Spotify Expands Free Radio Service Abroad, Should Pandora Be Worried?

Spotify is looking to offer free Internet radio service in international markets. ^[1] Should Pandora Media’s (NYSE:P) investors be worried that as an early entrant to international markets Spotify could hamper Pandora’s future growth?

That could happen, but practically speaking, Pandora has much bigger issues to solve right now, and the competition in international markets is the least of its worries. The company is struggling to break even in the U.S. where it has more than 60 million active users.

Pandora expanded last year to Australia and New Zealand. Although these are upscale markets, the population is small and therefore the overall market opportunity is limited. In addition, Pandora will face the same problem in new markets as it is faces in the U.S. – making its business profitable.

Let’s take a brief look at how Pandora is doing in the U.S., which is the only thing that matters right now.

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As overall listener hours growth is slowing down, Pandora is diverting its resources towards expanding its sales team and selling more of its mobile ad inventory directly to advertisers. Although there is some pressure on desktop monetization due to the shift of ad dollars to mobile, it bodes well for the company from a long-term perspective. Pandora is battling high royalty costs, which are variable in nature, and gaining subscribers is not the solution. Pandora needs to sell more ads or resort to an ad-hoc or monthly subscription fee structure ultimately.

For the fourth quarter, Pandora’s mobile revenues grew by 111% amounting to over $80 million. ^[2] On the other hand, mobile listener hour growth stood at around 70%. There was a clear improvement in monetization of the platform. Mobile RPM (revenue per 1000 listener hours) grew from $20.15 in Q4 fiscal 2012 to $25.05 in Q4 fiscal 2013. ^[1] If we look at the figures for the entire year, we see a similar trend. For the full fiscal 2013, Pandora’s mobile revenues grew by 105% while listener hour growth stood at 89%, thereby increasing mobile RPM from $21.93 to $23.83. ^[1]

Close to 80% of the total listener hours now come from the mobile platform for Pandora. The improvement in mobile RPM is a result of increased investment in the sales team and the slowdown in growth of listener hours.  This slowdown is helping Pandora in direct sell-through of its mobile ad inventory. Earlier, the mobile usage was growing higher than the rate at which Pandora could sell ads. Since then, the company has invested significantly on building its sales force, which seems to be paying off.

Our price estimate for Pandora stands at $9.75, implying a discount of about 30% to the market price.

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1. Spotify Said Expanding Pandora-Like Web Radio Worldwide, Bloomberg, Mar 12 2013 [↩] [↩] [↩]
2. Pandora Media’s Q4 fiscal 2013 earnings transcript [↩]