Pandora Can Narrow Losses And Increase Its Value With Better Mobile Monetization

The biggest concern for Pandora Media (NYSE:P) remains its unabating content acquisition costs, which contribute to significant operating losses. To make things worse, the Copyright Royalty Board (CRB) is set to increase the company’s royalty rates  for 2016 onward, which will further widen its losses. Pandora paid 48.5% of its revenues in royalties last year and is expected to pay slightly less this year, followed by a significant increase in 2016 and 2017. With a considerable portion of revenues going to royalties, Pandora is unlikely to post profits any time soon, though it can reduce its losses by more effectively monetizing its listener base on mobile devices.

The company can accomplish this task by selling mobile ad inventory directly, targeting local advertisers and offering better products. To this end, Pandora is investing heavily in its sales team, hiring new talent every quarter, who can bring in new local advertisers. Most recently, the company announced the availability of programmatic display ad inventory on its mobile platform, enabling advertisers to offer more interactive and targeted ads. This provides Pandora an opportunity to charge a higher amount for its mobile ad inventory slots, which can eventually bolster ad revenues earned per user.

Almost 80% of Pandora’s listening takes place of smartphones and tablets, which makes it the most lucrative platform. A better-than-expected improvement in ad revenues per user on this front driven by the aforementioned factors can potentially increase Pandora’s value by over 10%.

Our price estimate for Pandora is at $20.48, implying a premium of about 20% to the current market price.

Direct Ad Inventory Sell-Through

Pandora has stated in the past that direct sell-through of its ad inventory to advertisers is key to its mobile monetization. About 65% to 75% of Pandora’s desktop ad inventory is sold directly, whereas for mobile, the direct sell-through is almost one-third of desktop. To bridge this gap, the Internet radio company is building up its sales force to reach more advertisers across local and national markets. During 2014, Pandora increased its overall employee base from 1,067 to 1,414, mainly with the addition of quota bearing sales representatives, which pushes sales and marketing expenses up by 52% year on year. However, despite such a significant increase in the second biggest item on Pandora’s expense sheet, the company’s losses narrowed by 25%, thanks to higher ad revenues from mobile. As per our estimates, mobile ad revenues account for over 75% of total ad revenues for Pandora.

Targeting Local Advertisers

Pandora’s main aim behind reinforcing sales team was to target advertisers in local markets across the country, where competition from its free and subscription based music streaming rivals is less intense. As the name suggests, local advertising refers to commercials and advertisements that are specific to a particular area, and advertisers involved are usually small business owners. Pandora has a sales team in over 40 local markets across the U.S., where it has seen advertising revenues rise significantly. Though the company does not provide details around what portion of its advertising revenues comes from local markets, it surely has a lot to explore in this space.

Terrestrial radio services currently dominate the local ad industry, earning close to $14 billion in revenues from local ads, which is over 80% of their overall ad revenues. ^[1] By strengthening its sales team in key local markets and expanding its reach in underpenetrated markets, Pandora can take some share away from the terrestrial radio industry, given that it already has a user base big enough to attract advertisers. The company has already made significant progress on expanding its presence in cars, and appears in a favorable position to take away listeners and ad revenues from terrestrial radios.

Better Product For Mobile

On Pandora’s mobile platform, advertisers usually invest a smaller amount as compared to desktops (difference in average revenue per user is an indicative of this fact), since ads on mobile devices are relatively less interactive. On desktops, there is ample room for visual ads and, thus, advertisers pay a higher amount for this platform. However, Pandora recently announced that the display ad inventory will be available for programmatic buying across mobile devices, which puts it in a better position to charge a higher amount to mobile advertisers.

Visual ads are more engaging and with access to Pandora’s registration data, advertising IDs and proprietary targeting segments, advertisers will be able to reach the most relevant audience. The Internet radio company launched the beta phase of its mobile programmatic solutions in March this year and has already attracted brands such as Ford and Essence. It is expected that with better engagement and viewable content, Pandora will be able to draw higher revenues from its customers.

Potential For Upside

The cumulative impact of the aforementioned efforts can result in a better-than-expected increase in Pandora’s mobile ad revenues per 100 listener hours. This metric increased from $1.49 in 2010 to $3.78 in 2014, and we currently estimate it to rise to $6.23 over the next five-six years. However, if it increases to $7.50 instead of $6.23, driven by Pandora’s consistent push, there can be over 10% upside to our price estimate for Pandora. The plausibility of this scenario solely depends on Pandora’s ability to bring in new advertisers from local markets and generate higher revenues from the existing national advertising customers.

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1. Pandora unleashes sales force on local markets, Crain’s New York, Apr 21 2014 [↩]