Pandora Falls On Wider Losses; Future Remains Grim

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Pandora Media

Pandora Media (NYSE:P) was down 5% in after hours trading despite its revenues and earnings beat in the first quarter of 2015. The company reported 19% year over year growth in its revenues to $230.8 million, driven by growth in active users, listener hours and ad RPMs. This topline performance was better than Pandora’s initial guidance of $220-$225 million. The Internet radio provider recorded a net loss of $48.3 million or 23 cents a share, which was marginally better than analysts expectations of 27 cents a share loss. [1]

While Pandora’s bottomline performance was better than expected, its losses widened by over 67% year over year and that appears to be the reason behind investor skepticism. It must be noted that in 2014, Pandora had reported a 25% decrease in its losses, which indicated that it was gradually heading in the right direction. Now, with a substantial increase in losses and rise in royalty rates just around the corner, the Internet radio provider’s long term sustainability has come into question yet again. The fact remains that Pandora is burning its cash reserves and generating profits with the existing business model seems a little far-fetched. This is why the company’s future still looks dull, despite the slight positive revision in 2015 revenues and earnings guidance.

Our current price estimate for Pandora stands at $20.22, implying a premium of more than 15% to the current market price. However, we are in the process of updating our model in light of the recent earnings release.

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See our complete analysis for Pandora Media

Pandora reported significant increase in losses even when its content acquisition cost as percentage of revenues declined year over year in Q1 2015. It stood at around 55.7% in the first quarter of 2014, and came down slightly to 54.6% in the same quarter this year. The company would be pleased with this efforts, but content acquisition cost isn’t the only concern here. Sales and marketing expenses in Q1 2015 were 36.5% of net revenues while they were 31.8% in the year ago period. Pandora has been ramping up its sales and marketing teams to aggressively improve its local ad revenues, which although is propelling revenue growth, is weighing heavily on profits. During the quarter, advertisement revenues increased 27%, with a staggering 67% growth in local ad revenues, and sales and marketing expense increased 36% year over year. As of now, Pandora is losing more due to a rise in its sales and marketing expenses, than it is gaining from incremental ad revenues. However, the Internet radio provider will most likely continue to invest in this area, because after a certain point, an increase in sales and marketing expenses will be countered by rise in local ad revenues. Until then, it may not see any notable decline in its losses. Pandora said that it currently has 138 sales representatives in local geographies and 430 quota-bearing sales representatives overall. It would look to grow this team to at least 600 in the next five years. [2] Hence, the company’s expenses will continue to grow in the future.

Although its bottomline performance wasn’t good, Pandora did very well in terms of increasing its listener hours and market share, as well as monetization. Total listener hours increased 11% year over year to 5.3 billion and active listener count was up 5% year over year to 79.2 million, but down slightly from 81.2 million in Q4 2014. Pandora’s share in the U.S. radio market in terms of listener hours reached 10% for the first time and its ad RPMs across mobile and desktop continued to improve. Advertising RPM increased to $38.30 from $33.40 in Q1 2014, and total RPM ticked up a little from $40.51 to $43.53. These gains were not has sizable as what Pandora has seen in the past, but they were positive nonetheless.  And they were consistent with the company’s strategy of expanding its sales and marketing teams to earn better ad revenues.

However, even in the best case scenario, Pandora will struggle to be profitable given that its content acquisition cost and sales and marketing expenses are just too high, compared to its ad revenues. Eventually, it needs a much higher share from subscriptions, if it wants to move towards a profitable business model. In Q1 2015, subscription revenue growth at 32% (non-GAAP) did outpace overall revenue growth at 28%, but not by much. This implies that Pandora is having a tough time converting its free users to paid users. This is only going to get tougher with the rise in royalty rates next year, that will narrow down the Internet radio company’s content, as it might look to favor the music of artists and labels that have a direct deal with the company. Regarding the ongoing ‘Webcasting IV’ proceedings for royalty-rate setting, there wasn’t any significant update in the earnings call.

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Notes:
  1. Pandora Reports Q1 2015 Financial Results, Pandora, Apr 23 2015 []
  2. Pandora’s Q1 2015 earnings transcript, Apr 2013 []