Pandora Stumbles On Weaker-Than-Expected Topline Growth; Bottomline Worries Remain

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Shares of Pandora Media (NYSE:P) plunged more than 20% in after-hours trading after its Q4 fiscal 2014 revenue growth fell short of its own guidance and fiscal 2015 revenue outlook missed analysts’ estimates. The company reported its Q4 revenues at $268 million, which was below its guidance of $273-$278 million. For the first quarter of 2015, Pandora expects revenues between $220-$225 million, while analysts had predicted the figure to be around $244 million. For the full year 2015, Pandora has guided revenues between $1.15-$1.17 billion, some way below the consensus estimate of $1.21 billion. [1] Although the company’s results and guidance missed estimates by a fair margin, 20% fall in share price seems like an overreaction in the market. However, it must be noted that investors are already skeptical about the company’s business model due to its volatile profitability, and weaker-than-expected topline growth has just increased their worries.

Our current price estimate for Pandora stands at $24, implying a premium of more than 50% 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


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While Pandora missed its own estimates, its revenues did increase by a healthy amount. The company’s net revenues for the fourth quarter increased 33% on a non-GAAP basis and adjusted EBITDA increased by 68%. Total listeners hours increased 15% year over year to 5.20 billion, and the active listener count at the end of 2014 rose to 81.5 million. Although these figures look impressive, questions still linger around the company’s sustainability, as it remains a loss making business. Advertisers tend to invest a higher amount in the fourth quarter followed by a lull in the first quarter and small increase in the second and the third. Due to this seasonality, Pandora does make profits in Q4, but its annual results reflect significant losses. Pandora’s net income in Q4 fiscal 2014 totaled at $12.2 million, but it clocked up $29.8 million in losses during the full year. Although it can be argued that the company’s annual losses declined 25% in 2014, the fact remains that it is burning its cash reserves, and generating profits with the existing business model seems a little far-fetched.

Pandora’s sales and marketing expenses are soaring, as it is ramping up its sales team to improve its monetization with better ad-inventory sell-throughs. During 2014, sales and marketing expenses increased by almost 52% due to the addition quota bearing sales representatives, which helped the company’s monetization, but contributed significantly to losses. Although Pandora was able to bring down its content acquisition cost as percentage of revenues in the fourth quarter, potential rise in royalty rates going forward still remains a major threat. The company reported an all time low content acquisition cost as percentage of revenues (43%) in Q4 2014 and said that it is well positioned for 2015 in terms of managing content costs. [2]

However after 2015, Pandora may have to pay significantly higher royalty rates, thanks to SoundExchange’s proposal, which can potentially drive the Internet radio company’s content acquisition costs up. Pandora’s royalty rates are set for 2015, but they are yet to be decided for 2016 and beyond. The company paid $0.00137 per performance in 2013, and paid a slightly higher amount in 2014. The rate is set to increase by $0.0001 in 2015. For 2016, SoundExchange proposes royalty rates at $0.0025, drastically above what Pandora will pay in 2015. [3] If the Copyright Royalty Board accepts SoundExchange’s proposal and Pandora manages to negotiate just a marginal revision, it can put enormous pressure on the Internet radio provider’s profits. It may even force Pandora to consider switching from ad-based business model to subscription model.

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Notes:
  1. Pandora Revenue Falls Short, The Wall Street Journal, Feb 5 2015 []
  2. Pandora’s Q4 fiscal 2014 earnings transcript, Feb 5 2015 []
  3. Webcasting rate proposals for 2016-2020 now public, Broadcast law blog, Oct 19 2014 []