Pandora Earnings Preview: Monetization To Improve, But Losses Will Remain High

Internet radio company  Pandora Media (NYSE:P) is scheduled to release its Q2 2015 earnings on Thursday, July 23rd. ^[1] We are expecting a robust increase in the company’s revenues on account of a steady rise in its mobile and desktop ad monetization, as well as growth in number of active users. However, rapidly increasing sales and marketing expenses, along with high content acquisition costs, are likely to pummel Pandora’s bottomline yet again. The company’s net loss increased a staggering 70% in Q1 2015 due a substantial rise in expenses.

Pandora has been ramping up its sales team to enhance the direct sell-through of its mobile ad inventory, as well as make inroads into the local advertising market. Although this has helped the company improve its mobile monetization, it has come with an unwanted rise in expenses. On the royalties side, although Pandora had said that it was well positioned to reduce its content acquisition costs relative to revenues in 2015, they still loom large at around 45% of total revenues. A marginal reduction in this ratio will not have any material impact on the Internet radio company’s losses. In fact, this improvement wouldn’t even please investors much, given that royalty rates are set to increase significantly from 2016 on-wards. A slight improvement this year would prove insignificant from long term perspective.

Our current price estimate for Pandora stands at $20.22, implying a premium of more than 15% to the current market price.

See our complete analysis for Pandora Media

Uptrend In Monetization To Continue

We expect Pandora’s ad RPM levels (revenue per 1,000 listener hours) to be up compared to the second quarter of 2014. There will also be some sequential gain since advertisers tend to divert a disproportionate amount of their annual budgets to the fourth quarter, following relatively weaker investment in the first quarter, with gradual improvement in the subsequent quarters. In Q2 2013, Pandora’s overall RPM improved to $37.89 from $29.33 in the same quarter of the prior year. In Q2 2014, this figure had jumped to $40.11, clearly implying that the company’s monetization had gained some momentum. The primary driver for the increase was ‘mobile and other connected devices’, ad RPM for which increased to $36 in Q2 2014 from $32.56 in Q2 2013 and just $22.25 in Q2 2012. ^[2] Desktop ad RPM had also reported positive gains during the period, but its increase wasn’t as intense. In Q2 this year, we expect ad RPM  continued its strong momentum, especially across ‘mobile and other connected devices’, given that Pandora has been very aggressive with the sales and marketing of its ad inventory. Moreover, it has recently made display ad inventory available for programmatic buying across mobile devices, that will likely have a positive impact on ad revenues. Hence, we expect the company to report that overall ad RPM for Q2 2015 was much higher than $40.11.

Expenses Will Likely Increase

Pandora has stated in the past that royalty rates it pays have increased by 53% in the last five years and will go up by another 9% in 2015. 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. For this purpose, Pandora has been growing its sales force for the past several quarters. Last year, sales and marketing expenses as percentage of revenues was around 30.1%, while it was 28.5% a year earlier. The net increase in selling and marketing expenses for the period was over 52%, which is mainly attributable to the addition of new quota bearing sales representatives and other employees in these areas. In Q1 2015, sales and marketing expenses increased 38%, much faster than growth in overall revenues, settling at 37% of net revenues.

We believe that Pandora likely continued to bolster its sales team in Q2 2015 as well, which could only have pushed its sales and marketing expenses relative to revenues higher, negatively impacting operating income. In addition, commissions on subscriptions that the company pays Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL), and soaring product development costs, will also weigh on its margins.

Active Listener Count Expected To Grow

Pandora has often said that it can grow its active listener count to close to 100 million by targeting under-penetrated market segments. The company has been focusing aggressively on the used and new car market for the purpose. Last year, the active listener count increased around 7% from 76 million to 81.5 million. In Q1 this year, number of active listeners surprisingly came down to 79.2 million, but the figure was up 5% year over year. There may not be any drastic increase in this figure in Q2 2015 given that it is nearing saturation, but there will be some gains nonetheless.

More importantly, Pandora seeks a faster increase in the number paid subscribers, who still do not contribute much to the company’s overall value. In 2014, paying subscribers increased 9% year over year to 3.6 million and the subscription segment contributed just 20% to overall revenues. The subscription segment is the most productive one for the company for obvious reasons, but Pandora is finding it hard to convince free users to pay for ad-free services. Interestingly, subscription revenues increased 32% year over year on a non-GAAP basis in Q1 2015, suggesting some progress on converting free users to subscribers. ^[2] For long term sustainability, Pandora needs the proportion of its paying subscribers in its overall active user base to be much higher than the current level of 5%. It will be interesting to see if subscription revenues continued their momentum in Q2 2015 as well.

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1. Pandora Announces Timing Of Its Second Quarter 2015 Financial Results Conference Call, Pandora, Jul 1 2015 [↩]
2. Pandora Reports Q2 2014 Results, Pandora, July 24 2014 [↩] [↩]