Pandora’s Q2 Results Showcase Its Survival Instincts

Pandora Media‘s (NYSE:P) shares increased almost 10% in after-hours trading, after it surprisingly trumped analysts estimates on Q2 2015 revenues and adjusted earnings. The company’s net revenues grew 30% year over year to $285.6 million, just ahead of the consensus estimate of $283 million. ^[1] Pandora’s topline growth was mainly driven by a staggering 67% increase in its local advertising revenues, which has been one of the prime focus areas for the Internet radio company lately. ^[2] In fact, it is local advertising for which Pandora has been building up its sales force over the past several quarters, and the recent results indicate that its investments have not gone to waste. The company has even raised its full year revenue guidance slightly to $1.175-$1.185 billion, from the earlier outlook of $1.16-$1.18 billion.

On the bottomline front, while the company’s net loss widened from $11.7 million in Q2 2014 to $16.2 million this year, excluding amortization and stock-based compensation, Pandora reported profit of $ 11.6 million, an increase of 30% year over year. The company’s non-GAAP earnings per share came in at $0.o5, three cents ahead of the street estimates. ^[1] The company managed to bring down its content acquisition costs relative to revenues by over 5 percentage points year over year, showing ample resolve against the potential rise in royalty rates. Pandora’s ability to properly manage its content cost will come in handy when it starts paying higher royalties beginning next year. In fact, the company’s survival will depend upon it.

Our current price estimate for Pandora stands at $20.22, implying a premium of more than 30% 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

During the quarter, the biggest driver for Pandora’s revenue growth was its local ad revenues. Growing close to 70%, they now account for over 20% of the company’s total revenues and 25% of its advertisement revenues. There still exists significant scope for growth for Pandora given that the local ad industry is currently dominated by terrestrial radio companies, who cumulatively earn over $14 billion from the market. ^[3] Pandora had been reinforcing its sales team for some time now 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. 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. While Pandora’s revenue growth was ultimately expected to slow, local ad markets seem set to provide the next wave of topline growth.

Pandora’s royalty rates are set to increase substantially in 2016, which will have a significant negative impact on its bottomline. Though the company has presented the best possible case in the ongoing ‘Webcasting IV’ royalty rate setting proceedings, it is unlikely that Pandora will be able to prevent scheduled increases. The best thing it can do is to leverage its content acquisition costs, by growing revenues at a faster pace with better monetization. Fortunately for the company, Q2 turned out one of the better quarters for its content acquisition costs as they declined close to 500 basis points (as percentage of revenues) to 46%. There will definitely be a spike in content acquisition costs as percentage of revenues next year, but recent performance indicates that Pandora will be able to bring the figure down gradually in the subsequent years.

Pandora did very well in terms of increasing its listener hours and monetization. Total listener hours increased 11% year over year to 5.3 billion and active listener count was up 4% year over year to 79.4 million, but down slightly from 81.2 million in Q4 2014. Pandora ad RPMs across mobile devices and desktops continued to improve. Advertising RPM increased to $49.94 from $40.11 in Q1 2014, and total RPM ticked up from $43.41 to $53.91. These sizable gains were facilitated by 30% rise in advertising revenues and 32% increase in subscription revenues. ^[2]

Increasing investments in sales and marketing, when the company was clocking huge losses, was a gritty move on Pandora’s part.  But it is now beginning to pay off, demonstrating why that investment made sense. While we still believe that Pandora needs to acquire much better content and balance its business model by adding more subscribers, it has shown in bits and pieces that it is not out of the race yet.

View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap | More Trefis Research

1. Pandora raises full year forecast on higher ad sales, Reuters, Jul 23 2015 [↩] [↩]
2. Pandora Reports Q2 2015 Financial Results, Pandora, Jul 23 2015 [↩] [↩]
3. Pandora unleashes sales force on local markets, Crain’s New York, Apr 21 2014 [↩]