Shares of Internet radio provider Pandora Media fell by almost 10% in extended trading, after it reported slower-than-expected growth in active listeners and listener hours in Q3 2014. The company had a total of 76.5 million active listeners at the end of the third quarter, which was marginally below analysts’ estimate of 76.7 million. Its listeners hours increased from 3.99 billion (Q3 2013) to 4.99 billion, trailing the consensus estimate of 5.02 billion. However, Pandora did well in terms of topline and bottomline growth. Total revenues increased 42% year over year to $239.6 million, slightly more than what the street expected ($238.5 million). Earnings per share came in at $0.09, a penny ahead of the market consensus.
The recent results suggest that the brisk growth phase Pandora had seen in the last couple of years is slowly coming to an end. Its monthly active listener base has reached a level, from where rapid growth is unrealistic. In a way, it may be a blessing in disguise for Pandora, as the more users it has, the more royalties it will have to pay. These royalties have become a big concern for the company now, as SoundExchange offered a new proposal last week, that can potentially increase Pandora’s royalties 2016 onwards. This is somewhat threatening for the company’s bottomline growth, and hence it is seeking legal aid against this re-proposal. If the Credit Royalty Board accepts SoundExchange’s proposal and Pandora is able to bring down the proposed royalty rates only marginally, it can put enormous pressure on the Internet radio provider’s profits. Therefore, we believe that the long term solution for Pandora is to improve its monetization, because otherwise it may not be able to sustain the rise in its user base.
Our current price estimate for Pandora stands at $24, implying a premium of close to 20% 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
Royalty Rates can Trouble Pandora
Copyright Royalty Board has set the royalty rates for Pandora Media on per performance basis. The Internet radio provider has stated in the past that royalties it pays have increased by 53% in the last five years and will go up by another 9% in 2015. During the recent earnings call, the company’s CFO stated that Pandora has already paid more than $1 billion in royalties, which is highest among all the radio forms. While the Internet radio provider already pays a significant amount in royalties, it might have to pay even more in the coming years, thanks to SoundExchange’s latest proposal. Pandora paid just 0.093 cents per performance in 2010 and it increased by only 10% every year, amounting to 0.13 cents in 2013. For the next two years, the rates were set at 0.14 cents and 0.15 cents, respectively.
Although the increase in royalty rates has been moderate so far, SoundExchange has proposed a significant increase going forward. According to the proposal, while non-subscription royalty rates for Pandora will increase consistently from 0.11 cents to 0.118 cents between 2016-2020, subscription royalty rates will increase from 0.21 cents to 0.23 cents during the same period. Given that royalties account for almost 40% of Pandora’s expenses, an increase in rates could greatly impact the company’s bottomline growth, which is already struggling. This is the reason why Pandora is soliciting legal help to bring down the proposed rates slightly. Pandora’s CFO stated during the earnings call that they are putting together the best economic and legal team against SoundExchange’s proposal.
Monetization Needs to be Among Priorities
Over the past few years, Pandora’s active listener base has increased at a rapid pace, while its profits have remained under pressure due to high content acquisition and product development costs. Since these expenses are unlikely to come down, Pandora needs to focus on improving its monetization to create a sustainable business model. For this purpose, the company is pushing for direct sell-through of its mobile ad inventory. About 65%-75% of Pandora’s desktop ad inventory is sold directly, while direct sell-through for mobile ads is almost one-third of desktop. There is a huge scope for improvement for mobile ad inventory sell-through, for which the company is ramping up its sales force.
During the recently concluded quarter, Pandora increased its employee headcount by almost 35% year over year to 1,380 employees. The primary driver for this increase was the addition of 80 quota bearing sales representatives. Although adding new talent to the sales team is leading to a rise in sales and marketing expenses, it is placing Pandora in a position where it can sell its mobile ad inventory in a better manner. With effective sell-through, we believe that the company’s mobile and overall revenue per 1,000 listener hours can improve.
In fact, the rise in RPM levels is already visible. In 2012, Pandora’s RPM improved just 3% from $29.33 in the second quarter to $30.30 in the third quarter. In the following year, overall RPM improved 5% sequentially in Q3 to $39.68. Interestingly, the rate of increase in RPM from Q2 to Q3 has increased to over 10% this year. This clearly indicates that rise in Pandora’s RPM is accelerating, which implies that the company is headed in the right direction.
View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap | More Trefis Research
Like our charts? Embed them in your own posts using the Trefis WordPress Plugin.
