which stands tall at $17.6 billion, generates almost 50% of its revenues from cars, while this medium accounts for just 44% of the total listening hours. ^{[3] [1]} This indicates that ad revenues per 100 listener hours in car radios is slightly higher than other medium. All the more reason for Pandora to focus on this market.

Improving Monetization

Pandora’s ad RPM (revenue per 1,000 listener hours) has shown significant improvement over the last several quarters, driven by targeted ad inventory selling. The company has been pushing for direct sell-through of its mobile ad inventory, similar to what it does for desktop ads. About 65%-75% of Pandora’s desktop ad inventory is sold directly, while direct sell-through for mobile ads is almost one-third of desktop. There is a huge scope for improvement for mobile ad inventory sell-through, for which the company is ramping up its sales force. During the third quarter of 2014, Pandora increased its employee headcount by almost 35% year over year to 1,380 employees. The primary driver for this increase was the addition of 80 quota bearing sales representatives. ^[4] Although adding new talent to the sales team is leading to a rise in sales and marketing expenses, it is placing Pandora in a position where it can sell its mobile ad inventory in a better manner.

The impact of ramped up sales force selling mobile ad inventory directly is already visible. In 2012, Pandora’s RPM improved just 3% from $29.33 in the second quarter to $30.30 in the third quarter. In the following year, overall RPM improved 5% sequentially in Q3 to $39.68. Interestingly, the rate of increase in RPM from Q2 to Q3 increased to over 10% in 2014. ^[5] This clearly indicates that rise in Pandora’s RPM is accelerating, which is a pleasing sign. However, the company should not get complacent with this strategy, as its current business model does offer any other significant source of revenues, and the rise in its expenses is threatening.

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1. The remarkable resilience of the old-fashioned radio in the US, Quartz, Apr 4 2014 [↩] [↩]
2. Pandora Makes Mark With In-Car Subscriptions, Bidness, Jul 11 2014 [↩]
3. Network, Digital, Off-Air Shine as Radio Ends 2013 in the Black, Radio Advertising Bureau, Mar 14 2014 [↩]
4. Pandora’s Q3 2014 earnings transcript, Oct 24 2014 [↩]
5. Pandora Reports Q3 2014 Financial Results, Pandora, Oct 24 2014 [↩]